Investment-Based Trade-Off Theory

Dirk Hackbarth and Axel Stahmer

No 20511, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: 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

Keywords: Capital structure; Firm investment; Firm's leverage (search for similar items in EconPapers)
JEL-codes: G13 G31 G32 G33 (search for similar items in EconPapers)
Date: 2025-07
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