On the Existence of an Optimal Capital Structure: Theory and Evidence

On the Existence of an Optimal Capital Structure: Theory and Evidence On the Existence of an Optimal Capital Structure: Theory and Evidence MICHAEL BRADLEY, GREGG A. JARRELL, and E. HAN KIM* ONE OF THE MOST contentious issues in the theory of finance during the past quarter century has been the theory of capital structure. The geneses of this controversy were the seminal contributions by Modigliani and Miller [18, 191. The general academic view by the mid-19709, although not a consensus, was that the optimal capital structure involves balancing the tax advantage of debt against the present value of bankruptcy costs. No sooner did this general view become prevalent in the profession than Miller [16] presented a new challenge by showing that under certain conditions the tax advantage of debt financing at the firm level is exactly offset by the tax disadvantage of debt at the personal level. Since then there has developed a burgeoning theoretical literature attempting to reconcile Miller’s model with the balancing theory of optimal capital structure [e.g., DeAngelo and Masulis [5], Kim [12], and Modigliani [17]. The general result of this work is that if there are significant “leverage-related” costs, such as bankruptcy costs, agency costs of debt, and loss of non-debt tax shields, and if http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

On the Existence of an Optimal Capital Structure: Theory and Evidence

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Publisher
Wiley
Copyright
1984 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1984.tb03680.x
Publisher site
See Article on Publisher Site

Abstract

On the Existence of an Optimal Capital Structure: Theory and Evidence MICHAEL BRADLEY, GREGG A. JARRELL, and E. HAN KIM* ONE OF THE MOST contentious issues in the theory of finance during the past quarter century has been the theory of capital structure. The geneses of this controversy were the seminal contributions by Modigliani and Miller [18, 191. The general academic view by the mid-19709, although not a consensus, was that the optimal capital structure involves balancing the tax advantage of debt against the present value of bankruptcy costs. No sooner did this general view become prevalent in the profession than Miller [16] presented a new challenge by showing that under certain conditions the tax advantage of debt financing at the firm level is exactly offset by the tax disadvantage of debt at the personal level. Since then there has developed a burgeoning theoretical literature attempting to reconcile Miller’s model with the balancing theory of optimal capital structure [e.g., DeAngelo and Masulis [5], Kim [12], and Modigliani [17]. The general result of this work is that if there are significant “leverage-related” costs, such as bankruptcy costs, agency costs of debt, and loss of non-debt tax shields, and if

Journal

The Journal of FinanceWiley

Published: Jul 1, 1984

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