Highlights
• Conventional partial adjustment model is deficient for explaining capital structure model.
• We present and estimate a financing-based partial adjustment model.
• We separate the effects of financing decisions on leverage evolution from mechanical evolution.
• Speed of adjustment in our model more than doubles than that of mechanical mean reversion.
Abstract
The conventional partial adjustment model, which focuses on leverage evolution, has difficulty identifying deliberate capital structure adjustments as it confounds financing decisions with the mechanical autocorrelation of leverage. We propose and estimate a financing-based partial adjustment model that separates the effects of financing decisions on leverage evolution from mechanical evolution. The speed of adjustment (SOA) is firm-specific and stochastic, and active targeting of capital structure has a multiplier effect that depends on the size of financial deficit. Overall, we find expected SOA from active rebalancing (30%) more than doubles what is expected from mechanical mean reversion alone (13%).
Page:
204-204
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