Capital Structure Deviation and Speed of Adjustment

49 Pages Posted: 16 Sep 2011

See all articles by Tarun K. Mukherjee

Tarun K. Mukherjee

University of New Orleans

Wei Wang

Cleveland State University

Date Written: September 4, 2011

Abstract

As a firm deviates from its target leverage, marginal bankruptcy costs change at a faster speed than marginal tax shield. This renders the speed of adjustment (SOA) of capital structure an increasing function of the starting deviation from the target. Adopting a bootstrapping-based estimation, we confirm the existence of such heterogeneity in SOA that is statistically significant and economically nontrivial. Typically, if Firm A is one standard deviation (about 17%) and Firm B is two standard deviations away from their leverage targets, then B’s SOA is 41% greater than that of A, and the half life of B’s leverage deviation is shorter by 2.5 years. The findings are consistent with the dynamic tradeoff theory in the presence of reasonable adjustment costs.

Keywords: Capital structure, Speed of adjustment, leverage deviation, heterogeneity, bootstrapping

JEL Classification: G32

Suggested Citation

Mukherjee, Tarun K. and Wang, Wei, Capital Structure Deviation and Speed of Adjustment (September 4, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1927698 or http://dx.doi.org/10.2139/ssrn.1927698

Tarun K. Mukherjee

University of New Orleans ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States

Wei Wang (Contact Author)

Cleveland State University ( email )

Cleveland, OH 44115
United States

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