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Do Firms Rebalance Their Capital Structures?

Michael Roberts () and Mark T. Leary

No 52, Econometric Society 2004 North American Summer Meetings from Econometric Society

Abstract: We empirically examine the trade-off theory of capital structure, allowing for costly adjustment. After confirming that financing behavior is consistent with the presence of adjustment costs, we use a dynamic duration model to show that firms behave as though adhering to a dynamic trade-off policy in which they actively rebalance their leverage to stay within an optimal range. We find that firms respond to changes in their equity value, due to price shocks or equity issuances, by adjusting their leverage over the two to four years following the change. The presence of adjustment costs, however, often prevents this response from occurring immediately, resulting in shocks to leverage that have a persistent effect.We then show that this persistence in leverage is positively correlated with adjustment costs. Our evidence suggests that this persistence is more likely a result of optimizing behavior in the presence of adjustment costs, as opposed to indifference with regard to capital structure.

Keywords: Capital Structure; Trade-Off Theory; Duration Model (search for similar items in EconPapers)
JEL-codes: G32 C41 (search for similar items in EconPapers)
Date: 2004-08-11
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