Investment-based optimal capital structure

This paper extends the classical capital structure model by introducing the output of firm with 'AK' production technology dynamically depends on the endogenous investment decision and capital accumulation. Based on our calibration, it shows that the flexibility of dynamic investment and capital accumulation induces the firm to take the lower leverage at financing time and makes the leverage estimate closer to empirically observed leverage ratios, which provides an effective explanation for the 'under-leverage puzzle'. In addition, this model predicts that the market leverage behaves in a U-shaped manner with capital liquidity, which provides a novel empirical test.