Knowledge that Transforms

ABSTRACT While the benefits of bank financing are relatively well understood, the costs are not. This paper argues that while informed banks make flexible financial decisions which prevent a firm's projects from going awry, the cost of this credit is that banks have bargaining power over the firm's profits, once projects have begun. The firm's portfolio choice of borrowing source and the choice of priority for its debt claims attempt to optimally circumscribe the powers of banks.

ABSTRACT Two easily measured variables, size and book‐to‐market equity, combine to capture the cross‐sectional variation in average stock returns associated with market β , size, leverage, book‐to‐market equity, and earnings‐price ratios. Moreover, when the tests allow for variation in β that is unrelated to size, the relation between market β and average return is flat, even when β is the only explanatory variable.

In the article Theory of Capital Structure, by Milton Harris and Artur Raviv (The Journal of Finance, March 1991, vol. 46, no. 1, pp. 297-355) there is an error in Tables IV, V, and VII concerning the description of results reported in Investment-Financing Nexus: Some Empirical Evidence, by Michael Long and Ileen Malitz (Midland Corporate Finance Journal, 1985). While the text of Theory of Capital Structure (p. 334) correctly states that Long and Malitz find a negative relationship between leverage and profitability, in Tables IV, V, and VII, a positive, but insignificant, relationship is incorrectly reported. The authors apologize for this error and thank Professor Michael Long of Rutgers University for bringing it to their attention.