Capital Structure Deviation and Speed of Adjustment

19 Pages Posted: 11 Oct 2013

See all articles by Tarun Mukherjee

Tarun Mukherjee

University of New Orleans

Wei Wang

Cleveland State University

Date Written: November 2013

Abstract

As a firm deviates from its target leverage from above (below), the bankruptcy costs (foregone tax savings) rise at an increasing rate while the tax savings (reduced bankruptcy costs) rise at a decreasing rate, generating a stronger incentive for rebalancing capital structure. This phenomenon renders the speed of adjustment (SOA) an increasing function of the deviation. Employing a bootstrapping‐based estimation strategy that averts well‐known estimation biases, we find U.S. firms exhibit a positive SOA sensitivity to leverage deviation. Also, the SOA sensitivity is greater for overlevered than underlevered firms.

Keywords: capital structure, speed of adjustment, adjustment costs, heterogeneity, bootstrapping

JEL Classification: G32

Suggested Citation

Mukherjee, Tarun and Wang, Wei, Capital Structure Deviation and Speed of Adjustment (November 2013). Financial Review, Vol. 48, Issue 4, pp. 597-615, 2013. Available at SSRN: https://ssrn.com/abstract=2338851 or http://dx.doi.org/10.1111/fire.12017

Tarun Mukherjee (Contact Author)

University of New Orleans ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States
5042807146 (Phone)

Wei Wang

Cleveland State University ( email )

Cleveland, OH 44115
United States

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