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A comparative analysis of proxies for an optimal leverage ratio

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  • D'Mello, Ranjan
  • Farhat, Joseph

Abstract

Previous studies that test the tradeoff theory commonly use one of the following debt ratio measures to proxy for a firm's hypothesized optimal ratio: firm's time-series mean leverage, moving average leverage based on a firm's historical debt ratios, industry median leverage, and predicted leverage ratio based on cross-sectional regressions. We find that these alternative proxies yield results that are significantly different from each other. Further, regression results of models that use the optimum target leverage and the conclusions drawn from the findings are sensitive to the model's proxy. Of the proxies that are commonly used in the literature, the moving average debt measure exhibits characteristics that are most consistent with the theoretical optimal leverage ratio.

Suggested Citation

  • D'Mello, Ranjan & Farhat, Joseph, 2008. "A comparative analysis of proxies for an optimal leverage ratio," Review of Financial Economics, Elsevier, vol. 17(3), pages 213-227, August.
  • Handle: RePEc:eee:revfin:v:17:y:2008:i:3:p:213-227
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    Cited by:

    1. M. E. Bontempi & L. Bottazzi & R. Golinelli, 2015. "Dynamic corporate capital structure behavior: empirical assessment in the light of heterogeneity and non stationarity," Working Papers wp988, Dipartimento Scienze Economiche, Universita' di Bologna.
    2. Sabiwalsky, Ralf, 2010. "Nonlinear modelling of target leverage with latent determinant variables -- new evidence on the trade-off theory," Review of Financial Economics, Elsevier, vol. 19(4), pages 137-150, October.
    3. Dominique Dufour & Eric Molay, 2010. "La Structure Financiere Des Pme Françaises : Une Analyse Sectorielle Sur Donnees De Panel," Post-Print hal-00479529, HAL.
    4. Lamoureux, Christopher G. & Nejadmalayeri, Ali, 2015. "Costs of capital and public issuance choice," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 27-45.
    5. Ludwig Reinhard & Steven Li, 2010. "A note on capital structure target adjustment – Indonesian evidence," International Journal of Managerial Finance, Emerald Group Publishing, vol. 6(3), pages 245-259, June.
    6. Gharsalli Mazen, 2011. "French firm's financing choices: towards a reconciliation of the static trade-off theory and the pecking order theory?," Post-Print hal-00603762, HAL.
    7. Gharsalli Mazen, 2012. "French Firm¡¯s Financing Choices: Towards a Reconciliation of the Static Trade-Off Theory and the Pecking Order Theory?," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 3(1), pages 57-72, January.
    8. Gonzalo Rubio & Francisco Sogorb, 2011. "The Adjustment To Target Leverage Of Spanish Public Firms: Macroeconomic Conditions And Distance From Target," Revista de Economia Aplicada, Universidad de Zaragoza, Departamento de Estructura Economica y Economia Publica, pages 35-63.

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