Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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JWBT436-c01 JWBT436-Baker February 11, 2011 7:53 Printer Name: Hamilton

CHAPTER 1

Capital Structure: An Overview

H. KENT BAKER

University Professor of Finance and Kogod Research Professor, American University

GERALD S. MARTIN

Associate Professor of Finance, American University

INTRODUCTION

According to Baker and Powell (2005, p. 4), financial management is “an inte-

grated decision-making process concerned with acquiring, financing, and man-

aging assets to accomplish some overall goal within a business entity.” Jensen

(2001) indicates that among most financial economists the criterion for evaluat-

ing performance and deciding between alternative courses of action should be

maximization of long-term market value of the firm. He notes that this value maxi-

mization proposition has its roots in 200 years of research in economics and finance.

For publicly-held firms, the maximization of shareholder wealth is reflected in the

market price of the stock. By maximizing shareholder wealth, managers are serving

the interests of the firm’s owners as residual claimants. Under most circumstances,

the premise of maximizing total firm value is also consistent with maximizing

shareholder wealth.

This book focuses on one major aspect of financial management—how capital

structure and financing decisions can contribute to maximizing the value of the

firm. Financing decisions go hand in hand with investment decisions. That is, a

firm needs sufficient funds to support its activities resulting from its investment ...