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Capital Structure Theory

💼 Business By CampusDown Wiki Editorial Team Last updated
Quick answer: capital structure theory asks whether and how a firm's mix of debt and equity affects its value and cost of capital.
Contents
  1. 1. Starting from MM
  2. 2. Main theories
  3. 3. In practice
  4. 4. References

Starting from MM

Modigliani and Miller (1958) showed that in a perfect market capital structure is irrelevant to value. Later theories explain how taxes, distress costs and information problems change that conclusion.

Main theories

  • Trade-off theory: firms balance the tax shield of debt against the costs of financial distress, implying a target debt ratio.
  • Pecking order theory: Myers and Majluf (1984) argued that because managers know more than investors, equity issues send a negative signal, so firms prefer internal funds, then debt, then new equity.
  • Agency theory: Jensen and Meckling (1976) traced financing choices to conflicts among shareholders, managers and creditors; debt can discipline managers.
  • Market timing: firms issue equity when shares are overvalued (Baker and Wurgler, 2002).

In practice

Evidence supports parts of each view: profitable firms tend to borrow less, as the pecking order predicts, while industries show stable leverage targets, as the trade-off view predicts. Credit ratings and financial flexibility also shape decisions.

References

  1. Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3), 261-297.
  2. Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187-221.
  3. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
  4. Baker, M., & Wurgler, J. (2002). Market timing and capital structure. Journal of Finance, 57(1), 1-32.

Reports and materials that use this theory (Korean)

There are no materials dedicated to this theory yet, but you can search related reports in the CampusDown library (Korean).

Find more reports · Search '자본구조이론' on CampusDown →
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This article was last updated on October 15, 2026. It is based on widely recognized original works and textbooks; when citing it in a paper, please check the original sources listed in the references.