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

P1: TIX/XYZ P2: ABC

JWBT436-c10 JWBT436-Baker February 11, 2011 9:6 Printer Name: Hamilton

CHAPTER 10

Trade-Off, Pecking Order,

Signaling, and Market

Timing Models

ANTON MIGLO

Associate Professor, University of Bridgeport

INTRODUCTION

The modern theory of capital structure began with the famous proposition of

Modigliani and Miller (1958) that described the conditions of capital structure ir-

relevance. Since then, many financial economists have altered these conditions to

explain the factors driving capital structure decisions. Harris and Raviv (1991) syn-

thesize the major theoretical literature in the field and suggest promising avenues

for future research. They argue that asymmetric information theories of capital

structure are less promising than control-based or product-based theories.

The financial crisis during 2008 and 2009 forced financial economists to look

critically at capital structure theory because the problems faced by many compa-

nies stemmed from their financing policies. Corporate managers appeared to lack

an understanding of the role of asymmetric information and agency problems.

The market for mortgage-backed securities, which many believe was at the core of

financial crisis, involved asymmetric information between investors and issuers.

Various scandals, such as the one involving Bernie Madoff, illustrate the depth of

agency problems in finance. Financial economists failed to give sufficient atten-

tion to the links among taxes, bankruptcy costs, and capital structure until recent

surveys ...