Date of Degree


Document Type


Degree Name





Liuren Wu

Committee Members

Armen Hovakimian

Jun Wang

Ren Raw Chen

Subject Categories

Corporate Finance | Portfolio and Security Analysis


Speed of Adjustment, standardized leverage ratio


This dissertation consists of three coherent chapters that discuss the capital structure target, speed of adjustment and effect of speed of adjustment on credit risk.

Ⅰ: We standardize leverage ratio by underlying business risk. The methodology of standardization follows the assumption that asset value follows a geometric Brownian motion. We find that by standardizing book leverage ratio, standardized leverage ratio can be explained by firm characteristics with a much larger coefficient of determination compared with book leverage ratio. The coefficient of determination difference of regression with standardized leverage ratio and book leverage ratio becomes even larger if we exclude zero debt firms from our sample. These results suggest firms more likely target at the standardized leverage instead of the book leverage ratio. We also discuss the methodologies of estimating target standardized leverage ratio. Target standardized leverage ratio is estimated in both of Fama and French (2002) approach and Hovakimian and Li (2012)’s historical panel firm fixed effect approach.

Ⅱ: Firms on average adjust to their target standardized leverage ratio at a much higher speed compared with the speed they adjust to the target book leverage. This result further supports our argument in Chapter 1 that firms more likely target at the standardized leverage ratio. In addition to calculating the average speed of adjustment, we calculate firm specific speed of adjustment by implementing partial adjustment regression on each firm’s historical capital structure time series on the rolling window base. Firm individual speed of adjustment is shown to have significant predictive power on future capital structure adjustment. We also study the determinants of speed of adjustment. Larger size and lower price to book ratio firms tend to have larger speed of adjustment. Short term variables like past stock return, recent debt trend can also affect the instantaneous capital structure adjustment behavior.

Ⅲ: We show how firm specific speed of adjustment affects Credit Spreads. To our knowledge, we are the first to empirically test how speed of adjustment affects credit risk. In addition to confirm previous empirical results that target standardized leverage affects credit risk along with standardized leverage ratio, we show that speed of adjustment significantly affects Credit Spreads. Larger speed of adjustment reduces credit risk on average and the effect is economically significant. We also study the second order effect of speed of adjustment on credit risk. Firm’s credit risk depends more on speed of adjustment when firm is highly leveraged. Firm’s credit risk depends less on standardized leverage when speed of adjustment is large.