Liquidity and speed of leverage adjustment

This article investigates the effect of liquidity on the speed of adjustment (SOA) of corporate leverage at the individual company level. Using panel analysis of data from 35 countries between 1996 and 2016, we find that high-liquidity firms have a significantly faster SOA than less liquid firms. This result survives a series of robustness checks and holds after addressing the endogeneity concern using exogenous shocks and additional control variables. We find that the positive effect of liquidity on the SOA exists only for over-levered firms, and this impact is moderated in countries with bankruptcy codes. We further find that the positive liquidity-SOA relationship is less (more) pronounced for firms in strong (weak) institutional environments. The results provide new insights into the role of liquidity in firms’ capital structure decisions and the determinants of capital structure dynamics. JEL Classification: G12, G32