contradicts Hamada who used the work of Modigliani and Miller to derive a positive relationship between these two variables. Agency costs Three types of agency costs can help explain the relevance of capital structure. Asset substitution effect: As debt-to-equity ratio increases, management has an incentive to undertake risky, even negative net present value (NPV) projects. This is because if the project is successful, share holders earn the benefit, whereas if it is unsuccessful, debtors experience the downside. Underinvestment problem or debt overhang problem: If debt is risky e.g., in a growth company, the gain from the project will accrue to debt holders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value. Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management. Structural corporate finance An active area of research in finance is that which tries to translate the models above as well as others into a structured theoretical setup that is time-consistent and that has a dynamic set up similar to one that can be observed in the real world. Managerial contracts, debt contracts, equity contracts, investment returns, all have long lived, multi-period implications. Therefore, it is hard to think through what the implications of the basic models above are for the real world if they are not embedded in a dynamic structure that approximates reality. A similar type of research is performed under the guise of credit risk research in which the modeling of the likelihood of default and its pricing is undertaken under different assumptions about investors and about the incentives of management, shareholders and debt holders. Examples of research in this area are Goldstein, Ju, Leland (1998) and Hennessy and Whited (2004). Capital structure and macroeconomic conditions In addition to firm-specific characteristics, researchers find macroeconomic conditions have a material impact on capital structure choice. Korajczyk, Lucas, and McDonald (1990) provide evidence of equity issues cluster following a run-up in the equity market. Korajczyk and Levy (2003) find that target leverage is counter-cyclical for unconstrained firms, but pro-cyclical for firms that are constrained; macroeconomic conditions are significant for issue choice for firms that can time their issue choice to coincide with periods of favorable macroeconomic conditions, while constrained firms cannot. Levy