Analysis of the Optimum Capital Structure of the Firm under Arbitrage, Agency and Asymmetric Information Theories
Since the publication of the classical papers by Modigliani and Miller in 1958 and 1963, the relationship between the equity value of the firm and its capital structure has been continually studied by numerous scholars. Among other hypotheses, we examined arbitrage, agency, asymmetric information, and pecking order theories. Our review also included the model developed by Baker and Wurgler (2002) that attempts to understand the effect of market valuations on the capital structure of the firm. We then developed an econometric model that provides for comprehensive financial theory to maximize the firm's capital structure. Our regression analysis of arbitrage, agency, asymmetric information and pecking order theories, in addition to Baker and Wurgler's hypothesis, as well as our econometric model, resulted in evidence that, to optimize the firm's capital structure, its financial policy should represent a targeted debt-equity ratio that results in the after-tax cost of debt essentially equaling the cost of equity. Accordingly, this paper confirms the arbitrage hypothesis of Modigliani and Miller, as well as Myers' pecking order theory. Our examination also disclosed inconsistencies with Baker and Wurgler's regression model.
Durdock, Joseph Gregory, "Analysis of the Optimum Capital Structure of the Firm under Arbitrage, Agency and Asymmetric Information Theories" (2010). ETD Collection for Fordham University. AAI3431918.