The endogeneity and dynamics of capital structure

Most corporate finance studies that examine the relation between capital structure and firm specific variables ignore dynamic endogeneity - the idea that a firm's capital structure affects both future capital structure and its firm specific determining factors. However, since theory suggests that a firm's characteristics will adjust in response to past capital structure - ignoring dynamic endogeneity may introduce bias into estimates of the relation between capital structure and firm characteristics explanatory variables. The aim of this project is to show: theoretically and empirically, how a dynamic panel GMM estimator can be used to deal with endogeneity in capital structure research. The findings of this project will provide valid and powerful instruments to account for unobserved heterogeneity and simultaneity, and will be straight forward to implement in research on corporate finance.