| Abstract: | Even if the value of the firm is unaffected by its capital structure, managers may have reasons to choose a particular structure. The prices of the firm's securities reflect the “market's” assessment of the value and riskiness of the firm. Should managers disagree with the market's assessment of the firm's risk or value, they will also disagree about the relative returns on the firm's securities. Concern about shareholder welfare may, therefore, lead them to prefer a specific capital structure. If managers believe the market has underestimated the firm's value, they will prefer debt financing; if the market has overestimated risk, they will prefer equity; and, if managers disagree about both risk and value, they may prefer to finance using both debt and equity. |
