Do Firms Have Unique Target Debt Ratios to Which They Adjust?
38 Pages Posted: 29 May 2008 Last revised: 30 Mar 2010
Date Written: April 27, 2009
The estimates of the speed of adjustment to target leverage tend to be significant but low. One interpretation for the slow adjustment is that firms fully adjust to target only infrequently, when the benefits of adjustment exceed its costs. Using both ex-ante and ex-post information to identify situations when the adjustment should be full, we find no evidence of full adjustment. We find that adjustments to target are rarely full, with many firms adjusting beyond or away from the target. The results imply that firms may have target ranges but no unique target debt ratios to which they ever want to fully adjust. One implication of this is that empirical analyses, such as partial adjustment regressions, that rely on the existence of a well-defined target debt ratio may be ill-suited for quantifying the importance of dynamic tradeoff behavior vis-a-vis alternative theories.
Keywords: target capital structure, target leverage, target adjustment, partial adjustment, speed of adjustment
JEL Classification: G32
Suggested Citation: Suggested Citation