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A Critique of Recent Quantitative and Deep-Structure Modeling in Capital Structure Research and Beyond

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  • Welch, Ivo

Abstract

This paper highlights four shortcomings of recent quantitative and deepstructure models in corporate finance: (1) These models have omitted too many plausible forces not based on evidence but based on authors' priors. (2) The link between their unobserved structures and their reduced-form empirical evidence has been too weak (even orthogonal forces could have affected their inference), (3) The existing tests have largely ignored many important econometric issues, such as selection and survivorship biases. (4) The models have never been held to reasonable test standards, such as performance in quasi-experimental settings. Constructively, my paper offers two primary suggestions: The first is to search for more direct empirical proxies instead of relying on "assumed" first-order conditions. The second is to design quasi-experimental tests of structural models. It illustrates these points in the context of Hennessy and Whited (2005) and Strebulaev (2007).

Suggested Citation

  • Welch, Ivo, 2013. "A Critique of Recent Quantitative and Deep-Structure Modeling in Capital Structure Research and Beyond," Critical Finance Review, now publishers, vol. 2(1), pages 131-172, July.
    • Handle: RePEc:now:jnlcfr:104.00000006
    DOI: 10.1561/104.00000006
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    Cited by:

    1. Toni M. Whited, 2022. "Integrating Structural and Reduced-Form Methods in Empirical Finance," Papers 2205.01175, arXiv.org.
    2. Hennessy, Christopher A. & Kasahara, Akitada & Strebulaev, Ilya A., 2020. "Empirical analysis of corporate tax reforms: What is the null and where did it come from?," Journal of Financial Economics, Elsevier, vol. 135(3), pages 555-576.
    3. Zhou, Qing & Faff, Robert & Alpert, Karen, 2014. "Bias correction in the estimation of dynamic panel models in corporate finance," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 494-513.
    4. Zhou, Qing & Tan, Kelvin Jui Keng & Faff, Robert & Zhu, Yushu, 2016. "Deviation from target capital structure, cost of equity and speed of adjustment," Journal of Corporate Finance, Elsevier, vol. 39(C), pages 99-120.
    5. Karpavičius, Sigitas & Yu, Fan, 2019. "Managerial risk incentives and a firm’s financing policy," Journal of Banking & Finance, Elsevier, vol. 100(C), pages 167-181.
    6. Bilgin, Rumeysa, 2023. "The Selection Of Control Variables In Capital Structure Research With Machine Learning," SocArXiv e26qf, Center for Open Science.
    7. Liu, Tingting & Mulherin, J. Harold, 2018. "How has takeover competition changed over time?," Journal of Corporate Finance, Elsevier, vol. 49(C), pages 104-119.
    8. Lotfaliei, Babak, 2018. "The variance risk premium and capital structure," ESRB Working Paper Series 70, European Systemic Risk Board.
    9. Mieczysław Kowerski, 2022. "A number of capital structure models presented even in prominent papers are estimated with incorrect estimators," Bank i Kredyt, Narodowy Bank Polski, vol. 53(5), pages 475-496.

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