The Common Determinants of Capital Structure and Stock Returns - A LISREL Approach

Prior research on capital structure by Titman (1988) utilizes structural equation models (LISREL) to find out the determinants of capital structure. In this paper, we use the same methodology and add another endogenous variable – stock return to construct two equations. One regards capital structure and the other one regards stock returns. By solving the two equations simultaneously, we want to investigate the relationship between capital structure and stock returns and seek their common determinants as well. Our results show that stock returns, expected growth, uniqueness, asset structure, profitability, and industry classification are main factors of capital structure, while the primary determinants of stock returns are leverage, expected growth, profitability, value and liquidity. The level of debt ratios and stock returns are mutually determined by the aforementioned factors and the results that the two endogenous variables have opposite influences on each other may predict that they will both remain in a stable range.