The mix of debt and equity in a firm’s capital structure has been associated with varied strategic actions, such as diversification and innovation. Different forms of debt and equity have been associated with particular types of strategic actions. Although there are clear differences between debt and equity, I argue there are also similarities across the two forms of capital. I develop a theoretical framework to categorize both debt and equity along the dimensions of time horizon and risk tolerance, so as to categorize the providers of capital as Transient Equity, Dedicated Equity, Transactional Debt, and Relational Debt. I then empirically investigate the association between the presence of these four forms in the capital structure of firms and their strategic actions.
My theory development is anchored in transaction cost economics, which conceptualizes debt and equity as not merely financing choices but also governance structures (Williamson, 1988). Debt (rules) resembles markets while equity (discretion) has features of hierarchies. My integrated categorization of heterogeneous debt holders and equity holders along the dimensions of time horizon and risk tolerance augments this transaction cost reasoning to within debt and equity. I test my hypotheses on multiple panels of publicly held U.S. firms between 1996 and 2010 in the contexts of diversification, research & development (R & D), and mergers & acquisitions (M & A). After controlling for endogeneity – using Generalized Methods of Moments (GMM) regressions for dynamic panels with robust inference – I find strong support for the hypothesized relationships in the case of mergers and acquisitions; and partial support for association between forms of capital and diversification, and research and development. In essence, my theory development and empirical analysis suggests a more nuanced role in strategy formation of capital providers than envisioned in extant theory
