Hostname: page-component-cd9895bd7-hc48f Total loading time: 0 Render date: 2025-01-05T13:50:45.444Z Has data issue: false hasContentIssue false
  • English
  • Français

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]
Get access Rights & Permissions [Opens in a new window]

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

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

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.

References

Badoer, D., and James, C.. “The Determinants of Long-Term Corporate Debt Issuances.” Journal of Finance, 71 (2016), 457–492.CrossRefGoogle Scholar
Baghai, R.; Servaes, H.; and Tamayo, A.. “Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing.” Journal of Finance, 69 (2014), 1961–2005.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 1–32.CrossRefGoogle Scholar
Barclay, M.; Smith, C.; and Watts, R.. “The Determinants of Corporate Leverage and Dividend Policies.” Journal of Applied Corporate Finance, 7 (1995), 4–19.CrossRefGoogle Scholar
Boubaker, S.; Rouatbi, W.; and Saffar, W.. “The Role of Multiple Large Shareholders in the Choice of Debt Source.” Financial Management, 46 (2017), 241–274.CrossRefGoogle Scholar
Bratton, W.“Bond Covenants and Creditor Protection: Economics and Law, Theory and Practice, Substance and Process.” Georgetown Business, Economics, and Regulatory Law Research Paper No. 902910 (2006).Google Scholar
Brisker, E., and Wang, W.. “CEO’s Inside Debt and Dynamics of Capital Structure.” Financial Management, 46 (2017), 655–685.CrossRefGoogle Scholar
Byoun, S.“How and When Do Firms Adjust Their Capital Structures toward Targets?” Journal of Finance, 63 (2008), 3069–3096.CrossRefGoogle Scholar
Chang, X., and Dasgupta, S.. “Target Behavior and Financing: How Conclusive Is the Evidence?” Journal of Finance, 64 (2009), 1767–1796.CrossRefGoogle Scholar
Dang, V.; Kim, M.; and Shin, Y.. “Asymmetric Capital Structure Adjustments: New Evidence from Dynamic Panel Threshold Models.” Journal of Empirical Finance, 19 (2012), 465–482.CrossRefGoogle Scholar
DeAngelo, H.; DeAngelo, L.; and Whited, T.. “Capital Structure Dynamics and Transitory Debt.” Journal of Financial Economics, 99 (2011), 235–261.CrossRefGoogle Scholar
DeAngelo, H., and Roll, R.. “How Stable Are Corporate Capital Structures?” Journal of Finance, 70 (2015), 373–418.CrossRefGoogle Scholar
Elsas, R., and Florysiak, D.. “Heterogeneity in the Speed of Adjustment toward Target Leverage.” International Review of Finance, 11 (2011), 181–211.CrossRefGoogle Scholar
Elsas, R., and Florysiak, D.. “Dynamic Capital Structure Adjustment and the Impact of Fractional Dependent Variables.” Journal of Financial and Quantitative Analysis, 50 (2015), 1105–1133.CrossRefGoogle Scholar
Fama, E., and French, K.. “Testing Trade-Off and Pecking Order Predictions about Dividends and Debt.” Review of Financial Studies, 15 (2002), 1–33.CrossRefGoogle Scholar
Faulkender, M.; Flannery, M.; Hankins, K.; and Smith, J.. “Cash Flows and Leverage Adjustments.” Journal of Financial Economics, 103 (2012), 632–646.CrossRefGoogle Scholar
Flannery, M., and Rangan, K.. “Partial Adjustment toward Target Capital Structures.” Journal of Financial Economics, 79 (2006), 469–506.CrossRefGoogle Scholar
Fu, X., and Tang, T.. “Corporate Debt Maturity and Acquisition Decisions.” Financial Management, 45 (2016), 737–768.CrossRefGoogle Scholar
Graham, J., and Harvey, C.. “The Theory and Practice of Corporate Finance: Evidence from the Field.” Journal of Financial Economics, 60 (2001), 187–243.CrossRefGoogle Scholar
Halling, M.; Yu, J.; and Zechner, J.. “Leverage Dynamics over the Business Cycle.” Journal of Financial Economics, 122 (2016), 21–41.CrossRefGoogle Scholar
Ho, P.; Huang, C.; Lin, C.; and Yen, J.. “CEO Overconfidence and Financial Crisis: Evidence from Bank Lending and Leverage.” Journal of Financial Economics, 120 (2016), 194–209.CrossRefGoogle Scholar
