In Search of Conclusive Evidence: How to Test for Adjustment to Target Capital Structure

Posted: 21 Jul 2010

See all articles by Armen Hovakimian

Armen Hovakimian

Baruch College - Zicklin School of Business

Guangzhong Li

Sun Yat-Sen Business School, Sun Yat-Sen University

Multiple version iconThere are 2 versions of this paper

Date Written: July 20, 2010

Abstract

Simulation experiments show that both partial adjustment and debt-equity choice models can generate spuriously significant estimates that are consistent with the hypothesis that firms have target debt ratios to which they periodically adjust. Regressions relying on full-sample fixed effects models of target leverage, in particular, produce results severely biased in favor of the target adjustment hypothesis. Various target proxies and modifications to the standard methodologies are examined to identify partial-adjustment and debt-equity choice models that have power to reject the target adjustment hypothesis. The resulting estimates of the speed of adjustment are in the range of five-eight percent per year.

Keywords: capital structure, target leverage, adjustment to target

JEL Classification: G32

Suggested Citation

Hovakimian, Armen and Li, Guangzhong, In Search of Conclusive Evidence: How to Test for Adjustment to Target Capital Structure (July 20, 2010). Journal of Corporate Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1645939

Armen Hovakimian

Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-225
New York, NY 10010
United States
646-312-3490 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://zicklin.baruch.cuny.edu/faculty-profile/armen-hovakimian/

Guangzhong Li (Contact Author)

Sun Yat-Sen Business School, Sun Yat-Sen University ( email )

135 Xingang Xi Road
Guangzhou, Guangdong 510275
China

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