Hostname: page-component-745bb68f8f-v2bm5 Total loading time: 0 Render date: 2025-01-25T20:30:36.398Z Has data issue: false hasContentIssue false
  • English
  • Français

The Capital Structure Puzzle: What Are We Missing?

Published online by Cambridge University Press:  14 January 2022

Harry DeAngelo Open the ORCID record for Harry DeAngelo [Opens in a new window]
Harry DeAngelo*
Affiliation:
USC Marshall School of Business
*
hdeangelo@marshall.usc.edu
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

An important piece of the capital structure puzzle has been missing, and it is not a contracting friction. It is recognition that managers do not have sufficient knowledge to optimize capital structure with any real precision. The literature critique in this paper i) identifies the conceptual sources of the main empirical failures of the leading models of capital structure and ii) shows how those failures can be repaired by taking into account imperfect managerial knowledge and several other factors. The analysis yields a compact set of principles for thinking about capital structure in an empirically supported way.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 2 , March 2022 , pp. 413 - 454
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

I thank Malcolm Baker, David Denis, Eugene Fama, Andrei Gonçalves, John Graham, Jarrad Harford (the editor), Gerard Hoberg, Jonathan Karpoff, Arthur Korteweg, Stewart Myers, Christopher Parsons, Rodney Ramcharan, Jay Ritter, Richard Roll, Andrei Shleifer, René Stulz, Sheridan Titman, Ivo Welch, and an anonymous referee for helpful comments. I owe special thanks to René Stulz for many useful discussions on this paper and, more generally, about corporate finance over the last 40 years.

