NBER Working Paper #1393 Ju1y1984 Capital Structure Puzzle ABSTRACT This paper contrasts the "static tradeoff"and "pecking order" theories of capital structure choice by corporations.In the static tradeoff theory,optimal capital structure is reached when the tax advantage to borrowing is balanced,at the margin,by costs of financial distress.In the pecking order theory,firms prefer internal to external funds,and debt to equity if external funds are needed.Thus the debt ratio reflects the cumulative requirement for external financing.Pecking order behavior follows from simple asymmetric information models.The paper closes with a review of empirical evidence relevant to the two theories. Stewart C.Myers Finance Section Sloan School of Management Massachusetts Institute of Technology 50 Memorial Drive Cambridge,MA 02139 (617)253-6696