Deviation from target capital structure and corporate misconduct

Prior studies indicate that deviations from target leverage ratios may undermine firm value and influence corporate decision-making. Extending this literature, we investigate whether pre-misconduct leverage deviation affects the incidence of corporate misconduct and subsequent adjustments toward target leverage. Using a sample of 1156 misconduct events from 272 publicly listed firms in Taiwan between 1996 and 2021, we document that firms with leverage deviations adjust their capital structures aggressively following misconduct revelations. Overleveraged firms reduce leverage, while underleveraged firms increase leverage, thereby narrowing the deviation gap. We further find that pre-misconduct leverage deviation is positively associated with the likelihood of misconduct, and the effect of leverage deviation on the occurrence of misconduct is primarily driven by overleveraged firms. Moreover, market reactions are significantly more negative when misconduct is disclosed by overleveraged family firms with concentrated director ownership, highlighting the interaction between financial misalignment and governance characteristics. Overall, these findings support the existence of target leverage and demonstrate how firms involved in misconduct proactively adjust their capital structures to mitigate the negative consequences of deviations from their target.