How does capital structure change during crises? A study through 2006-2021. Starring: The Financial crisis 2008 & the Covid-19 pandemic

Abstract

In this paper the changes in the capital structure in large European firms was studied through the years 2006-2021. The focus was on how the capital structure changes in a crisis. The timeline includes two crises, the financial crisis 2008 and the Covid-19 pandemic. Through the empirical research it is shown that corporations, on an aggregate level, choose to change their capital structure in different ways depending on the crisis. The analysis was performed through a regression with equity to asset as the response variable depending on size, equity to asset, return on equity and interest rate in the previous period. To isolate the crisis period and the recovery period after said crisis, two dummy variables were added. The results showed all variables to be significant except for the dummy recovery. Size and interest rate showed a negative relationship, with the equity to asset ratio, while equity to asset and return on equity showed a positive relationship. Through the analysis on how the capital structure changes, the pecking order theory is determined to not be sufficient. Since the cost of capital was high during the financial crisis the unexplained positive net cash flow is proposed to come from divestment activities, through selling off non-current assets. A method we have named downsizing. The pecking order theory is proposed to include the option of downsizing since it cannot be assumed that external capital is available.