In an efficient market, spreads will reflect both the issuer’s current risk and investors’ expectations about how that risk might change over time. Collin-Dufresne and Goldstein (<xref>2001</xref>) show analytically that a firm’s expected future leverage importantly influences the spread on its bonds....

We find that equity mispricing impacts the speed at which firms adjust to their target leverage (TL) and does so in predictable ways depending on whether the firm is over- or underlevered. For example, firms that are above their TL and should therefore issue equity (or retire debt) adjust more...