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Imperfect Market or Imperfect Theory: A Unified Analytical Theory of Production and Capital Structure of Firms

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Author Info
Jing Chen (University of Northern British Columbia)

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Abstract

We present a unified analytical theory of production and capital structure of firms. It is extended from an analytical theory of production, whose main result is an analytical formula of variable cost of production as a function of fixed cost and uncertainty. Problems on capital structure can be naturally incorporated into the theory on production from a simple observation. Debt is fixed income for investors and hence fixed cost for issuing firms. The decision on capital structure is part of the decision process that determines the level of the fixed cost and variable cost of firms to achieve a high rate of return based on the understanding of current and future market conditions. The new theory offers a simple and parsimonious understanding to a broad range of empirical patterns documented in the literature. It reinforces the impression from other recent studies that puzzles in corporate finance often result not from “imperfect market” but rather from “imperfect theory”.

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Publisher Info
Paper provided by EconWPA in its series Finance with number 0509009.

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Length: 18 pages
Date of creation: 08 Sep 2005
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Handle: RePEc:wpa:wuwpfi:0509009

Note: Type of Document - pdf; pages: 18
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Web page: http://129.3.20.41

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Related research
Keywords: capital structure; analytical theory; fixed cost; variable cost; imperfection;

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Find related papers by JEL classification:
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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  3. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June. [Downloadable!] (restricted)
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  11. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
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  13. Hovakimian, Armen & Hovakimian, Gayane & Tehranian, Hassan, 2004. "Determinants of target capital structure: The case of dual debt and equity issues," Journal of Financial Economics, Elsevier, vol. 71(3), pages 517-540, March. [Downloadable!] (restricted)
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