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How Quickly Do Firms Readjust Capital Structure?

Peter Iliev
Pennsylvania State University - Department of Finance

Ivo Welch
Brown University - Department of Economics; National Bureau of Economic Research (NBER)


November 10, 2009


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This paper is obsolete. It will be superseded by multiple other papers.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

Date posted: April 29, 2009 ; Last revised: January 19, 2010

Suggested Citation

Iliev, Peter and Welch, Ivo, How Quickly Do Firms Readjust Capital Structure? (November 10, 2009). Available at SSRN: http://ssrn.com/abstract=1395885


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Contact Information

Ivo Welch (Contact Author)
Brown University - Department of Economics ( email )
64 Waterman Street
Providence, RI 02912
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Peter Iliev
Pennsylvania State University - Department of Finance ( email )
University Park, PA 16802
United States
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