On The Separability Of The Real And The Financial Decisions Of A Firm: A Review

Abstract

This paper demonstrates the necessity for the simultaneous determination of a firm’s investment, production and capital structure decisions in imperfect capital markets.  The non-separability of the three corporate decisions arises from the fact that the savings and/or costs due to the market imperfections for different financial packages can be imputed to the effective cost of the firm’s real variables.  Thus, shifts in the firm’s capital structure lead to adjustments of the firm’s investment and production decisions, which in turn cause a change in the firm’s value.  Given the necessity for an integrated approach, the paper examines the extent to which the literature has taken into account the interactions between the three corporate decisions when addressing the optimal capital structure question.