This note provides an overview of the current state of the capital structure theory. It is well suited for advanced corporate finance course, after students have been exposed to the basic theory. One look at the capital structure choice to view it as representing a compromise between the five elements: (1) tax incentives, financing, (2) the explicit costs of financial distress, (3) the agency cost of debt (including the array of indirect costs associated with financial difficulties), (4) the agency costs of equity, and (5) signaling effect of issuance. The first two elements represent a "modern, traditional" balancing theory of capital structure. Third and fourth based on the theory of imperfect information, and the agency and emphasize individual incentives of decision makers. Fifth element is recognized that the fact that the issuance of security can give new information to investors when there is imperfect information. Though new theory provides a rich set to look at the aspects of financial policy for how much debt the company should take, the downside is that at present there is no comprehensive synthesis of these theories. As a result of the practical application requires a careful definition of how these theories are relevant to business, the markets, and the situation at hand.
This Darden study. "Hide
by Susan Chaplinsky, Robert S. Harris Source: Darden School of Business 14 pages. Publication Date: January 5, 1998 year. Prod. #: UV0105-PDF-ENG
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