This study examines the link between share repurchases and capital structure. Our investigation of U.S. firms’ share repurchase initiations over 1994-2015 reveals that firms experience substantial changes or wild swings in the debt-to-equity ratio during the nine-year period surrounding share repurchase initiations. Prior to share repurchases, the average debt-to-equity ratio drops gradually but significantly. In the years subsequent to share repurchases, the average debt-to-equity ratio remains at a lowered level for non-dividend-paying (i.e., unstable firms), whereas this ratio reverts to the initial level for dividendpaying firms (i.e., stable firms). Our evidence suggests that debt capacity plays an important role in capital structure decisions of share repurchasing firms. Our evidence also suggests that, despite the mechanical (+) effect of share repurchases on leverage, share repurchases do not have decisive effects on capital structure. And contrary to popular wisdom, most firms do not finance share repurchases with debt issuance.

JEL classification: G31, G32, G35

Key words: Share repurchases, leverage, dividends, debt capacity, accumulation of earnings