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Capital Structure under Heterogeneous Beliefs

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  • Hae Won (Henny) Jung
  • Ajay Subramanian

Abstract

We develop a structural model to quantitatively analyze the effects of asymmetric beliefs and agency conflicts on capital structure. Capital structure reflects the dynamic tradeoff between the positive incentive effects of managerial optimism and the negative effects of risk-sharing costs. Consistent with empirical evidence, long-term debt declines with optimism, whereas short-term borrowing increases. Permanent and transitory risk components have contrasting effects. Long-term debt increases with the intrinsic risk, but varies nonmonotonically with the transient risk. Short-term borrowing declines with the intrinsic risk, but increases with the transient risk. Overall, our findings show that asymmetric beliefs significantly influence firms’ financial policies.

Suggested Citation

  • Hae Won (Henny) Jung & Ajay Subramanian, 2014. "Capital Structure under Heterogeneous Beliefs," Review of Finance, European Finance Association, vol. 18(5), pages 1617-1681.
    • Handle: RePEc:oup:revfin:v:18:y:2014:i:5:p:1617-1681.
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    2. Weining Niu, 2017. "Corporate Financing Under Heterogeneous Beliefs," Annals of Financial Economics (AFE), World Scientific Publishing Co. Pte. Ltd., vol. 12(04), pages 1-12, December.
    3. Gungoraydinoglu, Ali & Çolak, Gönül & Öztekin, Özde, 2017. "Political environment, financial intermediation costs, and financing patterns," Journal of Corporate Finance, Elsevier, vol. 44(C), pages 167-192.
    4. Hong-Yi Chen & Cheng Few Lee & Tzu Tai, 2020. "The Joint Determinants of Capital Structure and Stock Rate of Return: A LISREL Model Approach," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 35, pages 1345-1397, World Scientific Publishing Co. Pte. Ltd..
    5. Shilin Li & Jinqiang Yang & Siqi Zhao, 2022. "Robust leverage dynamics without commitment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 74(2), pages 643-679, September.

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