An Empirical Investigation of the Dynamics of Qualitative Decisions of Firms

This paper focuses on qualitative aspects of financing, investment and output decisions offirms. Such dimensions can be modeled econometrically by means of dynamic limited dependent variables models. We develop a partial equilibrium dynamic stochastic programmingproblem of investment, dividend and financing decisions for a typical firm.We apply techniques involving limited dependent variable models to study the discretedecisions of whether or not firms pay dividends, use borrowing or issue equity to financeinvestment. We use panel data from COMPUSTAT for publicly traded U.S. manufacturingfirms. We study the pattern of transitions over time across various regimes that representalternative modes of finance while controlling for individual heterogeneity with a generalstochastic structure for unobservables. Our dynamic limited dependent variable modelsshow considerable success in explaining the dynamics of such decisions, with individualcharacteristics of firms, which include firm fundamentals and lagged values of past decisions,exhibiting a strong explanatory impact. The dynamics implied by the estimated modelsreveal high persistence in firms' qualitative decisions. Unobserved firm heterogeneity, whichis modelled by means of random effects, plays a very significant explanatory role.[...]