What determines the speed of adjustment to the target capital structure?

Applied Financial Economics | 09/2006


A dynamic adjustment model and panel methodology are used to investigate the determinants of a time varying target capital structure. Because firms may temporarily deviate from their target capital structure in the presence of adjustment costs, the adjustment process is also endogenized. Specifically, we analyse the impact of firm-specific characteristics as well as macroeconomic factors on the speed of adjustment to the target debt ratio. The sample comprises a panel of 90 Swiss firms over the years from 1991 to 2001. We document that faster growing firms and those that are further away from their optimal capital structure adjust more readily. The results also reveal interesting interrelations between the adjustment speed and well-known business cycle variables. Most important, the speed of adjustment is higher when the term spread is higher and when economic prospects are good.