Which capital structure theories does the empirical evidence seem to support?

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Which capital structure theories does the empirical evidence seem to support?

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Which capital structure theories does the empirical evidence seem to support?

Explanation & AnswerSolution by a verified expert

Explanation

Following are the theories which supports empirical evidence:

Pecking order- This theory states that when a company has asymmetric information then the company should issue debt first followed by issue of equity.
Trade-off theory- This theory states that when there is a difference between actual and target market-based debt ratio then companies make partial adjustments so as to reduce the difference.
Market timing- This theory states that when the market is overvalued then managers issue debt to achieve its target. But generally firms issue stock when the market is overvalued.

Verified Answer

Empirical evidence supports the following theories:

Pecking order- It is an issue of debt before issuing equity.
Trade-off theory- It is making partial adjustments to align target and actual market-based debt ratio.
Market timing- It is issuing debt to achieve its target.

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