Capital Structure Equilibrium Under Incomplete Market Conditions

40 Pages Posted: 19 Aug 2004 Last revised: 19 Jul 2010

See all articles by Robert A. Taggart

Robert A. Taggart

Boston College - Carroll School of Management; National Bureau of Economic Research (NBER)

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Date Written: September 1981

Abstract

Most discussions of corporate capital structure have been set in the context of a complete capital market. In this paper we study the determinants of capital structure for the incomplete markets case, where incompleteness manifests itself in the form of divergent borrowing and lending rates. We argue that firms have a natural incentive to tailor their financing choices so as to narrow such divergences. While this implies an optimal capital structure for firms in the aggregate, however, competition will drive out profits, and the capital structure of any individual firm may still be a matter of indifference. Firms' incentive to try to complete the market provides a rationale for corporate finance even in a taxless environment. This incentive may also shed light on such related issues as corporate mergers, the use of complex securities and the role of financial intermediaries.

Suggested Citation

Taggart, Robert A. and Senbet, Lemma W., Capital Structure Equilibrium Under Incomplete Market Conditions (September 1981). NBER Working Paper No. w0747. Available at SSRN: https://ssrn.com/abstract=349136

Robert A. Taggart

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Dept. of Finance
Chestnut Hill, MA 02467
United States
617-552-4113 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Lemma W. Senbet (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

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