The Joint Determinants of Capital Structure and Stock Rate of Return: A LISREL Model Approach

Titman and Wessels (1988) have used alternative debt instruments and factor analysis techniques (LISREL approach) to study the theories of optimal capital structure. Dittmar and Thakor (2007) developed a new theory called “managerial investment autonomy” to explain that a firm’s stock price and its capital structure are simultaneously decided. The main purpose of this paper is to integrate the research results of Titman and Wessels (1988) and Dittmar and Thakor (2007) and to develop a simultaneous determination model of capital structure and stock returns. In this paper, we also use LISREL model to deal with the measurement error-in-variable problem. In addition, we also introduce managerial variables such as CEO tenure, CEO compensation, and other related variables. Furthermore, we introduce macroeconomic variables such as debt to GDP ratio, total public debt, and Excess return on the market. The empirical results from the structural equation modeling (SEM) with confirmatory factor analysis (CFA) show that stock returns, asset structure, growth, industry classification, uniqueness, volatility and financial rating, profitability, government financial policy, and managerial entrenchment are major factors for determining capital structure.