Market Timing or Growth Opportunities: Evidence from Australia

The theory of market timing introduced by Baker and Wurgler (2002) received enormous attention in recent years. Since the authors found positive evidence for the theory of market timing in US firms, this aspect of empirical literature is expanding though there is little research completed using Australian firms. This empirical study analyses the market timing behaviour on Australian capital structure considering 1438 available firms over the period of 1997-2005. We find that the effect on leverage explained by the market-to-book ratio comes through net equity issues as market timing theory implies. We also document that the results are sensitive to filter choice with variation in the strength of the negative relationship observed between external finance weighted average/past market-to-book (EFWAMB) and leverage. This is inconsistent with the findings of Baker and Wurgler (2002) and suggests that while market timing appears to affect capital structure choice, it does not support the hypothesis that past market timing decisions have a long lasting impact on Australian firm capital structure. Further, we extend the research following Hovakimian (2006). And contrary to Baker and Wurgler (2002) we find that the importance of EFWAMB on leverage does not reflect the past equity market timing rather it shows that the past market-to-book ratio has significant impact on current financing decisions because it contains information about growth opportunities not captured by the current market-to-book ratio. Hence, our results support the Hovakimian’s argument that the growth opportunities provide a reasonable explanation for the past market-to-book ratio effect for Australian firms.