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EPS-Maximizing Capital Structure

Author

Listed:
  • Itzhak Ben-David
  • Alex Chinco

Abstract

A simple EPS-maximizing model delivers a rich set of capital-structure implications. The earnings cost of equity is a firm’s earnings yield. The earnings cost of debt is the interest expense on the next dollar borrowed. CEOs lever up when creditors want less earnings than shareholders for the marginal dollar. There is an EPS-maximizing leverage before adding frictions. “Value stocks” have earnings yields above the riskfree rate. They see riskfree debt as cheap, lever up, and repurchase shares. “Growth stocks” have earnings yields below the riskfree rate. They see equity as cheaper, remain unlevered, and hold cash. Data support these predictions.

Suggested Citation

  • Itzhak Ben-David & Alex Chinco, 2023. "EPS-Maximizing Capital Structure," NBER Working Papers 31125, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:31125
    Note: AP CF
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    File URL: http://www.nber.org/papers/w31125.pdf
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    More about this item

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • 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
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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