The capital structure puzzle revisited

Corporate finance researchers have long been puzzled by lowcorporate debt ratios given debt's corporate tax advantage.This article recognizes that firm value typically reflects agrowing stream of earnings, while current debt reflects a nongrowingstream of interest payments. Debt to value is therefore a distortedmeasure of corporate tax shielding. Even with very small debt-relatedcosts, this may explain the observed magnitude and cross-sectionalvariation of debt ratios. Since this variation may be independentof tax shielding, debt ratios provide an inappropriate frameworkfor empirically examining the trade-off theory of capital structure.