Theories of Captial Structure

The theories of capital structure were developed in order to chance on an best capital structure for companies.
The Miller and Modigilani(MM1958;1963) theory on capital structure suggested that financing decisions dont preserve the high societys cash devolve stream itself. It showed that capital structure decisions dont affect a callers value when the capital market is perfect and when the companys investing and financing decisions be independent. When one of these assumptions is relaxed, it is shown that a firms value changes with changes in the debt-equity mix. Emphasis has been move on taking into account the MM assumptions like: incarnate evaluatees(MM1963), personal taxes(miller1973), informational asymmetric(myers1984), agency woos(jensen and Meckling, 1976) or bankruptcy costs(Stiglitz, 1972). This has stretch forth to the learning of various alternate theories and the 2 main that dominate are the trade-off and pecking-order theory of capital structure.

According to the Static tradeoff theory, a firm should set a target debt-to-equity symmetry and gradually move towards it. Thus implying that some form of optimal capital structure exists that maximizes the firms value musical composition at the same time minimizing external claims to the cash flow streams, like taxes, bankruptcy and agency costs.



The theory is based on trade-off between the tax advantages from borrowing and the costs of pecuniary distress of borrowing a lot. The marginal costs and welfares of from each one financing unit are considered while deciding the optimal structure and that form of financing is chosen where marginal benefit equals the marginal costs. The theory is based on certain imperfections that lead to the optimal trade-off(footnote(1)). The early models balanced the corporate tax advantages of debt with the cost of disadvantages of bankruptcy, e.g Kraus and Litzenbergers(1973) approach but in later refinements, personal tax and non-debt tax shields were also considered, e.g. DeAngelo and Masuliss(1980)...If you want to get a sound essay, order it on our website: Orderessay



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