The Tortoise and the Snail: Reconciling the Evidence on Capital Structure Stability

46 Pages Posted: 2 Nov 2017 Last revised: 15 May 2019

See all articles by Filippo Ippolito

Filippo Ippolito

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics; Centre for Economic Policy Research (CEPR)

Stefano Sacchetto

IESE Business School

Roberto Steri

University of Luxembourg

Date Written: May 11, 2019

Abstract

We reconcile two seemingly contrasting empirical facts, active capital structure rebalancing and slow adjustments towards target leverage, through the lens of a standard dynamic capital structure model. In the model, firms adjust leverage towards a dynamic target, which is firm specific and responds to changes in firms' characteristics and investment opportunities. Capital market imperfections make leverage more stable than target leverage, generating slow adjustments despite active capital structure rebalancing. We quantify the extent of convergence towards dynamic targets by means of structural estimation. Although neither leverage ratios nor leverage targets are moving fast|making it a race between a tortoise and a snail - we find that leverage targets are roughly twenty to forty percent more volatile than leverage ratios over horizons ranging from five to thirty years. Adjustment speeds exhibit significant heterogeneity across firms and time. Standard reduced-form partial adjustment models neglect this property and, as a consequence, largely underestimate average speeds of adjustment.

Keywords: target leverage, dynamic leverage adjustments, capital structure stability, leverage spikes

JEL Classification: G30, G32

Suggested Citation

Ippolito, Filippo and Ippolito, Filippo and Sacchetto, Stefano and Steri, Roberto, The Tortoise and the Snail: Reconciling the Evidence on Capital Structure Stability (May 11, 2019). Swiss Finance Institute Research Paper No. 17-59, Available at SSRN: https://ssrn.com/abstract=3063517 or http://dx.doi.org/10.2139/ssrn.3063517

Filippo Ippolito (Contact Author)

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(+34) 93 542 2578 (Phone)
(+34) 93 542 1746 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Stefano Sacchetto

IESE Business School ( email )

08034 Barcelona
Spain
+34 93 253 6461 (Phone)

Roberto Steri

University of Luxembourg ( email )

Kirchberg, 6, rue Richard Coudenhove-Kalergi
Luxembourg
Luxembourg

HOME PAGE: http://https://sites.google.com/site/robertosteripersonalpage/

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