Knightian Uncertainty and Capital Structure: Theory and Evidence

Macroeconomic and institutional determinants of firms% choices of capital structure in Nigeria: a system-GMM approach

“…Modigliani and Miller's theorem of 1958 undoubtedly form the basis for critical modern thinking in recent times on capital structure (Tomschik, 2015). Though the premise of this theory has been argued that it can only be achievable in artificial settings (Smith and Watts, 1992;Lee, 2017), nevertheless, more studies have investigated the determinants of capital structure decision and provided several theoretical models. Three major theories of capital structure are however, predominant in corporate financial literature.…”

“…The trade-off theory developed by Kraus and Litzenberger (1973) explained that a company will prefer issues of debt over and above equity to a given extent in order to maximise business value. That is the debt benefits are equivalent to the marginal cost of debt that maximises firms value (Lee, 2017). In a nut shell, trade-off theorists are of the opinion that debt will be taken up until a point when the tax benefit associated with leverage are at par with the bankruptcy cost.…”

“…This therefore implies that leverage is procyclical . Trade-off theory, as it is argued in the extant literature, favours rising/additional debt that brings about tax shields benefits but however, increase leverage-related cost and influences the optimal capital structure formation process (Lee, 2017). Pecking order theory expounded by Myers and Maijluf (1984) differs from the Trade-off Theory in that it does not necessitate any target capital structure to be attained or achieved.…”

“…It states that companies will prefer to finance investment opportunities through the use of own fund whose priority cost is minimal, then to retain earnings and issuance of debt before finally considering equity finance. This is so because of the information asymmetry existing between managers and outside investors (Myers, 1984;Myers and Majluf, 1984;Lee, 2017). According to this theory therefore, leverage is counter cyclical (i.e., negatively correlated especially for firms that are not financially handicapped and can easily rely more on internal funds to finances viable projects) .…”

“…For this reason, the value of a company would be independent of the capital structure. Early researchers contend the premise of this theory and they conclude that it can only be achieved in artificial settings (Smith and Watts, 1992;Lee, 2017). Subsequent studies have examined the determinants of capital structure and provided new theoretical models.…”