The Financial Review, Eastern Finance Association
Finance and Financial Management
As a firm deviates from its target leverage, marginal bankruptcy costs change at a faster speed than marginal tax shield. This renders the speed of adjustment (SOA) of capital structure an increasing function of the starting deviation from the target. Adopting a bootstrapping-based estimation, we confirm the existence of such heterogeneity in SOA that is statistically significant and economically nontrivial. Typically, if Firm A is one standard deviation (about 17%) and Firm B is two standard deviations away from their leverage targets, then B’s SOA is 41% greater than that of A, and the half life of B’s leverage deviation is shorter by 2.5 years. The findings are consistent with the dynamic tradeoff theory in the presence of reasonable adjustment costs.
Mukherjee, T., Wang, W. (2013). Capital Structure Deviation and Speed of Adjustment. The Financial Review, Eastern Finance Association, 48, pp.597-615.
This is the accepted version of the following article: Mukherjee, T., Wang, W. (2013). Capital Structure Deviation and Speed of Adjustment. The Financial Review, Eastern Finance Association, 48, pp.597-615., which has been published in final form at 10.2139/ssrn.1927698