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The Effect of Business Risk on Corporate Capital Structure: Theory and Evidence
Author(s) -
KALE JAYANT R.,
NOE THOMAS H.,
RAMÌREZ GABRIEL G.
Publication year - 1991
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1991.tb04640.x
Subject(s) - capital structure , portfolio , debt , limited liability , corporate tax , economics , business risks , monetary economics , business , liability , financial economics , actuarial science , double taxation , tax avoidance , finance , risk analysis (engineering)
Under corporate and personal taxation, we demonstrate that the relation between optimal debt level and business risk is roughly U‐shaped. This result follows from the fact that the tax liability is an option portfolio that is long in the corporate tax option and short in the personal tax option. Therefore, the net effect of a change in business risk on the optimal debt level depends upon the relative magnitudes of the resultant marginal changes in the values of these two options. Results of empirical tests offer support for the predicted U‐shaped relationship.