Capital Structure Decisions: Evaluating Risk and Uncertainty

Chapter Nine

Theoretical Frameworks for Capital Structure Decision Making

THEORIES ON CAPITAL STRUCTURE decisions provide for a full array of financial policy choices. Corporate financing choices are a puzzle for researchers, and every attempt has been made to solve this puzzle, using contradictory views and opinions empirically tested and developed in the past. Practitioners and students may find it amusing that such contradictions exist simultaneously. When such contradictions persist in the theories, one may question the relevance of reading and understanding these theories. Yet each work or theory, despite its contradiction, offers a new vertical or horizontal dimension to the practitioner, which helps him make a more informed decision about his choices. Theoretical models that are limited by their assumptions are not perfect solutions to practical problems but are an outline of how to approach the problem. In this chapter, we discuss some of the existing and new research on capital structure decisions to bring to light several dimensions that can aid the decision-making process.

REVIEW AND SYNTHESIS OF THEORETICAL FRAMEWORKS

Capital structure decision making assumed importance with Harris’s original work in 1954, with his definition of capital structures. The definition associated capital structures with asset values, bank solvency, and the availability of credit to the business community. Later on, the work of Dobrovolsky in 1955 began the debate on financing choices and ...