Trade-Off Theory Of Capital Structure

One of the journal that I have choose to explain the trade-off theory of capital structure is “A survey of the trade-off theory of corporate financing” which is written by Chikashi TSUJI. According to this journal, the author show that the study of the trade-off theory of capital structure and the survey of the experiential evidence to support the trade-off theory for the US capital market and other international countries. Trade-off theory of capital structure is the theory that a company used to balance the company’s costs and benefits by determining the amount of debt finance and amount of equity finance. The company also control the balance among the tax saving benefits of debt and the dead-weight costs of bankruptcy. The trade-off theory

(2002) identified that corporations always tended to achieve the target of leverage levels in the static trade-off theory when increase or retire a larger amount of new capital. The study also found that the higher the market-to-book ratio of corporations, the lower the target of debt ratios. Frank and Goyal (2004) stated that the deviation from the leverage ratio were useful in predicting the adjustment of debt, but not in the adjustment of equity. The study show that when the different between the present value of tax shields and the present value of financial distress cost reached the maximization, the optimal leverage was gained. This study also pointed out that the important of firm size for determining the validity of the trade-off theory. On the other hand, the international empirical evidence stated that the countries with stronger protection of property rights have achieved more validation of the trade-off theory. Both empirical and survey evidence have its different part and have some contradictory. As to Myers (2003) noted that, there are no a perfect theory, each theory have its own function in different situations, the corporations should do some research to more understanding which theory is most suitable to apply in its

The dynamic trade-off theory suggested that the firm which do not achieved their capital structure target will make the adjustment to reach the target. Reckoning the speed of adjustment (SOA) is a research for the joint hypotheses that the firms will do the adjustment to reach the target that actually existing. There are largely different real dynamic behaviour of the firms, therefore, all firms cannot used a single and same estimated SOA because it will lead to misleading and it cannot be used as evidence for the dynamic trade-off theory. In addition, the study show that the different in the SOA for the Malaysia firms which used the Generalized Method of Moments (GMM) method. GMM is a method that used for the parameters estimation in the statistical models and it is usually used in the context of the model of semi parametric. The research also stated that the firms that have the far off distance to the target show a faster adjustments than the firms that are close to the target. While the overleveraged firm show a faster adjustment than the firms that are underleveraged. The above results are consistent with the dynamic trade-off theory. The dynamic trade-off theory clearly explain the adjustment behaviour for the leverage ratio. The trade-off theory consist of two characteristics which are the presence of the target and the adjustment behaviour to the target. Both