This paper considers several related problems in the theory of optimal capital structure for corporations. It is divided into four sections, which may be briefly summarized as follows.

1. Modigliani and Miller (MM) proposed that under the assumption of perfect markets and in the absence of taxes on corporate income, the total market value of the firm is unaffected by leverage. They showed that the leverage irrelevance proposition holds for “non-growth” firms when all investors agree in their estimates of the expected amount and the risk of each firm's future earnings. In section I, we show that this conclusion is not affected by growth trends or heterogeneous investor expectations. However, our analysis uncovers several additional assumptions which must be made explicitly for MM's Proposition I to hold. These additional assumptions pertain to the effects of leverage on the firm's future financing needs and future investment decisions. The generalized state-preference framework used for this demonstration is retained for subsequent discussion.

In attempting to analytically discover or test economic relationships, econometricians have available many computational techniques by which to estimate the parameters of their models. But different solution methods may give unbiased and consistent, biased and consistent, or biased and inconsistent estimates under varying assumptions. The model builder is vitally interested in how each of these procedures reacts under varying conditions that may impinge on his model, but which are conditions not assumed by the estimation technique.

When a company enters into a bond indenture or loan agreement, certain restrictions usually are placed on it. These restrictions, known as protective covenants, may have a significant influence on profitability, making the bargaining strategy of the company very important. But to bargain effectively over the restrictiveness of the protective covenants, management must know the impact that the covenants have on profitability.

Applied economics consists of the application of the general principles of economics to a particular situation in order to provide an explanation of the behavior of economic agents in that situation. However, the degree of specificity of any explanation depends upon the particular uses to which the explanation is to be put. Thus, in applied economics one may wish to explain the behavior of the agents who operate a particular enterprise. Or, one may wish to provide a. broader frame of reference to explain the behavior of agents who operate a. type or class of enterprises. By utilizing the analysis of the general economic theory of the firm one may introduce the additional constraints under which, for example, a public utility operates, and thereby derive a. theory of public utilities. Or, in the same way, one may wish to construct a, theory of transport firms, or a theory of retail firms, or a theory of manufacturing firms.

Economists have long been creating models by which to describe optimum behavior for firms to maximize profits. The rigor and inclusiveness of such models have increased steadily in recent years. In the field of commercial banking, however, this has not generally been the case. Concerning the topic of asset management, the typical analyst discusses the decisions to be faced by the bank manager, the reasons for the problems involved, and considerations to include in the solution of such problems. Often, specific rules-of-thumb for the handling of individual asset accounts are advocated.