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A critical assessment of the partial leverage adjustment model: Target-overshooting behavior

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  • Choi, Heejung
  • Lee, Eun Jung
  • Suh, Jungwon

Abstract

More than 30 percent of Compustat firms overshoot target leverage within one to two years, contrary to the partial leverage adjustment model’s (PLAM) central tenet of incremental adjustments year by year. Because overshooting involves large adjustments, the presence of overshooting firms can skew researchers’ inferences drawn from the PLAM. This study reveals that if we remove overshooting firms from the dataset, the estimated leverage-adjustment speed is much lower and, more importantly, the average firm stops moving toward the target well before the halfway point. Ironically, the conclusion of firms’ partial and steady movements toward target leverage in the PLAM research looks like a statistical artifact arising from the preponderance of overshooting.

Suggested Citation

  • Choi, Heejung & Lee, Eun Jung & Suh, Jungwon, 2024. "A critical assessment of the partial leverage adjustment model: Target-overshooting behavior," Research in International Business and Finance, Elsevier, vol. 71(C).
    • Handle: RePEc:eee:riibaf:v:71:y:2024:i:c:s0275531924002381
    DOI: 10.1016/j.ribaf.2024.102445
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    References listed on IDEAS

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    More about this item

    Keywords

    Capital structure; leverage adjustment speed; partial leverage adjustment; target leverage; overshooting;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • 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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