On the Robustness of Models of Optimal Capital Structure

Abstract

This paper investigates the robustness of models of optimal capital structure i.e. their sensitivity for small changes in their specification. This question is addressed by incorporating well known models of optimal capital structure within a uniform framework of assumptions and definitions. Using both a single and a multi-period setting, the effects of limited liability, risk of default, bankruptcy costs and agency costs are investigated. In contrast with published models, virtually all of which are well behaved, many models in this study appear to produce inderminate results. It is concluded that the robustness of models of optimal capital structure leaves much to be desired, so that the prospects of extending the models with more realistic assumptions than the ones used here are rather questionable.