ABSTRACT
This chapter focuses on the investigation whether a firm's Debt/Equity mix follows "optimal capital structure" theory or "pecking order" theory. It utilizes the criteria of the industry mean as a predictor of a firm's capital structure as in Claggett Jr and Ghosh and Cai. First Hypothesis and first Lemma are used to test the optimal capital structure theory, while Second Hypotheses and Second Lemma, Third Hypothesis and Third Lemma are for the testing of pecking order theory. The percentage of firms using internal financing is significantly higher than fifty percent except for three industries: computer and office equipment, industrial and farm equipment, and mining and crude oil. A binomial model is constructed and is used to perform the empirical test on the financial data of the 2001 Fortune 500 manufacturing companies. This finding and subsequent researches by Miller and DeAngelo/Masulis led to the theory of "Optimal Capital structure," the debt and equity mix where the firm's value is maximized.
