The Optimal Capital Structure

Abstract

Through time different theories have been proposed to explain the various ways corporations and individuals can fund capital asset projects and select the financial assets used as savings mechanisms. Frictions and transaction costs in the real economy mean that there are advantages in using each type of security. For example, the interest tax subsidy granted by some governments has conferred an advantage on debt financing. The evidence shows that, across sectors and at different periods of their lives, companies make choices that result in unique ‘capital structures’. However, a few variables such as asset composition and expected future cash flow stability play a major role in a firm’s ability to acquire debt. Hence, the belief is that an ‘optimal structure’ exists for each company at a specific point in time.