Discussion paper
DP20511 Investment-Based Trade-Off Theory
This paper develops a novel trade-off theory of capital structure. When frequent re-balancing of firm leverage is restricted due to capital structure stickiness (or refinancing frictions), optimal capital structure reflects current and future investment profitability. That is, optimal leverage crucially depends on the asset growth and tax rate, and yields various capital structure equilibria, such as all-debt, all-equity, and debt-equity financing, by balancing the tax benefits of debt and the cash benefits of equity. Notably, the model endogenously generates low and zero leverage and also offers insights into the determinants of leverage life-cycle patterns observed in practice
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