Target Behavior and Financing: How Conclusive Is the Evidence?




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    • Chang is from Nanyang Business School, Nanyang Technological University. Dasgupta is from the Department of Finance, Hong Kong University of Science and Technology. We are grateful to John Graham (the editor), Campbell Harvey (the editor), an anonymous associate editor, two anonymous referees, two anonymous advisors, Heitor Almeida, Malcolm Baker, Sugato Bhattacharyya, Christine Brown, Murillo Campello, Howard Chan, Eric Chang, Long Chen, Kevin Davis, Doug Foster, Murray Frank, Fangjian Fu, Bruce Grundy, Gilles Hilary, Armen Hovakimian, Nengjiu Ju, Ayla Kayhan, Laura Liu, Peter MacKay, Salih Neftci, Douglas Rolph, Nilanjan Sen, Lewis Tam, Sheridan Titman, Mungo Wilson, Xueping Wu, and especially Michael Lemmon (AFA 2007 discussant), Jie Gan, Vidhan Goyal, and Michael Roberts for helpful comments, discussions, and suggestions. We thank Rongbing Huang for providing us his codes for the long-differencing technique. We also thank seminar participants at the 11th Finsia—Melbourne Centre Banking and Finance Conference, 2007 American Finance Association meetings, Arizona State University, Chinese University of Hong Kong, City University of Hong Kong, Hong Kong Baptist University, University of Macau, Hong Kong University of Science and Technology, Nanyang Technological University, National University of Singapore, Singapore Management University, University of Hong Kong, University of New South Wales Research Camp 2006, and University of Southern California. Chang acknowledges financial support from the Melbourne Centre for Financial Studies. Dasgupta acknowledges financial support from Hong Kong's Research Grants Council under grant # HKUST6451/05H.


The notion that firms have a debt ratio target that is a primary determinant of financing behavior is influential in finance. Yet, how definitive is the evidence? We address this issue by generating samples where financing is unrelated to a firm's current debt ratio or a target. We find that much of the available evidence in favor of target behavior based on leverage ratio changes can be reproduced for these samples. Taken together, our findings suggest that a number of existing tests of target behavior have no power to reject alternatives.