References

Acharya, V.; Almeida, H.; and Campello, M.. “Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies.” Journal of Financial Intermediation, 16 (2007), 515–554.CrossRefGoogle Scholar
Acharya, V., and Steffen, S.. “The Risk of Being a Fallen Angel and the Corporate Dash for Cash in the Midst of Covid.” Review of Corporate Finance Studies, 9 (2020), 430–471.CrossRefGoogle Scholar
Admati, A.; DeMarzo, P.; Hellwig, M.; and Pfleiderer, P.. “The Leverage Ratchet Effect.” Journal of Finance, 73 (2018), 145–198.CrossRefGoogle Scholar
Alchian, A. “Uncertainty, Evolution, and Economic Theory,” Journal of Political Economy, 58 (1950), 211–221.CrossRefGoogle Scholar
Asquith, P.; Mullins, D.; and Wolff, E.. “Original Issue High Yield Bonds: Aging Analyses of Defaults, Exchanges, and Calls.” Journal of Finance, 44 (1989), 923–952.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 1–32.CrossRefGoogle Scholar
Bargeron, L.; Denis, D.; and Lehn, K.. “Financing Investment Spikes in the Years Surrounding World War I.” Journal of Financial Economics, 130 (2018), 215–236.CrossRefGoogle Scholar
Barzel, Y. “Measurement Cost and the Organization of Markets.” Journal of Law and Economics, 25 (1982), 27–48.CrossRefGoogle Scholar
Bertrand, M., and Schoar, A.. “Managing with Style.” Quarterly Journal of Economics, 118 (2003), 1169–1208.CrossRefGoogle Scholar
Binsbergen, J.; Graham, J.; and Yang, J.. “The Cost of Debt.” Journal of Finance, 65 (2010), 2089–2136.CrossRefGoogle Scholar
Black, F. “The Dividend Puzzle.” Journal of Portfolio Management, 2 (1976), 5–8.CrossRefGoogle Scholar
Black, F. “Noise.” Journal of Finance, 41 (1986), 528–543.CrossRefGoogle Scholar
Black, F., and Scholes, M.. “The Effects of Dividend Yield and Dividend Policy on Common Stock Prices and Returns.” Journal of Financial Economics, 1 (1974), 1–22.CrossRefGoogle Scholar
Brav., A.; Graham, J.; Harvey, C.; and Michaely, R.. “Payout Policy in the 21st Century.” Journal of Financial Economics, 77 (2005), 483–527.CrossRefGoogle Scholar
Browne, J. Darwin’s Origin of Species. New York, NY: Grove Press (2006).Google Scholar
Campello, M.; Graham, J.; and Harvey, C.. “The Real Effects of Financial Constraints.” Journal of Financial Economics, 97 (2010), 470–487.CrossRefGoogle Scholar
Collins, D.; Morduch, J.; Rutherford, S.; and Ruthven, O.. Portfolios of the Poor. Princeton, NJ: Princeton University Press (2009).Google Scholar
Dann, L. “Common Stock Repurchases: An Analysis of Returns to Shareholders and Bondholders.” Journal of Financial Economics, 9 (1981), 113–138.CrossRefGoogle Scholar
Darwin, C. On the Origin of Species. Facsimile of the first edition (1859). Cambridge, MA and London, England: Harvard University Press (reprinted 1964).Google Scholar
DeAngelo, H. “Competition and Unanimity.” American Economic Review, 71 (1981), 18–29.Google Scholar
DeAngelo, H. “Corporate Financial Policy: What Really Matters?” Journal of Corporate Finance, 68 (2021), 101925.CrossRefGoogle Scholar
DeAngelo, H., and DeAngelo, L.. “Capital Structure, Payout Policy, and Financial Flexibility.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=916093 (2007).CrossRefGoogle Scholar
DeAngelo, H.; DeAngelo, L.; and Skinner, D.. “Corporate Payout Policy.” Foundations and Trends in Finance, 3 (2009), 95–287. Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1400682.CrossRefGoogle Scholar
DeAngelo, H.; DeAngelo, L.; and Whited, T.. “Capital Structure Dynamics and Transitory Debt.” Journal of Financial Economics, 99 (2011), 235–261.CrossRefGoogle Scholar
DeAngelo, H.; Gonçalves, A.; and Stulz, R. “Corporate Deleveraging and Financial Flexibility.” Review of Financial Studies, 31 (2018), 3122–3174.CrossRefGoogle Scholar
DeAngelo, H.; Gonçalves, A.; and Stulz, R.. “Leverage and Cash Dynamics.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3871170 (2021).CrossRefGoogle Scholar
DeAngelo, H., and Masulis, R.. “Optimal Capital Structure Under Corporate and Personal Taxation.” Journal of Financial Economics, 8 (1980), 3–29.CrossRefGoogle Scholar
DeAngelo, H., and Roll, R.. “How Stable Are Corporate Capital Structures?” Journal of Finance, 70 (2015), 373–418.CrossRefGoogle Scholar
DeAngelo, H., and Roll, R.. “Capital Structure Instability.” Journal of Applied Corporate Finance, 28 (2016), 38–52.Google Scholar
DeAngelo, H., and Stulz, R.. “Liquid-Claim Production, Risk Management, and Bank Capital Structure: Why High Leverage Is Optimal for Banks.” Journal of Financial Economics, 116 (2015), 219–236.CrossRefGoogle Scholar
Denis, D. “Organizational Form and the Consequences of Highly Leveraged Transactions: Kroger’s Recapitalization and Safeway’s LBO.” Journal of Financial Economics, 36 (1994), 193–224.CrossRefGoogle Scholar
Denis, D., and McKeon, S.. “Debt Financing and Financial Flexibility: Evidence from Proactive Leverage Increases.” Review of Financial Studies, 25 (2012), 1897–1929.CrossRefGoogle Scholar
