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A Model of Capital Structure when Earnings Are Mean-Reverting

Published online by Cambridge University Press:  06 April 2009

Steven Raymar
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Abstract

A multiperiod model of optimal capital structure is developed under the assumption that earnings follow an autoregressive process. Firm value and leverage vary through time and, at each date, the firm achieves an optimal debt level that is a function of the full state contingent debt policy. The reversion parameter of the earnings series is shown to be positively related to various measures of variability and negatively related to leverage. If earnings processes are not homogeneous across firms, then standard earnings risk measures in capital structure studies do not adequately represent crosssectional differences in variability in firm value.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 26 , Issue 3 , September 1991 , pp. 327 - 344
Copyright
Copyright © School of Business Administration, University of Washington 1991

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