Reliable Factors of Capital Structure: Stability Selection Approach

Abstract In the extant literature, researchers introduced many variables as potential determinants of capital structure, highlighting the importance of identifying reliable factors as an essential step before constructing a theoretical framework to explain a firm’s capital structure choice. We combine stability selection as a general approach to improve the performance of a variable selection technique with state-of-art variable selection, the Least Absolute Shrinkage and Selection Operator (LASSO), to identify a sparse and stable set of capital structure determinants. Our findings show that industry leverage and profitability are two of the most stable factors of market and book-based leverage of Iranian firms with high-selection probabilities. Compared with evidence from developed markets, we identified liquidity as a new stable factor of market-based and book-based leverage in a point-of-probability view. Moreover, in contrast to prior studies, we found no evidence to prove the stability of firm size for book- and market-based leverage. Also, the stability of assets tangibility as another core factor of capital structure in the literature is not robust to different definitions of leverage. Prediction accuracy measures show that stable-LASSO-selected variables have better in-sample and out-of-sample performance than core factors of capital structure. Further analysis indicates that when we measure capital structure based on long-term debt ratios, assets tangibility can be viewed as one of the most stable factors of capital structure.