Denis, D., and McKeon, S.. “Persistent Negative Cash Flows, Staged Financing, and the Stockpiling of Cash Balances.” Journal of Financial Economics, 142 (2021), 293–313.CrossRefGoogle Scholar
Diamond, D., and Dybvig, P.. “Bank Runs, Deposit Insurance, and Liquidity.” Journal of Political Economy, 99 (1983), 689–721.CrossRefGoogle Scholar
Diamond, D., and Rajan, R.. “Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking.” Journal of Political Economy, 109 (2001), 287–327.CrossRefGoogle Scholar
Duchin, R.; Gilbert, T.; Harford, J.; and Hrdlicka, C.. “Precautionary Savings with Risky Assets: When Cash Is Not Cash.” Journal of Finance, 72 (2016), 793–852.CrossRefGoogle Scholar
Easterbrook, F. “Two Agency-Cost Explanations of Dividends.” American Economic Review, 74 (1984), 650–659.Google Scholar
Fama, E., and French, K.. “Taxes, Financing Decisions, and Firm Value.” Journal of Finance, 53 (1998), 819–843.CrossRefGoogle Scholar
Fama, E., and French, K.. “Who Issues Stock?” Journal of Financial Economics, 76 (2005), 549–582.CrossRefGoogle Scholar
Fama, E., and French, K.. “Capital Structure Choices.” Critical Finance Review, 1 (2012), 59–101.CrossRefGoogle Scholar
Fama, E., and Miller, M.. The Theory of Finance. Hinsdale, IL: Dryden Press (1972).Google Scholar
Farre-Mensa, J.; Michaely, R.; and Schmalz, M.. “Financing Payouts.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2535675 (2020).Google Scholar
Fee, C.; Hadlock, C.; and Pierce, J.. “Managers With and Without Style: Evidence Using Exogenous Variation.” Review of Financial Studies, 26 (2013), 567–601.CrossRefGoogle Scholar
Frank, M., and Goyal, V.. “Capital Structure: Which Factors Are Reliably Important?” Financial Management, 38 (2009), 1–37.CrossRefGoogle Scholar
Frank, M.; Goyal, V.; and Shen, T.. “The Pecking Order Theory of Capital Structure: Where Do We Stand?” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3540610 (2020).CrossRefGoogle Scholar
Gorton, G. Slapped by the Invisible Hand: The Panic of 2007. Oxford, UK: Oxford University Press (2010).Google Scholar
Gorton, G. Misunderstanding Financial Crises. Oxford, UK: Oxford University Press (2012).Google Scholar
Gorton, G., and Pennacchi, G.. “Financial Intermediaries and Liquidity Creation.” Journal of Finance, 45 (1990), 49–71.CrossRefGoogle Scholar
Graham, J. “Corporate Finance and Reality.” Working Paper, Duke University (2021).Google Scholar
Graham, J., and Harvey, C.. “The Theory and Practice of Corporate Finance: Evidence from the Field.” Journal of Financial Economics, 60 (2001), 187–243.CrossRefGoogle Scholar
Graham, J., and Leary, M.. “A Review of Empirical Capital Structure Research and Directions for the Future.” Annual Review of Financial Economics, 3 (2011), 309–345.CrossRefGoogle Scholar
Graham, J.; Leary, M.; and Roberts, M.. “A Century of Capital Structure: The Leveraging of Corporate America.” Journal of Financial Economics, 118 (2015), 658–683.CrossRefGoogle Scholar
Graham, J., and Narasimhan, K.. “Corporate Survival and Managerial Experiences During the Great Depression.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=489694 (2004).CrossRefGoogle Scholar
Harford, J.; Klasa, S.; and Walcott, N.. “Do Firms Have Leverage Targets? Evidence from Acquisitions.” Journal of Financial Economics, 93 (2008), 1–14.CrossRefGoogle Scholar
He, W.; Hu, M.; Mi, L..; and Yu, J.. “How Stable Are Corporate Capital Structures? International Evidence.” Journal of Banking and Finance, 126 (2021), 106103.CrossRefGoogle Scholar
Hennessy, C., and Whited, T.. “Debt Dynamics.” Journal of Finance, 60 (2005), 1129–1165.CrossRefGoogle Scholar
Hovakimian, A. “The Role of Target Leverage in Security Issues and Repurchases.” Journal of Business, 77 (2004), 1041–1077.CrossRefGoogle Scholar
Hovakimian, A.; Kayhan, A.; and Titman, S.. “Credit Rating Targets.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1098351 (2009).CrossRefGoogle Scholar
Huang, R., and Ritter, J.. “Testing Theories of Capital Structure and Estimating the Speed of Adjustment.” Journal of Financial and Quantitative Analysis, 44 (2009), 237–271.CrossRefGoogle Scholar
Huang, R., and Ritter, J.. “Corporate Cash Shortfalls and Financing Decisions.” Review of Financial Studies, 34 (2021), 1789–1833.CrossRefGoogle Scholar
Im, H.; Mayer, C.; and Sussman, O.. “Heterogeneity in Investment Spike Financing.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2468424 (2020).Google Scholar
Ivashina, V., and Scharfstein, D.. “Bank Lending During the Financial Crisis of 2008.” Journal of Financial Economics, 97 (2010), 319–338.CrossRefGoogle Scholar
Jensen, M. “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.” American Economic Review, 76 (1986), 323–329.Google Scholar
Jensen, M., and Meckling, W.. “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.” Journal of Financial Economics, 3 (1976), 305–360.CrossRefGoogle Scholar
Kay, J., and King, M.. Radical Uncertainty. New York, NY: W.W. Norton & Company (2020).Google Scholar
Keynes, J. The General Theory of Employment, Interest, and Money. Reprint of original publication (1936) by Macmillan. San Diego, CA: Harcourt (1964).Google Scholar
