Dynamic Capital Structure Adjustment and the Impact of Fractional Dependent Variables

Abstract

Researchers in empirical corporate finance often use bounded ratios (e.g., debt ratios) as dependent variables in their regressions. Using the example of estimating the speed of adjustment toward target leverage, we show by Monte Carlo and resampling experiments that commonly applied estimators yield severely biased estimates, as they ignore that debt ratios are fractional (i.e., bounded between 0 and 1). We propose a new unbiased estimator for adjustment speed in the presence of fractional dependent variables that also controls for unobserved heterogeneity and unbalanced panel data. This new estimator is suitable for corporate finance applications beyond capital structure research.

Capital structure decisions in family firms: empirical evidence from a bank-based economy

“…In contrast, growth options (measured by the market-to-book ratio) and profitability have on average a negative influence on the leverage ratio. All these findings are consistent with standard capital structure theories and the recent empirical findings for the U.S. and Germany presented in Frank and Goyal (forthcoming) and Elsas and Florysiak (2008), respectively.…”

“…Rajan and Zingales 1995, Fama and French 2002, Baker and Wurgler 2002or Kayhan and Titman 2007. Moreover, just recently Elsas and Florysiak (2008) have applied similar definitions of leverage for a large sample study of capital structure in the German environment. This broad definition includes non-interest-bearing debt components, such as pension liabilities or accounts payable, and is likely to overestimate financial leverage.…”

“…None of those modifications changed our results. Elsas and Florysiak (2008) use regressor variables lagged by one year in all of their regressions. Behind this procedure is the idea that current firm characteristics, such as firm size and available collateral, determine future borrowing capacity.…”

“…In general empirical evidence on this topic based on a large sample of listed firms in Germany is rather limited. So far, Jostarndt and Wagner (2006) and Elsas and Florysiak (2008) provide the only large sample studies on capital structure in Germany. While Jostarndt and Wagner (2006) compare the development of capital structures in Germany and the U.S. over the 1994 to 2004 period, Elsas and Florysiak (2008) analyse whether recent trends in capital structure research hold true for Germany based on a longitudinal analysis for the 1987 to 2006 period.…”

CEO's Inside Debt and Dynamics of Capital Structure

“…These patterns indicate the presence of common firm and time factors that shape both the CEO's inside debt and firm leverage, yet CEO's inside debt may have a negative within‐firm effect on firm leverage. The estimation of an augmented capital structure dynamics model using the Elsas and Florysiak () doubly censored fractional dependent variable estimator (DPF estimator) and the Blundell and Bond () system generalized method of moments (GMM) estimator confirms our conjecture. We find that the CEO's inside debt ratio is negatively associated with firm leverage, and a one‐standard deviation increase in CEO's inside debt leads to a nontrivial decrease of 1.7 percentage points in the firm's debt ratio.…”