Critical Discussion
Trade-off theory代写 Critical Discussion：The tradeoff theory is pivotal in the understanding of a small firm’s capital structure.
Trade-off theory
Trade-off theory evaluates the capital structure and inquiries about the optimal capital structure that balances costs and benefits of additional financing using debt (Ahmadimousaabad et al. 2013, p. 242). The key essence of the trade-off theory is to explain the forms that the company capital takes, that is, debt and part equity. They stated that trade-off informs on the cost of debt financing which mainly is financial distress such as bankruptcy costs. The authors stated that the marginal benefits of tax shields decrease as the firm borrows more and more capital. However, the article fails to identify the key differences between three theories of capital structure. The article could have brought better understanding of the comparison between the three theories was made.
Capital structure Trade-off theory代写
Besides tax subsidies that come with interest payment without financial distress, there are other determinants of capital structure that align with the trade-off theory. Ghazouani (2013, p. 626), explains the advantage of debt financing especially to balance the level of conflicts of interests in corporations. They include conflicts between shareholders and managers and that shareholders and creditors. Trade-off theory代写**成品
Trade-off theory should ensure balance between managers’ interests and shareholders by ensuring managers have balanced stake in the company. Increasing the debt is one way of reducing manager’s control and reducing equity financing and hence creating a balance between shareholders and managers. Ghazouani’s approached trade-off theory in more dynamic form than restricting to Modigliani and Mille’s definition.
Tradeoff theory explain Trade-off theory代写
However, there conflicting findings on the ability of the tradeoff theory to explain how firms make financing decisions. According to Hirdinis (2019, p. 179), the trade-off theory fails to explain how debt ratio and profitability are related. He noted that it is not always true that increasing debt-equity ratio will yield higher profits. It is only under the circumstances that debt is used in the right way. Trade-off theory代写**成品
Thus, large and profitable firms prefer to finance their investments by raising capital internally through retained earnings. Internal sourcing offers higher creditors protections and confidence and hence lowers the agency costs and increases the availability of debt capital. Besides, the theory fails to provide for business preferences for the most optimal source of financing. Thus, it is not the most preferred theory for application in large firms.
Applicability Trade-off theory代写
Additionally, Butt, Khan, and Nafees (2013, p. 133) criticized the applicability of the trade-off theory in the long-run. There exists inverse relationship between firm borrowing and profitability in long-run. Due to information asymmetry, it is good for large firms to use pecking order theory to make decision regarding capital structure instead of trade-off theory. unlike trade-off theory, peck order theory enables control of the company and hence cost of equity is kept at minimum. Trade-off theory代写**成品
Nonetheless, the tradeoff theory is pivotal in the understanding of a small firm’s capital structure. The theory considerations help companies to determine their debt capacity. It is supplemented by the Pecking order theory on deciding the preference between equity and debt financing. Managers should use the capital mix that brings the highest benefits to the company.
References Trade-off theory代写
Ahmadimousaabad, A., Bajuri, N., Jahanzeb, A., Karami, M. and Rehman, S., 2013. Trade-off theory, pecking order theory and market timing theory: a comprehensive review of capital structure theories. International Journal of Management and Commerce Innovations, 1(1), pp.11-18.
Hirdinis, M., 2019. Capital structure and firm size on firm value moderated by profitability. International Journal of Economics and Business Administration, 6(1), pp. 174-191.
Butt, S., Khan, Z.A. and Nafees, B., 2013. Static trade-off theory or pecking order theory which one suits best to the financial sector. Evidence from Pakistan. European Journal of Business and Management, 5(23), pp.131-140.
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