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Optimal Capital Structure and Project Financing

  • Salman Shah

    (University of Toronto)

  • Anjan V. Thakor

    (Washington University in St. Louis)

We examine the financing and incorporation modes for new projects. There are two objectives. The first is to provide a theory of optimal capital structure that links risk, leverage, and value and is particularly applicable to large firms. Counter to conventional wisdom, we show riskier firms acquire more debt, pay higher interest rates, and have higher values in equilibrium. Second, we provide an economic rational for project financing which entails organizing a new project legally distinct from the firm's other assets. We explain why project financing involves higher leverage than conventional financing and why highly risky assets are project-financed.

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File URL: http://128.118.178.162/eps/fin/papers/0411/0411041.pdf
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Paper provided by EconWPA in its series Finance with number 0411041.

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Length: 35 pages
Date of creation: 29 Nov 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0411041
Note: Type of Document - pdf; pages: 35
Contact details of provider: Web page: http://128.118.178.162

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  1. Kim, E Han, 1978. "A Mean-Variance Theory of Optimal Capital Structure and Corporate Debt Capacity," Journal of Finance, American Finance Association, vol. 33(1), pages 45-63, March.
  2. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  3. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  4. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  5. Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January.
  6. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-75, May.
  7. John G. Riley, 1976. "Informational Equilibrium," UCLA Economics Working Papers 071, UCLA Department of Economics.
  8. DeAngelo, Harry & Masulis, Ronald W., 1980. "Optimal capital structure under corporate and personal taxation," Journal of Financial Economics, Elsevier, vol. 8(1), pages 3-29, March.
  9. 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.
  10. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
  11. Ross, Stephen A, 1985. " Debt and Taxes and Uncertainty," Journal of Finance, American Finance Association, vol. 40(3), pages 637-57, July.
  12. Ramakrishnan, Ram T S & Thakor, Anjan V, 1984. "Information Reliability and a Theory of Financial Intermediation," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 415-32, July.
  13. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  14. Paul K. Chaney & Anjan V. Thakor, 2004. "Incentive Effects of Benevolent Intervention - The case of government loan guarantees," Finance 0411047, EconWPA.
  15. Warner, Jerold B, 1977. "Bankruptcy Costs: Some Evidence," Journal of Finance, American Finance Association, vol. 32(2), pages 337-47, May.
  16. Talmor, Eli & Haugen, Robert & Barnea, Amir, 1985. "The Value of the Tax Subsidy on Risky Debt," The Journal of Business, University of Chicago Press, vol. 58(2), pages 191-202, April.
  17. Heinkel, Robert, 1982. " A Theory of Capital Structure Relevance under Imperfect Information," Journal of Finance, American Finance Association, vol. 37(5), pages 1141-50, December.
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