| The purpose of this study was to apply portfolio principles to the analysis of corporate financial behavior. The theory upon which the capital structure decision models rests has been drawn from the areas of corporate finance, capital asset pricing, and portfolio formation.;The capital structure optimization theory was tested using the data for 143 firms obtained from the Standard and Poor's COMPUSTAT annual industrial tape. The time period of analysis, 1959-1978, was representative of the range of problems facing the firms' financial officers. Analysis of the data supports the significant conclusions that firms do not borrow at the risk-free rate and that the firms portfolio risk parameters are such that capital structure can be optimized. Therefore, it was prudent to examine the optimization capital structure models to determine if they produced reasonable capital structure estimates. In the aggregate, all models produced reasonable estimates of the firms optimal capital structure. Consequently, the analysis was extended to the individual firm to determine if firms were near their optimum capital structure. In essence, the evidence supports the conclusion that the preponderance of firms were not at or near their optimum capital structure in either a capital asset pricing (systematic risk) or a Markowitz (total risk) framework.;The study includes documentation for the concepts of nondeferral earnings, the unlevered firm, bankruptcy, and expanded market indices.;Since there was no basis upon which to form a priori beliefs about the precise model of the firm's capital structure decision process, four concepts were developed. The first model assumed that the risk parameters of the firm's debt capital were invariant and, therefore, the firm borrows funds at the risk-free rate of interest. In this environment, the firm's optimal capital structure is determined by its probability of bankruptcy. The remaining models assume that firms do not borrow at the risk-free rate of interest; therefore, the firm's optimum capital structure is dependent upon its risk characteristics. The second model defines risk in terms of beta (systematic risk). The third and fourth models define risk in terms of variance of returns (total risk). |
