What Determines the Speed of Adjustment to the Target Capital Structure?

We use a dynamic adjustment model and panel methodology to investigatethe determinants of a time- varying optimal capital structure. Because firmsmay temporarily deviate from their optimal capital structure in the presenceof adjustment costs, we also endogenize the adjustment process. In partic ular,we analyze the effects of firm-specific characteristics as well asmacroeconomic factors on the speed of adjustment to the target leverage.Our sample comprises a panel of 90 Swiss firms over the years 1991 to2001. We find that faster growing firms and those that are further away fromtheir optimal capital structure adjust more readily. Our results also revealinteresting interrelations between the adjustment speed and popular businesscycle variables. For example, the speed of adjustment is higher when theterm spread is higher, i.e., when economic prospects are good.