Target-Overshooting Behavior and the Partial Leverage Adjustment Model

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 premise of incremental adjustments year by year. Because overshooting involves large adjustments, the presence of overshooting firms can skew researchers’ inference on the PLAM. This study shows 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 reaching the halfway point. Ironically, the appearance of firms’ partial and steady movements toward target leverage in the PLAM research may well be a statistical artifact of the abundance of overshooting