Business Shocks and Corporate Leverage

54 Pages Posted: 30 Jan 2017 Last revised: 30 Jul 2021

See all articles by Kelvin Jui Keng Tan

Kelvin Jui Keng Tan

University of Queensland - Business School; Financial Research Network (FIRN)

Qing Zhou

Department of Applied Finance and Actuarial Studies, Macquarie University

Zheyao Pan

Macquarie University

Robert W. Faff

Bond University; University of Queensland

Date Written: June 21, 2021


We examine whether and to what extent business shocks explain the puzzling instabilities of corporate leverage. We find that business shocks explain a large portion of the unexplained leverage deviation, cross-sectional leverage position migration, and evaporating leverage similarities in the cross-section of firms. The cross-sectional distribution of corporate leverage is relatively persistent when there are fewer and smaller business shocks but becomes unstable for firms with larger business shocks. Our findings suggest that business shocks lead to discontinuities in the corporate value creation process and investment, thereby affecting corporate financing decisions. Put simply, the lumpiness of investment creates a "lumpy" need for external financing. Our analysis implies that the empirical modeling of capital structure adjustment and, indeed, the modeling of other corporate policies, should be conditioned on business shocks.

Keywords: Capital Structure, Business Shocks

JEL Classification: G32

Suggested Citation

Tan, Kelvin Jui Keng and Zhou, Qing and Pan, Zheyao and Faff, Robert W., Business Shocks and Corporate Leverage (June 21, 2021). Journal of Banking and Finance, Forthcoming., Available at SSRN:

Kelvin Jui Keng Tan (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane

Qing Zhou

Department of Applied Finance and Actuarial Studies, Macquarie University ( email )

Sydney, NSW

Zheyao Pan

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109

Robert W. Faff

Bond University ( email )

Gold Coast, QLD 4229

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072

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