The New Palgrave Dictionary of Economics

2018 Edition
| Editors: Macmillan Publishers Ltd


  • J. S. S. Edwards
Reference work entry


The question whether a company’s choice of the proportion of debt to equity finance in its capital structure matters has involved a great deal of controversy. This choice, known as the gearing decision in the UK and the leverage decision in the USA, is widely regarded by corporate finance directors, investors, stock market participants and many others as an issue of considerable importance, yet the basic result of conventional economic theory applied to this question is that the gearing decision is irrelevant - there is no advantage to a firm in choosing one debt-equity ratio rather than another. This striking contrast between theory and practice has, of course, led to much critical examination of the assumptions of the theory, and some progress has been made in identifying ways in which gearing may matter. However it remains true that the determinants of a firm’s gearing decision, and its importance, are not yet fully understood.

This is a preview of subscription content, log in to check access.


  1. Auerbach, A.J., and M.A. King. 1983. Taxation, portfolio choice and debt-equity ratios: A general equilibrium model. Quarterly Journal of Economics 98(4): 587–609.CrossRefGoogle Scholar
  2. De Angelo, H., and R.W. Masulis. 1980. Optimal capital structure under corporate and personal taxation. Journal of Financial Economics 8(1): 3–29.CrossRefGoogle Scholar
  3. Grossman, S.J., and O.D. Hart. 1982. Corporate financial structure and managerial incentives. In Economics of information and uncertainty, ed. J. McCall. Chicago: University of Chicago Press.Google Scholar
  4. Jensen, M.C., and W.H. Meckling. 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics 3(4): 305–360.CrossRefGoogle Scholar
  5. Miller, M.H. 1977. Debt and taxes. Journal of Finance 32(2): 261–275.Google Scholar
  6. Modigliani, F., and M.H. Miller. 1958. The cost of capital, corporation finance, and the theory of investment. American Economic Review 48: 261–297.Google Scholar
  7. Nickell, S.J. 1978. The investment decisions of firms. Cambridge: Cambridge University Press.Google Scholar
  8. Ross, S.A. 1977. The determination of financial structure: The incentive-signalling approach. Bell Journal of Economics 8(1): 23–40.CrossRefGoogle Scholar
  9. Stiglitz, J.E. 1974. On the irrelevance of corporate financial policy. American Economic Review 64(6): 851–866.Google Scholar
  10. Warner, J.B. 1977. Bankruptcy costs: Some evidence. Journal of Finance 32(2): 337–347.CrossRefGoogle Scholar

Copyright information

© Macmillan Publishers Ltd. 2018

Authors and Affiliations

  • J. S. S. Edwards
    • 1
  1. 1.