The Speed of Adjustment to the Target Market Value Leverage Is Slower Than You Think

Qie Ellie Yin · Jay R. Ritter

66 citations0/0 files storedJournal of Financial and Quantitative Analysis

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Corporate Finance and Governance Financial Analysis and Corporate Governance Financial Reporting and Valuation Research

Abstract

In the capital structure literature, speed of adjustment (SOA) estimates are similar whether book or market leverage is used. This robustness is suspect, given the survey evidence that firms target their book leverage and the empirical evidence that they don't issue securities to offset market leverage changes caused by stock price changes. We show that existing market SOA estimates are substantially upward biased due to the passive influence of stock price fluctuations. Controlling for this bias, the SOA estimate is 16% for book leverage and 10% for market leverage, implying that the trade-off theory is less important than previously thought.

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References

1977Determinants of corporate borrowing 1981Biases in Dynamic Models with Fixed Effects 1984The Capital Structure Puzzle 2001The theory and practice of corporate finance: evidence from the field 2002Market Timing and Capital Structure 2002Testing Trade-Off and Pecking Order Predictions About Dividends and Debt 1984The Capital Structure Puzzle 2005Partial adjustment toward target capital structures

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2021Foreign institutional ownership and the speed of leverage adjustment: International evidence 2021Product market threats and leverage adjustments 2021Corporate Financial Policy: What Really Matters?2019Corporate capital structure actions 2020Social trust and the speed of corporate leverage adjustment: evidence from around the globe 2021The Trade-Off Theory of Corporate Capital Structure

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