Heterogeneity in the Speed of Adjustment toward Target Leverage


  • *We thank Sudipto Dasgupta for many insightful comments. All errors are our responsibility.

Ralf Elsas
Institute for Finance & Banking
University of Munich, Munich, Germany


Estimating the speed of adjustment toward target leverage using the standard partial adjustment model assumes that all firms within the sample adjust at the same (average) pace. Dynamic capital structure theory predicts heterogeneity in adjustment speed due to firm-specific adjustment costs. Applying an estimator designed to be unbiased in the context of unbalanced dynamic panel data with a fractional dependent variable (DPF estimator), we conduct an extensive analysis of cross-sectional heterogeneity in the speed of adjustment of firms. We find evidence for pronounced heterogeneity, where speed of adjustment is the highest for firms with high default risk or expected bankruptcy costs, and if opportunity costs of deviating from a target are high. Our evidence is consistent with the general relevance of the trade-off theory.