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The reduced form as an empirical tool: a cautionary tale from the financial veil

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  • Ben Craig
  • Christopher A. Richardson
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    Abstract

    An analysis of the limitations of the reduced-form empirical strategy as a method of testing the Modigliani-Miller model of corporate financial structure, demonstrating that an empirical strategy that is not closely tied to an underlying economic theory of behavior will usually yield estimates that are too imprecise or too unreliable to form a basis for policy.

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    File URL: http://www.clevelandfed.org/Research/Review/1996/96-q1-craig.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of Cleveland in its journal Economic Review.

    Volume (Year): (1996)
    Issue (Month): Q I ()
    Pages: 16-25

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    Handle: RePEc:fip:fedcer:y:1996:i:qi:p:16-25

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    Keywords: Corporations - Finance ; Investments;

    References

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    1. Peterson, Pamela P. & Benesh, Gary A., 1983. "A Reexamination of the Empirical Relationship between Investment and Financing Decisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 18(04), pages 439-453, December.
    2. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March.
    3. Gilchrist, S. & Himmelberg, C.P., 1995. "Evidence on the Role of Cash Flow for Investment," Papers 95-29, Columbia - Graduate School of Business.
    4. McDonald, John G. & Jacquillat, Bertrand & Nussenbaum, Maurice, 1975. "Dividend, Investment and Financing Decisions: Empirical Evidence on French Firms," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 10(05), pages 741-755, December.
    5. Fischer, Edwin O & Heinkel, Robert & Zechner, Josef, 1989. " Dynamic Capital Structure Choice: Theory and Tests," Journal of Finance, American Finance Association, vol. 44(1), pages 19-40, March.
    6. Michael S. Long & Ileen B. Malitz, 1985. "Investment Patterns and Financial Leverage," NBER Chapters, in: Corporate Capital Structures in the United States, pages 325-352 National Bureau of Economic Research, Inc.
    7. McCabe, George M., 1979. "The Empirical Relationship Between Investment and Financing: A New Look," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(01), pages 119-135, March.
    8. Phoebus J. Dhrymes & Mordecai Kurz, 1967. "Investment, Dividend, and External Finance Behavior of Firms," NBER Chapters, in: Determinants of Investment Behavior, pages 427-486 National Bureau of Economic Research, Inc.
    9. MacKie-Mason, Jeffrey K, 1990. " Do Taxes Affect Corporate Financing Decisions?," Journal of Finance, American Finance Association, vol. 45(5), pages 1471-93, December.
    10. Smirlock, Michael & Marshall, William, 1983. " An Examination of the Empirical Relationship between the Dividend and Investment Decisions: A Note," Journal of Finance, American Finance Association, vol. 38(5), pages 1659-67, December.
    11. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1994. "A Reconsideration of Investment Behavior Using Tax Reforms as Natural Experiments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 1-74.
    12. DeAngelo, Harry & Masulis, Ronald W., 1980. "Optimal capital structure under corporate and personal taxation," Journal of Financial Economics, Elsevier, vol. 8(1), pages 3-29, March.
    13. Mougoue, Mbodja & Mukherjee, Tarun K, 1994. "An Investigation into the Causality among Firms' Dividend, Investment, and Financing Decisions," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 17(4), pages 517-30, Winter.
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