A Dynamic Model of the Firm: Structural Explanations of Key Empirical Findings

Natalia Lazzati and Amilcar A. Menichini

The Financial Review, 2015, vol. 50, issue 3, 341-361

Abstract: We derive a dynamic model of the firm in the spirit of the trade-off theory of capital structure that explains firm behavior in terms of firm characteristics. We show our model is consistent with many important findings about the cross-section of firms, including the negative relations between profitability and leverage, and between dividends and investment-cash flow sensitivities. The model also explains the existence of zero-debt firms and their observed characteristics. These results have been used to challenge the trade-off theory and the assumption of perfect capital markets. We revisit these critiques and provide structural explanations for the regularities we replicate.

Date: 2015
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