1. A dynamic optimal capital structure model with costly adjustment mechanisms H. Liao, Y. Tung, T. Chen Discussion by Fei Ding Hong Kong University of Science & Technology Dec. 12, 2008

2. Overview and contribution A dynamic capital structure model with fixed and proportional adjustment costs.  Extend Goldstein, Ju, and Leland (2001).  Adjustment costs  recapitalization threshold, affects the frequency and magnitude of adjustments.  Consistent with empirical findings of Leary and Roberts (2005).

3. The model Exogenous cash flow process:  Geometric Brownian motion  Constant growth rate and volatility Firm value: discounted expected CF under the risk- neutral measure  Constant risk premium & riskfree rate Tradeoff the tax shield of debt with bankruptcy costs. Incorporate exogenous fixed & proportional adjustment costs of rebalancing capital structure.

4. Main results Due to adjustment costs, firms do not always rebalance when the leverage ratio deviates slightly from the optimal level.  There exists an optimal leverage range. Larger volatility of CF results in less leverage, less rebalancing but at bigger size. Higher riskfree rate results in slightly higher leverage, more rebalancing and smaller size. Lower bankruptcy costs result in higher leverage, more rebalancing at large size. Fixed costs reduce the frequency and speed of adjustments. Proportional costs reduce the size of adjustments.

5. Suggestions and Comments More simulation results with various parameter values. Compare with empirical results and data in practice.  Coupon, bankruptcy level, credit spreads, time- series of leverage ratios, etc.  Why higher cost when closer to the optimal level?  Alternative cost functions? Time varying, firm/industry shocks, natural experiments

6. Suggestions and Comments Any new insights / empirical implications generated? Better writing to facilitate understanding.