Measuring Equilibrating Forces of Financial Ratios.

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Abstract We test several categories of ratios--short-term liquidity, performance measures, earnings per share (EPS), capital structure, and the gross margin ratio-to determine if they have equilibrium values or follow a random walk. For ratios with an equilibrium value, the speed at which the ratio returns to equilibrium from out-of-equilibrium conditions is measured. Since equilibrating forces may differ with firm size, we also test for differences in adjustment speeds between small and large firms. An accounting ratio may have an equilibrium value if management targets a certain ratio so that any deviation from the target causes management to initiate actions that will return the ratio to target. Also, although management may not be targeting a ratio, the interaction of management's actions with external market industry forces may lead to an equilibrium value. We investigate the total adjustment over time and then assess both the relative adjustment speed and the relative weights of

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