Determining the optimal capital structure based on revised definitions of tax shield and bankruptcy cost

Abstract

For half a century, no consensus has been reached on optimal capital structure after numerous intensive studies. This paper develops three alternative simple models to derive optimal capital structure. Because the optimal leverage ratio determined by the models is close to most survey data, some relevant puzzles, such as “financial conservatism”, are easily explained. In addition, the new models can be extended to accommodate various decision situations, for instance, abnormal growth, bankrupt expectancy, debt guarantee, transaction cost, and personal income tax.