This paper examines whether firms rebalance their capital structures in response to changes in equity value, considering the presence of adjustment costs. Using a dynamic duration model, the authors find that firms actively rebalance their leverage to stay within an optimal range, responding to changes in equity value over two to four years. However, adjustment costs often prevent immediate responses, leading to persistent leverage shocks. The evidence suggests that this persistence is due to optimizing behavior, not market timing or indifference. The trade-off theory of capital structure posits that firms have an optimal debt-to-equity ratio that balances the costs and benefits of debt financing. While originally static, the theory implies dynamic rebalancing of capital structure over time. Adjustment costs, however, can prevent firms from responding immediately to shocks, leading to persistent leverage effects. The paper tests the trade-off theory while allowing for costly adjustment. It examines corporate financing decisions in a dynamic duration model and addresses three questions: (1) Is financing behavior consistent with adjustment costs? (2) Do firms rebalance leverage dynamically? (3) What are the implications of costly adjustment for alternative explanations of financing behavior? The authors find that firms are often inactive with respect to their financial policy but are active when issuing or repurchasing debt and equity. They tend to do so in clusters, consistent with empirical evidence on issuance costs. The results suggest that firms behave in a manner consistent with the trade-off theory, as predicted by the Fischer et al. (1989) model. Firms are inactive when leverage is within a target range and adjust when it moves outside. The paper also finds that the rate of leverage reversion to its target is often slow because firms do not rebalance every period and adjust to a target range rather than a specific level. This explains why leverage shocks have lasting effects despite trade-off behavior. The results challenge the findings of Baker and Wurgler (2002) and Welch (2004), who argue that leverage is unresponsive to shocks, suggesting the trade-off theory is inappropriate. The authors find that persistent leverage behavior is more likely due to adjustment costs than market timing or indifference. The paper also finds that firms respond to equity shocks by rebalancing their capital structure through debt issuances or retirements, erasing any impact on leverage within a few years. The results are consistent with the modified pecking order theory, suggesting that both bankruptcy costs and information asymmetry costs are important determinants of capital structure decisions. The paper concludes that the dynamic trade-off theory is supported by the evidence, and that adjustment costs play a significant role in shaping corporate financial policy. The results highlight the importance of considering adjustment costs in empirical studies of capital structure.This paper examines whether firms rebalance their capital structures in response to changes in equity value, considering the presence of adjustment costs. Using a dynamic duration model, the authors find that firms actively rebalance their leverage to stay within an optimal range, responding to changes in equity value over two to four years. However, adjustment costs often prevent immediate responses, leading to persistent leverage shocks. The evidence suggests that this persistence is due to optimizing behavior, not market timing or indifference. The trade-off theory of capital structure posits that firms have an optimal debt-to-equity ratio that balances the costs and benefits of debt financing. While originally static, the theory implies dynamic rebalancing of capital structure over time. Adjustment costs, however, can prevent firms from responding immediately to shocks, leading to persistent leverage effects. The paper tests the trade-off theory while allowing for costly adjustment. It examines corporate financing decisions in a dynamic duration model and addresses three questions: (1) Is financing behavior consistent with adjustment costs? (2) Do firms rebalance leverage dynamically? (3) What are the implications of costly adjustment for alternative explanations of financing behavior? The authors find that firms are often inactive with respect to their financial policy but are active when issuing or repurchasing debt and equity. They tend to do so in clusters, consistent with empirical evidence on issuance costs. The results suggest that firms behave in a manner consistent with the trade-off theory, as predicted by the Fischer et al. (1989) model. Firms are inactive when leverage is within a target range and adjust when it moves outside. The paper also finds that the rate of leverage reversion to its target is often slow because firms do not rebalance every period and adjust to a target range rather than a specific level. This explains why leverage shocks have lasting effects despite trade-off behavior. The results challenge the findings of Baker and Wurgler (2002) and Welch (2004), who argue that leverage is unresponsive to shocks, suggesting the trade-off theory is inappropriate. The authors find that persistent leverage behavior is more likely due to adjustment costs than market timing or indifference. The paper also finds that firms respond to equity shocks by rebalancing their capital structure through debt issuances or retirements, erasing any impact on leverage within a few years. The results are consistent with the modified pecking order theory, suggesting that both bankruptcy costs and information asymmetry costs are important determinants of capital structure decisions. The paper concludes that the dynamic trade-off theory is supported by the evidence, and that adjustment costs play a significant role in shaping corporate financial policy. The results highlight the importance of considering adjustment costs in empirical studies of capital structure.