NEW YORK UNIVERSITY FINECII Franklin Allen and Douglas gale 31,2003 Capital Structure The Modigliani and Miller capital structure and payout policy theorems were the result of the practical questions"How should a firm choose its capital structure". The theory that we covered last time clarified the nature of the modigliani and miller result This had taken some time to do. Along the way people expended a large amount of effort trying to understand what was going on. For example, the Stiglitz and Hellwig papers are interesting because they show how difficult people found it to understand the nature of the result. In terms of what we end up with the fact that capital structure can matter with incomplete markets is not a particularly useful result in answering the basic question. Nobody has really pursued this at any length as a way of explaining what we observe with regard to firms capital structures Atthisstageyoushouldreadthefollowingpaper(availablefromwww.jstor.org Rajan, R and L Zingales(1995)."What do we know about Capital Structure? Evidence from International Data, Journal of finance 50, 1421-1460 As the title suggests this outlines differences in capital structure across countries It shows that institutional factors such as taxes and bankruptcy codes may well be Importan1 NEW YORK UNIVERSITY FINECII Franklin Allen and Douglas Gale January 31, 2003 Capital Structure The Modigliani and Miller capital structure and payout policy theorems were the result of the practical questions ìHow should a firm choose its capital structureî. The theory that we covered last time clarified the nature of the Modigliani and Miller result. This had taken some time to do. Along the way people expended a large amount of effort trying to understand what was going on. For example, the Stiglitz and Hellwig papers are interesting because they show how difficult people found it to understand the nature of the result. In terms of what we end up with the fact that capital structure can matter with incomplete markets is not a particularly useful result in answering the basic question. Nobody has really pursued this at any length as a way of explaining what we observe with regard to firmís capital structures. At this stage you should read the following paper (available from www.jstor.org). Rajan, R. and L. Zingales (1995). ìWhat do we know about Capital Structure? Evidence from International Data,î Journal of Finance 50, 1421-1460. As the title suggests this outlines differences in capital structure across countries. It shows that institutional factors such as taxes and bankruptcy codes may well be important