Abstract
Traditional theories of capital structure do not explain the puzzling phenomena of zero-leverage firms and negative net debt ratios. We develop a theory where firms adopt a net debt target that acts as a balancing variable between equityholders and managers. Negative (positive) net debt occurs in human (physical) capital intensive industries. Negative net debt arises because tradeable claims cannot be issued against transferable human capital. Heterogeneity in capital structure occurs when firms have debt that is not fully collateralized. Physical capital intensive firms take on high leverage but may underlever to avoid bankruptcy costs. This creates excess rents for managers (even if the supply of human capital is competitive) because wealth constraints prevent managers from co-investing.
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