This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.

This paper provides a competitive equilibrium model of capital structure and industry dynamics. In the model, firms make financing, investment, entry, and exit decisions subject to idiosyncratic technology shocks. The capital structure choice reflects the tradeoff between the tax benefits of debt and the associated bankruptcy and agency costs. The interaction between financing and production decisions influences the stationary distribution of firms and their survival probabilities. The analysis demonstrates that the equilibrium output price has an important feedback effect. This effect has a number of testable implications. For example, high growth industries have relatively lower leverage and turnover rates. THE INTERACTION BETWEEN CAPITAL STRUCTURE and product market decisions has recently received considerable attention in both economics and finance. Beginning

In a setting where firms can choose their capital structures, we derive the optimal compensation contract for employees who are averse to bearing their own human capital risk, while equity holders can diversify this risk away. In the absence of other frictions, the optimal contract implies that all firms will be unlevered, and instead will hold cash. In the presence of corporate taxes, the optimal contract implies optimal debt levels consistent with those observed, implying that the importance of human capital risk is comparable to that of taxes in the capital structure decision. Our model makes a number of predictions for the cross-sectional distribution of firm leverage. Consistent with existing empirical evidence, it implies the existence of persistent unexplained idiosyncratic differences in leverage across firms. It also predicts that, ceteris paribus, firms with more leverage should pay higher wages, an as yet unexplored empirical implication of the model. JEL classification: G14.

We simulate marginal tax rates (MTRs) from 1998 to 2000 using U.S. tax return data for public corporations. We compare these tax rates to those calculated from public financial statement data and find that Graham’s (1996a) simulated tax rate is the book variable most highly correlated with the simulated tax return rate. We provide an algorithm to approximate the tax return MTR if the book simulated rate is not available. Finally, we find that tax return MTRs are significantly correlated with financial statement corporate debt ratios, although less so than the correlation between book MTRs and debt ratios.

This paper develops a model in the spirit of Hennessy and Whited (2005) in which the capital structure dynamics associated with transitory debt fully explain the long-horizon leverage paths documented by Lemmon, Roberts, and Zender (2008). The model shows how and why debt serves as a transitory financing vehicle to meet the funding needs associated with random shocks to investment opportunities. It yields a variety of new testable predictions about the time paths of leverage and the link between investment and capital structure dynamics. Although these dynamics also reflect financing frictions, predictable variation in capital structure primarily reflects the attributes of firms ’ investment opportunities–e.g., the volatility and serial correlation of investment shocks, the marginal profitability of investment, and the nature of capital stock adjustment costs–with the linkage between investment attributes and leverage dynamics reflecting firms ’ usage of transitory debt.

Corporate finance theory studies the way that firms choose to raise funds. Traditionally, this theory focused on the effect of capital structure on income tax payments and exogenously specified administrative costs of bankruptcy. More recently, this theory has emphasized the effect of capital structure on the control of subsequent investment decisions of the firm, in settings where managers ’ and investors ’ incentives are not perfectly aligned. Both the tax-oriented approach and the control-oriented approach capture important aspects of the decision that firms make when they choose a method of finance. To date, however, the insights from the two theories have not been integrated. Tax-oriented theories typically ignore issues of corporate control, while control-oriented theories typically ignore taxes. In addition, tax-oriented theories consider only a firm’s choice between debt and equity, while some of the control-oriented theories study the importance of the source of debt finance: the choice between bank loans (privately placed debt) and bonds (publicly issued debt). This article combines traditional tax-based capital structure theory with an analysis of the control and incentive effects of debt. It presents a model of both the firm’s choice of the amount of debt and equity and its choice between bank loans and publicly traded debt. Following the traditional approach, capital structure choice is framed as a trade-off between tax savings of debt and costs of bankruptcy. Accounting for the control roles of bank loans and public debt

This paper sets out to address the issue of equity duration, one of several risk measures available for asset and liability management. Equity duration, as derived from the use of traditional dividend discount models, results in extremely long duration estimates for equities- often in excess of 50 years for growth stocks. Leibowitz, in his seminal paper (1986), identified an alternative framework for assessing equity duration empirically. This methodology yields equity duration measures more consistent with the experience of practitioners, implying that equities behave as if they are much shorter duration instruments. In our paper, based on an application to UK data, we develop the intuition behind the Leibowitz approach to generate equity duration as a by-product of asset pricing. Our analysis suggests that the equity premium puzzle may comprise an important element in reconciling the Leibowitz approach to equity duration, with the more traditional dividend discount model alternative.

This paper addresses the theoretical foundations of bankruptcy prediction, using the neo-classical theory of capital structure as a starting point. The paper intends to demonstrate the feasibility of such an approach in a simple setting, i.e. by using a simple theoretical model and a limited empirical analysis. A model of optimal capital structure is constructed and rewritten as a model of default probability. Its empirical implications are derived and tested on a sample of Norwegian data. It is concluded that this approach clearly has its limitations, but also that it may be a valuable contribution compared to the multitude of theory-less empirical studies and a useful alternative to the default theory based on option pricing.

This paper studies the impact of the presence of bankers in the board of a corporation on its capital structure. We assume that the presence of bankers reduces information asymmetry problems, facilitating information transmission between corporations and financial institutions. Using a large database on Board of Directors, we construct the directors’s social network and measure the relative influence (centrality) of bankers on the information transmission mechanism. Our results indicate that the presence of bankers in the board increases the leverage ratio in US. This effect is magnified by the influence of the banker, i.e. the more connected a banker is, the higher the leverage ratio of the firm in which he or she sits. We also show that he effect of banker’s social influence on the leverage ratio increases with firm’s opacity, which is consistent with our interpretation of the role of bankers on the information transmission mechanism.

Are trade-off and pecking order theories mutually exclusive in explaining capital structure decisions?