Optimal Corporate Debt Financing and Real Investment Decisions under Controlled Banking Systems
The debate over the determinants of optimum corporate capital structure and its interaction with corporate real investment decisions has been in the forefront of the literature on the theory of finance at least for the past two decades. The discussion, however, has centered almost exclusively on the experience of a few industrialized countries where capital markets are assumed to be perfect and the existence of well-developed securities markets for pricing of various debt and equity claims on corporate assets is taken for granted. Within this context one important goal of research has been to modify the implications of the original Modigliani-Miller ( 1958) leverage irrelevance theorem by taking explicit account of the influences of taxes and bankruptcy cost ( Baxter 1967; Scott 1976), the agency cost (Jensen and Meckling 1976), and the asymmetry of information ( Ross 1977; Leland and Pyle 1977) on the determination of corporate financial leverage. These studies have generally treated the corporate real investment decisions as exogenous and have focused on the financing aspects of corporate investment behavior. In contrast, there is the important strand of research on the neoclassical theory of private investment behavior, which either in its original context ( Jorgenson 1963; Jorgenson and Hall 1971) or in its modified cost-of-adjustment context ( Lucas 1967; Hayashi 1982) assumes a perfect capital market and no uncertainty. 1 In this case it follows that the firm's real investment policy is independent of how it is financed.
Such a separation of research activity on the theory of investment and finance has often been a source of dissatisfaction and criticism ( Vickers 1970; Ciccolo and Fromm 1979, 1980; Hite 1977) where both logic and evidence are invoked to support the argument that the firm's real and financial investment decisions are in reality linked and are made simultaneously. Thus it is argued that the cost of capital to a firm is not determined completely exogenously but depends on its means of financing, and the timing of a firm's investment expenditures is condition upon