Monte Carlo simulations and capital structure research

The evolution of the debt ratio under alternative types of managerial behavior can generate non-standard leverage processes. This creates problems for statistical inference in empirical capital structure research. We argue in this paper that when the data generating process is not standard, a useful way to evaluate the appropriateness of inferences and the empirical methodology is via Monte Carlo simulations that mimic the data generating process under alternative assumptions about managerial behavior. We illustrate with several examples.