The relationship between business cycles and capital structure choice: The case of the international shipping industry

Research on capital structure choice depicts firm size, profitability, and asset tangibility as the main determinants of capital structure. The trade-off and pecking order theories of optimal capital structure predict contradictory relationships between each of these determinants and firm leverage. We attempt to reconcile the conflicting results in the literature by incorporating the impact of different phases of the economic cycle upon the choice of capital structure in a concentrated ownership setting. Studying 117 internationally listed shipping companies (about 60% of the entire population), we explore potential determinants of capital structure choice in periods of expansion (2003Q4), peak (2007Q4), trough (2008Q4), and sideways movement (2010Q4). Our finding that size, tangibility, and corporate performance constitute the main determinants of capital structure in the shipping sector is consistent with the literature. We employ the Generalized Method of Moments (GMM) to estimate the interaction between capital structure choice, corporate profitability and structure of ownership. Our model asserts bidirectional positive relationships between leverage and profitability and leverage and concentrated ownership in the peak period of 2007, but bidirectional negative relationships amongst these variables in all other periods. We conclude that the sentiment of the ship-owner during different phases of the business cycle, along with ownership concentration are key elements in explaining the relationship between profitability and leverage in the shipping sector.