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Incorporating active adjustment into a financing based model of capital structure

Neal Maroney, Wei Wang and M. Kabir Hassan

Journal of International Money and Finance, 2019, vol. 90, issue C, 204-221

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%).

Keywords: Capital structure; Trade-off theory; Partial adjustment model; Target financing model; Random financing; Speed of adjustment (search for similar items in EconPapers)
JEL-codes: G3 G30 G31 G32 C5 C52 (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:eee:jimfin:v:90:y:2019:i:c:p:204-221