Journal of Finance2014-09-28 5:05 PM

The Capital Structure Puzzle

This paper's title is intended to remind you of Fischer Black's well-known note on “The Dividend Puzzle,” which he closed by saying, “What should the corporation do about dividend policy? We don't know.” [6, p. 8] I will start by asking, “How do firms choose their capital structures?” Again, the answer is, “We don't know.”

The capital structure puzzle is tougher than the dividend one. We know quite a bit about dividend policy. John Lintner's model of how firms set dividends [20] dates back to 1956, and it still seems to work. We know stock prices respond to unanticipated dividend changes, so it is clear that dividends have information content—this observation dates back at least to Miller and Modigliani (MM) in 1961 [28]. We do not know whether high dividend yield increases the expected rate of return demanded by investors, as adding taxes to the MM proof of dividend irrelevance suggests, but financial economists are at least hammering away at this issue.

By contrast, we know very little about capital structure. We do not know how firms choose the debt, equity or hybrid securities they issue. We have only recently discovered that capital structure changes convey information to investors. There has been little if any research testing whether the relationship between financial leverage and investors' required return is as the pure MM theory predicts. In general, we have inadequate understanding of corporate financing behavior, and of how that behavior affects security returns.

Full Article





Journal of Finance

The Journal of Finance publishes leading research across all the major fields of financial research. It is the most widely cited academic journal on finance.

0 Following 12 Fans 0 Projects 72 Articles


AbstractWe study the performance of nearly 1,400 U.S. buyout and venture capital funds using a new data set from Burgiss. We find better buyout fund per

Read More

Abstract:During the past few decades, the fraction of the equity market owned directly by individuals declined significantly. The same period witnessed

Read More

Abstract:We propose a new definition of skill as general cognitive ability to pick stocks or time the market. We find evidence for stock picking in b

Read More

Abstract:We investigate the relationship between ex ante total skewness and holding returns on individual equity options. Recent theoretical developm

Read More

Abstract:We establish that CEOs of companies experiencing volatile industry conditions are more likely to be dismissed. At the same time, accounting

Read More

Abstract:Defining and measuring readability in the context of financial disclosures becomes important with the increasing use of textual analysis and

Read More

Abstract:Contrary to recent accounts of off-balance-sheet securitization by financial firms, we show that asset securitization by nonfinancial firms

Read More

Abstract:To rationalize the well-known underperformance of the average actively managed mutual fund, we exploit the fact that retail funds in differe

Read More

 The process of selecting a portfolio may be divided into two stages. The first stage starts with observation and experience and ends with beliefs abou

Read More

AbstractOne of the problems which has plagued those attempting to predict the behavior of capital markets is the absence of a body of positive microeco

Read More