Deviation from target capital structure, cost of equity and speed of adjustment

Qing Zhou, Kelvin Jui Keng Tan, Robert Faff, Yushu Zhu

Research output: Contribution to journalArticleResearchpeer-review

Abstract

In this paper, we analyze the impact of leverage deviation (i.e., actual minus target optimal leverage) on the implied cost of equity capital. Our special focus is on whether (and to what extent) the sensitivity of the cost of equity to leverage deviation, influences the speed with which firms adjust their financial leverage toward the target. Confirming theoretical predictions, we find that the cost of equity is positively related to leverage deviation and that firms whose cost of equity is more sensitive to leverage deviation exhibit faster speed of adjustment toward the target. Collectively, our findings imply that capital structure targeting is not equally important to all firms. Indeed, we argue that while evidence of the trade-off theory will tend to be obscured in broad samples, it can hold strongly in meaningfully chosen sub-samples of firms — namely, those characterized by high sensitivity of equity cost to leverage deviation.
LanguageEnglish
Pages99-120
Number of pages22
JournalJournal of Corporate Finance
Volume39
DOIs
Publication statusPublished - Aug 2016
Externally publishedYes

Fingerprint

Speed of adjustment
Cost of equity
Capital structure
Leverage
Deviation
Targeting
Prediction
Cost of equity capital
Financial leverage
Trade-off theory

Keywords

  • leverage deviation
  • sensitivity
  • cost of equity
  • speed of adjustment

Cite this

Zhou, Qing ; Tan, Kelvin Jui Keng ; Faff, Robert ; Zhu, Yushu. / Deviation from target capital structure, cost of equity and speed of adjustment. In: Journal of Corporate Finance. 2016 ; Vol. 39. pp. 99-120.
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Deviation from target capital structure, cost of equity and speed of adjustment. / Zhou, Qing; Tan, Kelvin Jui Keng; Faff, Robert; Zhu, Yushu.

In: Journal of Corporate Finance, Vol. 39, 08.2016, p. 99-120.

Research output: Contribution to journalArticleResearchpeer-review

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