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The Speed of Adjustment to the Target Market Value Leverage Is Slower Than You Think

Published online by Cambridge University Press:  06 August 2019

Qie Ellie Yin  and
Jay R. Ritter Open the ORCID record for Jay R. Ritter [Opens in a new window]
Qie Ellie Yin*
Affiliation:
Yin, [email protected], Hong Kong Baptist University School of Business
Jay R. Ritter
Affiliation:
Ritter, [email protected], University of Florida Warrington College of Business
*
Yin (corresponding author), [email protected]
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Abstract

In the capital structure literature, speed of adjustment (SOA) estimates are similar whether book or market leverage is used. This robustness is suspect, given the survey evidence that firms target their book leverage and the empirical evidence that they don’t issue securities to offset market leverage changes caused by stock price changes. We show that existing market SOA estimates are substantially upward biased due to the passive influence of stock price fluctuations. Controlling for this bias, the SOA estimate is 16% for book leverage and 10% for market leverage, implying that the trade-off theory is less important than previously thought.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 6 , September 2020 , pp. 1946 - 1977
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

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Footnotes

Comments from Chunrong Ai, Evan Dudley, Ralf Elsas (the referee), Robert Faff, Michael Faulkender, Mark Flannery, Fangjian Fu, Vidhan Goyal, Jarrad Harford (the editor), Joel Houston, Rongbing Huang, Nitish Kumar, Tongxia Li, M. Nimalendran, Valeriya Posylnaya, Yuehua Tang, and Jin Wang; seminar participants at Hong Kong Baptist and the University of Manitoba; and participants at the 2016 Academy of Economics & Finance (AEF) Conference, 2016 Shanghai International Conference on Applied Financial Economics, 2016 Financial Management Association (FMA) Conference, 2016 FMA Doctoral Student Consortium, 2017 Midwest Finance Association (MFA) Conference, 2017 China International Conference in Finance (CICF), and 2018 Asian Finance Association Conference are appreciated. All errors are our own.

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