The relationship between asset and capital structure: a compositional approach with panel vector autoregressive models

Abstract

The companies' investment and financing policies are dynamically interrelated and there is no general consensus about the direction of this relationship. There are theoretical arguments and empirical evidence supporting both possible directions, which makes panel vector autoregressive models an appropriate tool. However, the financial ratios normally used to assess this relationship empirically tend to be asymmetric, and to have extreme outliers and non-linear relationships. The aim of this article is to propose a methodological approach to address these issues by complementing panel vector autoregressive models with compositional data analysis. The usefulness of the proposed methodology is illustrated with real data of Spanish retail companies, while a reanalysis with standard financial ratios is inconclusive.