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Dynamic Leverage Targets

Author

Listed:
  • Filippo Ippolito

    (Universitat Pompeu Fabra, Barcelona Graduate School of Economics, and Centre for Economic Policy Research (CEPR))

  • Stefano Sacchetto

    (IESE Business School)

  • Roberto Steri

    (University of Lausanne and Swiss Finance Institute)

Abstract

Through the lens of a dynamic trade-off model of capital structure, we reconcile active capital structure rebalancing and slow average adjustment speeds towards target leverage, both of which have been documented by empirical studies. In the model, firms optimally adjust leverage towards a dynamic target, which is firm specific and responds to evolving firm characteristics and investment opportunities. In the presence of investment frictions and capital market imperfections, firms close only partially the gap that separates their current leverage from their target. Thus, targets are relatively less stable than leverage itself. By means of structural estimation, we show that there is convergence towards dynamic targets in the real data, at faster speed the larger the gap from the target. Over horizons ranging from five to thirty years, targets are roughly twenty to forty percent more volatile than leverage. Adjustment speeds exhibit significant heterogeneity across firms and time, and partial adjustment models that assume constant speed largely underestimate average speeds.

Suggested Citation

  • Filippo Ippolito & Stefano Sacchetto & Roberto Steri, 2017. "Dynamic Leverage Targets," Swiss Finance Institute Research Paper Series 17-59, Swiss Finance Institute, revised Jan 2018.
  • Handle: RePEc:chf:rpseri:rp1759
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    More about this item

    Keywords

    target leverage; dynamic leverage adjustments; leverage stability;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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