The Changing Nature of Debt and Equity: A Financial Perspective
As a result of the historical importance of debt and equity, the traditional focus of inquiry into firms’ choice of capital structure has been "What is the optimal debt/equity ratio?" This approach lead to the Modigliani and Miller theorems and a large body of subsequent work but has not been very successful in explaining firms’ actual choices of debt and equity. The notion that firms finance their activities with debt and equity is a simplification; corporations have issued securities other than standard debt and equity for many centuries. This fact and the rapid pace of financial innovation in recent years suggests that a more fundamental issue than "What is the optimal debt/equity ratio?" is "What are the optimal securities that should be issued?" This paper surveys recent studies of capital structure that have looked at this question.
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