ABSTRACT
No debt should ever be used in the absence of tax subsidies in the presence of bankruptcy costs. However, debt was commonly used prior to the existence of tax subsidies on interest payments. Myers (1977) as well as Jensen and Meckling (1976) propose the optimal capital structure minimizes agency problem arising from stakeholders’ incentives deviated from firm value maximizer. In particular, they claim a firm’s decision maker may have an incentive to make business decisions suboptimally in the presence of external finance. Debt contract may or may not give a firm’s decision maker an incentive to invest optimally, depending on the possibility of default.
