The speed of adjustment of capital structure and the long differencing estimator

Abstract

This thesis estimates the speed of adjustment (SOA) of capital structure using the long differencing estimator and finds that firms adjust back to their target leverage at a moderate pace of 20.9% per year for book leverage and 32.3% per year for market leverage. The effect of the long differencing length k on the SOA is examined and found to cause the long differencing estimator to overestimate the SOA when k is too short due to the highly persistent nature of leverage as a dependent variable. Additionally, the long differencing estimator process is tested with up to six iterations and it is determined that three are sufficient for estimation of the SOA. Finally, through a unique application of the long differencing estimator, this thesis finds that recessions, the financial crisis and coinciding great recession, and the dissolution of the American conglomerate era in the 1980s all affect firms’ capital structure, albeit market leverage more than book.