Leverage and how it affects shareholder value

Abstract

This paper investigates the factors that affect a firm’s capital structure decision and how the capital structure affects a firm’s shareholder value. The two most important theories that are used in the thesis are the trade-off and the pecking theory. By using a dataset consisting of 502 large US firms during the years 2005-2014 we find that 1) The factors that affect a firm’s capital structure are profitability, firm size and firm risk 2) A firm’s leverage has a positive effect on shareholder value. In general, we find that the pecking order theory rather than the trade-off theory can be used to explain the capital structure of a firm.