A New Capital Structure Theory: The Four-Factor Model

Abstract

This article presents a new capital structure model based on four factors well documented in literature: asymmetric information, taxes, bankruptcy costs and decision-makers' overconfidence. The model can simultaneously explain several facts about capital structure including those that remain puzzling from existing theories point of view eg. negative correlation between debt and profitability; why firms issue equity etc. Unlike many advanced research on capital structure, a closed-form solution is obtained for most results.

Keywords: capital structure, asymmetric information, overconfidence, debt tax shield, bankruptcy costs

JEL Classification: D82, D89, D90, G32, H21, H32, L26, L29