Do Firms Have Unique Target Debt Ratios to Which They Adjust?

Abstract

The estimates of the speed of adjustment to target leverage tend to be significant but low. One interpretation for the slow adjustment is that firms fully adjust to target only infrequently, when the benefits of adjustment exceed its costs. Using both ex-ante and ex-post information to identify situations when the adjustment should be full, we find no evidence of full adjustment. We find that adjustments to target are rarely full, with many firms adjusting beyond or away from the target. The results imply that firms may have target ranges but no unique target debt ratios to which they ever want to fully adjust. One implication of this is that empirical analyses, such as partial adjustment regressions, that rely on the existence of a well-defined target debt ratio may be ill-suited for quantifying the importance of dynamic tradeoff behavior vis-a-vis alternative theories.