The trade-off theory is found to allow bankruptcy that is considered. There is the benefit of using the offset to benefit of using the debt as tax shield. There are many advantages of the financing with the debt. The next theory is the pecking order theory. This is found to encompass the costs of asymmetric information. There are also companies that is found to prioritize the sources of the financing. There is internal financing that is considered. In this the debt is found to be the choice of the firm that can act as independently of the external finances of the company. The capital structure substitution theory is based on the hypothesis that the management of the company can manipulate the capital structure (Kayhan, and Titman, 2007). This is not a normative model. These are three kinds of agency costs. The asset substitution effect. This is the debt-to-equity ratio increases there will be lesser incentives for the company to undertake any risks. The Net present value is found to be reduced in this paradigm. There is underinvestment problem that is used to reject the positive NPV projects. Apart from this there is free cash flow. This is given to the investors and the management is found to have an incentive to destroy the firm value.
These are some of the major factors and theories that explain the capital structure of the firm
Macroeconomic and Firm Level Factors Affecting Capital Structure Decision of Firms
In the cases of moderate ranges, the firms must exhibit preference for the internal funds over the external securities. Within the moderate ranges, there is requirement for the external funds in these cases the firms must prefer debt to equity. There is the preference for the internal funds. These must be evident in the negative relationship that forms between the firms’ cash flow and the reliance on debt. There are various costs that are associated with the external finances. These are found to be lower for the informational asymmetries. There are various explicit and implicit costs that are associated with the finances. These are found to be lower for the firms with the various stakeholders. These stakeholders for the companies include debt holders, equity holders, creditors, customers and employees. There are found to be more in the cases of larger firms (Booth et al., 2001).