Indian Journal of Science and Technology

Abstract

This paper tests the speed of adjustment of lag leverage levels (actual) to lead levels (target) levels using partial adjustment models based on the dynamic trade-off view of capital structure. We estimate baseline speed of adjustments for first differences to the first difference of modelled lead levels from lag levels of firm level leverage for a sample of UK firms. In line with our expectations derived from the literature, we find that the adjustment speed is faster when lag levels exceed lead levels relative to when lead levels exceed lag levels. Dissecting the motivation of this paper further we find that our results do not hold when the differences of firms above and under target levels are large. Thus although initial findings provide support for the expectation in the literature, we find that the theory does not hold when tested further suggesting that a more dynamic framework would be necessary to best explain target adjustment behavior.
Keywords: First Differences Adjustment Behavior, Lead–Lag Relationship, Speed of Adjustment.