Recent research has focused on the estimates of the speed of adjustment to target leverage as the indicators of the importance of dynamic trade-off behavior. We show that the observed corporate financing behavior and the resulting dynamics of corporate debt ratios are such that the speed of adjustment is not an economically meaningful measure of the importance of target debt ratios. We conclude that partial adjustment regressions that rely on the existence of a well-defined target debt ratio are ill-suited for quantifying the importance of dynamic trade-off behavior vis-a-vis alternative theories.

Simulation experiments show that both partial-adjustment and debt-equity choice models can generate spuriously significant estimates that are consistent with the hypothesis that firms have target debt ratios to which they periodically adjust. Regressions relying on full-sample fixed effects models of target leverage, in particular, produce results severely biased in favor of the target-adjustment hypothesis. Various target proxies and modifications to the standard methodologies are examined to identify partial-adjustment and debt-equity choice models that have power to reject the target-adjustment hypothesis. The resulting estimates of the speed of adjustment are in the range of five-eight percent per year.

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Information production associated with derivatives markets is not a sideshow; rather, it has significantly positive spillover effects on an array of corporate decisions of underlying firms. Using a regression-discontinuity design based on exogenous variation in options availability as an instrument for changes in the information environment, we show that options introductions have causal effects on corporate policies on both sides of the balance sheet. Through improved information efficiency, options availability reduces the need for debt and payout, increases efficient investment, and yields superior innovation. We conduct two independent experiments demonstrating that our instrument’s impact is not derived from alternative channels.