How Quickly Do Firms Readjust Capital Structure?

Abstract:     
This paper seeks to reconcile the different results from prominent estimators of the speed of adjustment (SOA) of firms' leverage ratios. Previous papers overlooked the simple fact that leverage ratios less than 0% or greater than 100% are not possible. This made some of them find mean reversion, which they mistakenly considered as readjustment. When corrected, the best reconciled estimate for the SOA is not positive: On average, firms do not seem to adjust. Moreover, the data is so plentiful that SOA estimates can be extremely accurate even when the firm-specific target is not known. Finally, our paper suggests both a method of reconciling estimators from prior research and a better way of modeling the underlying leverage ratio process.

This paper is obsolete. It will be superseded by multiple other papers. The first, titled "Reconciling Speed of Adjustment Estimates of Leverage Ratios," will be available at the end of January 2010.

Keywords: capital structure, leverage ratios, speed of adjustment, dynamic tradeoff theories

JEL Classifications: G32

Working Paper Series