Hovakimian, A., and Li, G.. “Is the Partial Adjustment Model a Useful Tool for Capital Structure Research?” Review of Finance, 16 (2012), 733–754.CrossRefGoogle Scholar
Huang, R., and Ritter, J.. “Testing Theories of Capital Structure and Estimating the Speed of Adjustment.” Journal of Financial and Quantitative Analysis, 44 (2009), 237–271.CrossRefGoogle Scholar
Huang, R., and Ritter, J.. “Corporate Cash Shortfalls and Financing Decisions.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589096 (2018).Google Scholar
Iliev, P., and Welch, I.. “Reconciling Estimates of the Speed of Adjustment of Leverage Ratios.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1542691 (2010).CrossRefGoogle Scholar
Jiang, F.; Jiang, Z.; Huang, J.; Kim, K.; and Nofsinger, J.. “Bank Competition and Leverage Adjustments.” Financial Management, 46 (2017), 995–1022.CrossRefGoogle Scholar
Kayhan, A., and Titman, S.. “Firms’ Histories and Their Capital Structures.” Journal of Financial Economics, 83 (2007), 1–32.CrossRefGoogle Scholar
Kisgen, D.“Do Firms Target Credit Ratings or Leverage Levels?” Journal of Financial and Quantitative Analysis, 44 (2009), 1323–1344.CrossRefGoogle Scholar
Leary, M., and Roberts, M.. “Do Peer Firms Affect Corporate Financial Policy?” Journal of Finance, 69 (2014), 139–178.CrossRefGoogle Scholar
Lemmon, M.; Roberts, M.; and Zender, J.. “Back to the Beginning: Persistence and the Cross-Section of Corporate Capital Structure.” Journal of Finance, 63 (2008), 1575–1608.CrossRefGoogle Scholar
Lockhart, G.“Credit Lines and Leverage Adjustments.” Journal of Corporate Finance, 25 (2014), 274–288.CrossRefGoogle Scholar
Marciukaityte, D.“Right-to-Work Laws and Financial Leverage.” Financial Management, 55 (2015), 147–175.CrossRefGoogle Scholar
Myers, S.“Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (1977), 147–175.CrossRefGoogle Scholar
Myers, S.“The Capital Structure Puzzle.” Journal of Finance, 39 (1984), 575–592.CrossRefGoogle Scholar
Nash, R.; Netter, J.; and Poulsen, A.. “Determinants of Contractual Relations Between Shareholders and Bondholders: Investment Opportunities and Restrictive Covenants.” Journal of Corporate Finance, 9 (2003), 201–232.CrossRefGoogle Scholar
Nickell, S.“Biases in Dynamic Models with Fixed Effects.” Econometrica, 49 (1981), 1417–1426.CrossRefGoogle Scholar
Ozdagli, A.“Financial Leverage, Corporate Investment, and Stock Returns.” Review of Financial Studies, 25 (2012), 1033–1069.CrossRefGoogle Scholar
Oztekin, O.“Capital Structure Decisions around the World: Which Factors Are Reliably Important?” Journal of Financial and Quantitative Analysis, 50 (2015), 301–323.CrossRefGoogle Scholar
Oztekin, O., and Flannery, M.. “Institutional Determinants of Capital Structure Adjustment Speeds.” Journal of Financial Economics, 103 (2012), 88–112.CrossRefGoogle Scholar
Phan, H.“Inside Debt and Mergers and Acquisitions.” Journal of Financial and Quantitative Analysis, 49 (2014), 1365–1401.CrossRefGoogle Scholar
Phillips, P., and Sul, D.. “Bias in Dynamic Panel Estimation with Fixed Effects, Incidental Trends and Cross Section Dependence.” Journal of Econometrics, 137 (2007), 162–188.CrossRefGoogle Scholar
Walker, M.; Yost, K.; and Zhao, J.. “Credibility and Multiple SEOs: What Happens When Firms Return to the Capital Market?” Financial Management, 45 (2016), 675–703.CrossRefGoogle Scholar
Warr, R.; Elliott, W.; Koeter-Kant, J.; and Oztekin, O.. “Equity Mispricing and Leverage Adjustment Costs.” Journal of Financial and Quantitative Analysis, 47 (2012), 589–616.CrossRefGoogle Scholar
Welch, I.“Capital Structure and Stock Returns.” Journal of Political Economy, 112 (2004), 106–131.CrossRefGoogle Scholar
Supplementary material: File

Yin and Ritter supplementary materials

Yin and Ritter supplementary materials

Download Yin and Ritter supplementary materials(File)
File 165.6 KB