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  Marginal benefit of debt declines are debt increases – there is an optimal capital structure

Capital structure and trade-off

Initial tests sought to regress leverage against proxies for costs and benefits [Titman & Wessels,1988; Rajan & Zingales, 1995]
Profit, Marginal tax rate, Earnings volatility (Z-score), Book-to-Market, Capex, R&D
Leverage is positively related to marginal tax rate, asset tangibility & firm size
Leverage is negatively related to market-to-book ratio &non-debt tax shields
But leverage is negatively related to profitability

Institutional structures matter

Leverage influenced by:
market (equity and bond) development
institutional structures – preferences of suppliers of capital
governmental and legal systems
corporate governance regime
tax regime
Fan, Titman & Twite (2008)

Product market

Debt induces unions to act less aggressively
Bronars & Deere (1991)
Highly levered (transport) firms are less likely to survive deregulation than lower levered peers. Highly levered firms invest less aggressively and lower prices earlier
Zingales (1998)
Exogenous shock in leverage in grocery sector – oil prices. Competitor less (more) levered, LBOs lead decrease (increases) price, opportunistic predation by less financially constrained competitors (LBOs soften product market competition)
Chevalier (1995)

Testing Trade-off

Firms operate under a target D/E ratio, representing some “optimal D/E ratio.”
Firms do not instantaneously achieve their target D/E ratio.
They adjust the actual D/E ratio over time.
A dynamic trade-off model where the spped of adjustment is a function of market frictions.

Dynamic trade-off model

where Di,t is firm i’s realized D/E in period t, D*i,t is firm i’s target D/E ratio, Δ is the difference operator, γi is the partial adjustment coefficient (also called speed of adjustment); 0 ≤ γi ≤1, and ei,t is a regression error.
This model can be estimated using OLS.

M-M and the irrelevance of capital structure (Proposition I)
M-M and the cost of capital (Proposition II)
M-M and the irrelevance of distribution policy (Proposition III)

Assumption of MM

Frictionless capital markets
No taxes
corporate or personal
No costs of bankruptcy
No agency costs
Management maximizes the value of the firm, regardless of capital structure.
What happens when we relax them?

Capital structure matters?

If MM’s assumptions are violated, then capital structure matters.
Usual violations
Traditional finance: bankruptcy costs, agency problems, non-convex taxes, asymmetric information.
Behavioral finance: inefficient markets, managerial and investor behavior.
If MM is violated, what is the “optimal” capital structure?

Trade-off theory I

Target debt-equity ratio

But the target debt-equity ratio, D*i,t, is unobservable:it is not possible to directly test the dynamic trade-off model. Instead estimate the t本论文由英语论文网提供整理，提供论文代写，英语论文代写，代写论文，代写英语论文，代写留学生论文，代写英文论文，留学生论文代写相关核心关键词搜索。