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Investment-Based Trade-Off Theory

Author

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  • Hackbarth, Dirk
  • Stahmer, Axel

Abstract

This paper develops a novel trade-off theory of capital structure. When frequent re-balancing of firm leverage is restricted due to capital structure stickiness (or refinancing frictions), optimal capital structure reflects current and future investment profitability. That is, optimal leverage crucially depends on the asset growth and tax rate, and yields various capital structure equilibria, such as all-debt, all-equity, and debt-equity financing, by balancing the tax benefits of debt and the cash benefits of equity. Notably, the model endogenously generates low and zero leverage and also offers insights into the determinants of leverage life-cycle patterns observed in practice

Suggested Citation

  • Hackbarth, Dirk & Stahmer, Axel, 2025. "Investment-Based Trade-Off Theory," CEPR Discussion Papers 20511, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:20511
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    File URL: https://cepr.org/publications/DP20511
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    Keywords

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    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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