Theories Of Capital Structure: The Trade-Off Theory Of Capital Structure

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Trade-off theory of capital structure refers to the idea that a firm chooses how much debt finance and how much equity finance to use by balancing the costs and welfares. Trade-off theory of capital structure essentially involves offsetting the costs of debt against the benefits of debt. The Trade-off theory of capital structure converses the several corporate finance selections that a firm experience. Theories propose that there is a best capital structure that maximizes the value of the company in balancing the expenses and benefits of an additional unit of debt, are categorised as models of trade-off (World Finance, 2015).
2.1. Trade-off models linked to bankruptcy costs.
For Baxter (1967), the costs incurred by financial distress have
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According to Danso & Adomako (2014), the Market Timing theory is quite new therefore small numbers of research have been conducted to exam its validity. The Market Timing theory of capital structure assumes that companies time their equity issues whereby the company will issue new share when the share price is perceived to be high price and repurchase the stocks when there is low price (Luigi and Sorin, 2009) (Mostafa and Boregowda, 2014) and (Baker and Wurgler 2002). As a result, fluctuations in share prices will disturb company’s choice on capital …show more content…
(Mostafa and Boregowda, 2014) refer to Sham-Sunder and Myers (1999) declared that Pecking Order Theory is better in explaining the company’s behaviour rather than the Traditional Trade-off Theory. Nonetheless, several researchers claimed difference between the Traditional Trade-Off Theory and Pecking Order Theory. According to Fame and French (2002), approximately companies track Traditional Trade-Off Theory although others track Pecking Order Theory but none of them perhaps rejected. According to Sheikh and Wang (2010) refer to Myers (2001), there is not common theory of the debt-equity choice and no purpose to expect one. Nevertheless, there are quite a few useful conditional theories and each of them which helps to recognise the financial structure that companies

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