Cash Flows and Leverage Adjustments

40 Pages Posted: 21 Mar 2007 Last revised: 7 Nov 2013

See all articles by Michael W. Faulkender

Michael W. Faulkender

University of Maryland - Robert H. Smith School of Business

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Kristine Watson Hankins

University of Kentucky

Jason M. Smith

Utah State University

Date Written: May 31, 2011

Abstract

Recent research has emphasized the impact of transaction costs on firm leverage adjustments. We recognize that cashflow realizations can provide opportunities to adjust leverage at relatively low marginal cost. We find that a firm's cashflow features affect not only the leverage target, but also the speed of adjustment toward that target. Heterogeneity in adjustment speeds is driven by an economically meaningful concept: adjustment costs. Accounting for this fact produces adjustment speeds that are significantly faster than previously estimated in the literature. We also analyze how both financial constraints and market timing variables affect adjustments toward a leverage target.

Keywords: Capital Structure, Corporate Finance

JEL Classification: G32

Suggested Citation

Faulkender, Michael W. and Flannery, Mark Jeffrey and Hankins, Kristine Watson and Smith, Jason M., Cash Flows and Leverage Adjustments (May 31, 2011). Journal of Financial Economics (JFE), March 2012; AFA 2008 New Orleans Meetings Paper. Available at SSRN: https://ssrn.com/abstract=972148

Michael W. Faulkender

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

Mark Jeffrey Flannery

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

Kristine Watson Hankins

University of Kentucky ( email )

College of Business & Economics
Lexington, KY 40506-0034
United States

Jason M. Smith (Contact Author)

Utah State University ( email )

Logan, UT 84322
United States

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