Capital Structure Decisions: Evaluating Risk and Uncertainty

Chapter Twelve

The Role of a Decision Maker in Capital Structure Decisions

CAPITAL STRUCTURE DECISIONS ARE strategic decisions governed and determined by a firm’s top management. Theories on capital structures and new models closely identify the economic costs and benefits associated with the decision but fail to incorporate the role of the decision maker in the decision-making process. Myers (1984) mentioned that the trade-off theory and the pecking order theory were able to explain some financing patterns, but several patterns could not be explained by these theories. Most theories on capital structure are based on the premise of a decision maker’s rationality, which is strictly instrumental for achieving the goal through predefined models, as if the decision maker could be replaced with a computerised program. The actions and the inaction of a decision maker may range in a continuum from rationality to irrationality. Given the knowledge of the decision maker, he alone and no one else can comment on the rationality of his decision. What may appear to be completely irrational from the outside may well be rational on the part of the decision maker. In this continuum of decision making, no decision can be classified as fully rational or irrational, but decisions can be classified as informed decisions. Unfortunately, most theories consider the economic costs of the decision maker’s choices as agency cost or others. They fail to incorporate the behavioural aspect of Myers’s decision-making ...