Advances in Economics, Management and Political Sciences
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Advances in Economics, Management and Political Sciences
Series Vol. 76 , 18 April 2024
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Application of Trade-off Theory in Real-Life Corporate Capital Structure Adjustments
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Abstract
Trade-off theory is one of the important theories for firms to adjust their capital structure. However, there is still controversy about its applicability in reality. This paper focuses on exploring its practicality by analysing the literature and after examining the literature on commercial banks in Bangladesh, it is found that the impact of different financial indicators of these banks on the changes in their capital structure is consistent with the assumptions of the trade-off theory, and it is reasonably argued that the reason why firms in reality tend to use debt financing can be explained by the fact that firms are trying to gain the advantage of the tax shield. The paper also analyses the change in firm value of firms with different debt levels about the September 11 terrorist attacks in the United States and demonstrates that firms with high debt levels experience a decline in firm value as their probability of bankruptcy increases, which is consistent with the trade-off theory. In addition, while the traditional view is that the trade-off theory can only explain why firms with higher profitability have high debt ratios, this paper argues that the theory can also explain why firms with high profitability have low debt ratios. Therefore, this paper proposes a reasonable explanation for the utility of the trade-off theory.
Keywords
Trade-off theory, Interest tax shield, Tax benefits, Debt financing, Tax deduction
References
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Data Availability
The datasets used and/or analyzed during the current study will be available from the authors upon reasonable request.
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- Volume Title
- Proceedings of the 3rd International Conference on Business and Policy Studies
- ISBN (Print)
- 978-1-83558-375-3
- ISBN (Online)
- 978-1-83558-376-0
- Published Date
- 18 April 2024
- Series
- Advances in Economics, Management and Political Sciences
- ISSN (Print)
- 2754-1169
- ISSN (Online)
- 2754-1177
- DOI
- 10.54254/2754-1169/76/20241901
- Copyright
- 18 April 2024
- Open Access
- This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited