Abstract:
The decision on capital structure relates to the combination of the company's debt
and equity, which may have significant implications for the value of a firm and the
cost of capital. This is a crucial decision because the wrong choice of capital structure
can lead to financial distress and even to bankruptcy. Based on the theorems of
Modigliani and Miller (1958) and empirical evidence of financing decisions, two
competing capital structure theories have been developed and these two theories are
Trade-Off Theory and Pecking Order Theory, which seek to explain the shift in
leverage ratio by focusing on cost-benefit function and position of transaction costs
of borrowing, mostly dependent on observable firm attributes. As a consequence,
differences in capital structure theories emerge in their definitions of tax significance
and changes in information, transaction and agency costs. The predictions of
traditional capital structure models have been well established primarily in the
context of developed economies. However, the applicability of theoretical principles
to capital structure decisions by companies in emerging and developing countries
persist minimal. Many of the research conducted on the analysis of Capital Structure
Theories do not concentrate on the applicability of Capital Structure Theories
considering firm unique variables. The purpose of this study is to theoretically assess
the relevance of Trade-Off Theory and Pecking Order Theory in relation to firmspecific variables. The analysis included firm-specific elements such as profitability,
size, liquidity, tangibility and growth in order to review the relationship with the
above two theories and to validate the objective of the study. The study concludes
that there is an interaction with capital structure, firm-specific variables, and
relevance of Trade-Off Theory and Pecking Order Theory.
