The effect of neglecting the slope parameters’ heterogeneity on dynamic models of corporate capital structure

We present a parsimonious representation of debt-ratio dynamics that is able to nest the Trade-Off, Pecking-Order and Market-Timing theoretical models, at the same time avoiding the poolability of the slope parameters. The inference on the heterogeneous speed of adjustment of the firm towards the target debt ratio is based on a comparison of the unit root results from both individual company and (this is a relative novelty in the case of micro-data) panel data. Results show that company behavior is largely heterogeneous with regard to the theory underlying the historical data. Our proposed methodology may be usefully employed in order to identify sub-samples of companies behaving in an homogeneous manner, and can be extended to study the empirical capital structure models with more appropriate quantitative instruments. This would avoid the arbitrary a priori selection of sub-samples and the imposition of untested poolability assumptions as commonly occurs in the empirical literature.