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Please do not quote without permission Partial Adjustment toward Target Capital Structures

By Mark J. Flannery and Kasturi P. Rangan

Abstract

The literature provides conflicting assessments about firms ’ leverage decisions. We argue that econometric mis-specifications have influenced many past conclusions, because the estimated regression models implicitly impose strong, but unwarranted, assumptions on the data. This study estimates a partial-adjustment model for a firm’s leverage decision. Our model recognizes that a firm’s target capital structure can change over time and that (unanticipated) share price changes also have on effect on observed leverage. Our results indicate that firms do have specific target capital structures, and that they adjust quickly toward those targets when a gap arises. We estimate that the typical firm closes more than half the gap between its actual and its target debt ratios within two years

Year: 2003
OAI identifier: oai:CiteSeerX.psu:10.1.1.196.87
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