This review evaluates the four major theories of corporate financing: (1) the Modigliani-Miller theory of capital-structure irrelevance, in which firm values and real investment decisions are unaffected by financing; (2) the trade-off theory, in which firms balance the tax advantages of borrowing against the costs of financial distress; (3) agency theories, in which financing responds to managers' personal incentives; and (4) the pecking-order theory, in which financing adapts to mitigate problems created by differences in information.These theories are conditional, not general. It is easy to find examples of each theory at work, but otherwise difficult to distinguish the theories empirically. Large, safe firms with mostly tangible assets tend to borrow more. Firms with high profitability and valuable growth opportunities tend to borrow less. Each of these tendencies is consistent with two or more of the major theories of financing. It may be possible to devise sharper tests by exporting the theories to developing economies, where agency and information problems are more severe.Further progress in understanding corporate financing decisions will require a deeper understanding of agency issues when value-maximizing operating and investment decisions cannot be observed or verified. But managers are not just temporary agents motivated by immediate pecuniary compensation or perquisites. Managers specialize their human capital to the firm. Some recent research suggests how financing can support the co-investment of human and financial capital.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Publisher Info
Download reference. The following formats are available: HTML,
plain text,
BibTeX,
RIS (EndNote),
ReDIF This chapter was published in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.) Handbook of the Economics of Finance, , chapter 04, pages 215-253, 2003.
For technical questions regarding this item, or to correct its listing, contact: (Heidi Boesdal).
Related research
This chapter was published in the following book, which is listed on IDEAS: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003.
"Handbook of the Economics of Finance,"
Handbook of the Economics of Finance,
Elsevier,
edition 1, volume 1, number 1.
[Downloadable!] (restricted) Keywords:
Find related papers by JEL classification: G3 - Financial Economics - - Corporate Finance and Governance