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Equity Mispricing and Leverage Adjustment Costs

Published online by Cambridge University Press:  17 January 2012

Richard S. Warr ,
William B. Elliott ,
Johanna Koëter-Kant  and
Özde Öztekin
Richard S. Warr
Affiliation:
Poole College of Management, North Carolina State University, Box 7229, Raleigh, NC [email protected]
William B. Elliott
Affiliation:
Department of Economics and Finance, University of Texas at El Paso, 500 W University Ave, El Paso, TX [email protected]
Johanna Koëter-Kant
Affiliation:
Faculty of Economics and Business Administration, VU University Amsterdam, De Boelelaan 1105, Amsterdam 1081 HV, The Netherlands Koëter-Kant, [email protected]
Özde Öztekin
Affiliation:
College of Business Administration, Florida International University, 11200 SW 8th St, Miami, FL 33199. [email protected]
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Abstract

We find that equity mispricing impacts the speed at which firms adjust to their target leverage (TL) and does so in predictable ways depending on whether the firm is over- or underlevered. For example, firms that are above their TL and should therefore issue equity (or retire debt) adjust more rapidly toward their target when their equity is overvalued. However, when a firm is undervalued but needs to reduce leverage, the speed of adjustment is much slower. Our findings support the role of equity mispricing as an important factor that alters the cost of making capital structure adjustments.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 47 , Issue 3 , June 2012 , pp. 589 - 616
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2012

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