Kisgen, D. “Credit Ratings and Capital Structure.” Journal of Finance, 61 (2006), 1035–1072.CrossRefGoogle Scholar
Kisgen, D. “Do Firms Target Credit Ratings or Leverage Levels?” Journal of Financial and Quantitative Analysis, 44 (2009), 1323–1344.CrossRefGoogle Scholar
Knight, F. Risk, Uncertainty, and Profit. Boston, MA: Hart, Schaffner & Marx (1921).Google Scholar
Korteweg, A. “The Net Benefits to Leverage.” Journal of Finance, 65 (2010), 2137–2170.CrossRefGoogle Scholar
Korteweg, A.; Schwert, M.; and Strebulaev, I.. “Proactive Capital Structure Adjustments: Evidence from Corporate Filings.” Journal of Financial and Quantitative Analysis, 57 (2022), 31–66.CrossRefGoogle Scholar
Lambrecht, B., and Myers, S. “A Theory of Takeovers and Disinvestment.” Journal of Finance, 62 (2007), 809–845.CrossRefGoogle Scholar
Leland, H. “Corporate Debt Value, Bond Covenants, and Optimal Capital Structure.” Journal of Finance, 49 (1994), 1213–1252.CrossRefGoogle Scholar
Lemmon, M.; Roberts, M.; and Zender, J.. “Back to the Beginning: Persistence and the Cross-Section of Corporate Capital Structures.” Journal of Finance, 63 (2008), 1575–1608.CrossRefGoogle Scholar
Lins, K.; Servaes, H.; and Tufano, P.. “What Drives Corporate Liquidity? An International Survey of Cash Holdings and Lines of Credit.” Journal of Financial Economics, 98 (2010), 160–176.CrossRefGoogle Scholar
Lo, A. Adaptive Markets: Financial Evolution at the Speed of Thought. Princeton, NJ: Princeton University Press (2017).Google Scholar
Loughran, T., and Ritter, J.. “The New Issues Puzzle.” Journal of Finance, 50 (1995), 23–51.CrossRefGoogle Scholar
Ma, Y. “Nonfinancial Firms as Cross-Market Arbitrageurs.” Journal of Finance, 74 (2019), 3041–3087.CrossRefGoogle Scholar
Mackay, P., and Phillips, G.. “How Does Industry Affect Financial Structure?” Review of Financial Studies, 18 (2005), 1433–1466.CrossRefGoogle Scholar
Masulis, R. “The Effect of Capital Structure Change on Security Prices: A Study of Exchange Offers.” Journal of Financial Economics, 8 (1980), 139–178.CrossRefGoogle Scholar
Mayer, C., and Sussman, O.. “A New Test of Capital Structure.” Working Paper, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=643388 (2005).CrossRefGoogle Scholar
Miller, M. “Debt and Taxes.” Journal of Finance, 32 (1977), 261–275.Google Scholar
Modigliani, F., and Miller, M.. “The Cost of Capital, Corporation Finance, and the Theory of Investment.” American Economic Review, 48 (1958), 261–197.Google Scholar
Myers, S. “Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (1977), 147–175.CrossRefGoogle Scholar
Myers, S. “MM and Keynes.” Slides prepared for keynote speech at the Cambridge Corporate Finance Theory Symposium, Sept. 12 (2020).Google Scholar
Myers, S., and Majluf, N.. “Corporate Financing and Investment Decisions When Firms Have Information that Investors Do Not Have.” Journal of Financial Economics, 13 (1984), 187–221.CrossRefGoogle Scholar
Rajan, R., and L. Zingales, L.. “What Do We Know About Capital Structure? Some Evidence from International Data.” Journal of Finance, 50 (1995), 1421–1460.CrossRefGoogle Scholar
Ritter, J. “The Long-Run Performance of Initial Public Offerings.” Journal of Finance, 46 (1991), 3–27.CrossRefGoogle Scholar
Robichek, A., and Myers, S.. “Problems in the Theory of Optimal Capital Structure.” Journal of Financial and Quantitative Analysis, 1 (1966), 1–35.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “The Limits of Arbitrage.” Journal of Finance, 52 (1997), 35–55.CrossRefGoogle Scholar
Strebulaev, I., and Yang, B.. “The Mystery of Zero-Leverage Firms.” Journal of Financial Economics, 109 (2013), 1–23.CrossRefGoogle Scholar
Sufi, A. “Bank Lines of Credit in Corporate Finance: An Empirical Analysis.” Review of Financial Studies, 22 (2009), 1057–1088.CrossRefGoogle Scholar
Taggart, R. “Secular Patterns in the Financing of U.S. Corporations.” In Corporate Capital Structures in the United States, Friedman, B., ed. Chicago, IL: University of Chicago Press (1985).Google Scholar
Titman, S. “The Modigliani–Miller Theorem and the Integration of Financial Markets.” Financial Management, 31 (2002), 101–115.CrossRefGoogle Scholar
Uysal, V. “Deviation from Target Capital Structure and Acquisition Choice.” Journal of Financial Economics, 102 (2011), 602–620.CrossRefGoogle Scholar
Vermaelen, T. “Common Stock Repurchases and Market Signaling: An Empirical Study.” Journal of Financial Economics, 9 (1981), 139–183.CrossRefGoogle Scholar
Warusawitharana, M., and Whited, T.. “Equity Market Misvaluation, Financing, and Investment.” Review of Financial Studies, 29 (2016), 603–654.Google Scholar
Welch, I. “Capital Structure and Stock Returns.” Journal of Political Economy, 112 (2004), 106–131.CrossRefGoogle Scholar
Yin, Q., and Ritter, J.. “The Speed of Adjustment to Target Market Value Leverage is Slower than You Think.” Journal of Financial and Quantitative Analysis, 54 (2019), 1–32.Google Scholar