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The Effect of Business Risk on Corporate Capital Structure: Theory and Evidence

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  • Kale, Jayant R
  • Noe, Thomas H
  • Ramirez, Gabriel G

Abstract

Under corporate and personal taxation, the authors demonstrate that the relation between optimal debt level and business risk is roughly U-shaped. This result follows from the fact that the tax liability is an option portfolio that is long in the corporate tax option and short in the personal tax option. Therefore, the net effect of a change in business risk on the optimal debt level depends upon the relative magnitudes of the resultant marginal changes in the values of these two options. Results of empirical tests offer support for the predicted U-shaped relationship. Copyright 1991 by American Finance Association.

Suggested Citation

  • Kale, Jayant R & Noe, Thomas H & Ramirez, Gabriel G, 1991. " The Effect of Business Risk on Corporate Capital Structure: Theory and Evidence," Journal of Finance, American Finance Association, vol. 46(5), pages 1693-1715, December.
  • Handle: RePEc:bla:jfinan:v:46:y:1991:i:5:p:1693-715
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