Capital Structure Adjustments: Do Macroeconomic and Business Risks Matter?

We show that risk plays an important role in estimating the adjustment of the firm’s capital structure. We find that the adjustment process is asymmetric and depends on the type of risk, its magnitude, the firm’s current leverage, and its financial status. We also show that firms with financial surpluses and above-target leverage adjust their leverage more rapidly when firm-specific risk is low and when macroeconomic risk is high. Firms with financial deficits and below-target leverage adjust their capital structure more quickly when both types of risk are low. Our investigation suggests that models without risk factors yield biased results.