Optimal Capital Structure and Speed of Adjustment: Inside Debt Perspective
40 Pages Posted: 12 Feb 2016
Date Written: February 10, 2016
This study examines the effects of inside debts on a firm's target leverage and explains the low-leverage puzzle (e.g. Graham, 2000) by the over estimation of the target leverage due to neglecting the effects of inside debts. We find that a firm's inside debt affects not only the target leverage, but also the speed of adjustment toward that target. A firm’s target leverage is negatively related to the amount of inside debt and the effect of inside debt is alleviated when a firm's funding status is positive. Additionally, the adjustment speeds are faster when considering inside debt effects during 1985-2012 and 2007-2012. If we separated the whole sample firms into below- and above-traditional target leverage, we find that adjustment speeds are slower (faster) when firms have below-target (above-target) leverage after 2007.
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