Uncertainty, Investment Spikes, and Leverage Adjustments

We study the effects of uncertainty on corporate leverage adjustments with respect to investment spikes and find that overlevered and underlevered firms behave very differently in response to the combination of uncertainty and investment spikes. Overlevered firms facing high uncertainty converge to their targets substantially faster, whereas their counterparts facing low uncertainty tend to deviate from their targets. However, underlevered firms facing low uncertainty fully adjust to their targets, while underlevered firms facing high uncertainty adjust their leverage more slowly. We find that real options and transitory debt are channels that can account for various aspects of these leverage dynamics