Adjustment Cost Determinants and Target Capital Structure

Abstract:     
We empirically test two key predictions of the dynamic trade-off theory of capital structure: mean-reversion in the capital structure of firms and negative correlation between adjustment speed and adjustment costs. Our findings are consistent with the first prediction but not the second. Using directly measurable proxies for security issuance costs, we find that the correlation between adjustment costs and the speed of adjustment appears to be positive or in some cases zero. From a dynamic trade-off perspective, these results are puzzling as they cast serious doubt on the relevance of transaction costs in the adjustment process.

Number of Pages in PDF File: 59

Keywords: capital structure, target leverage, adjustment speed, security issuance costs

JEL Classification: G32

working papers series