The question whether a company’s choice of the proportion of debt to equity finance in its capital structure matters has involved a great deal of controversy. This choice, known as the gearing decision in the UK and the leverage decision in the USA, is widely regarded by corporate finance directors, investors, stock market participants and many others as an issue of considerable importance, yet the basic result of conventional economic theory applied to this question is that the gearing decision is irrelevant - there is no advantage to a firm in choosing one debt-equity ratio rather than another. This striking contrast between theory and practice has, of course, led to much critical examination of the assumptions of the theory, and some progress has been made in identifying ways in which gearing may matter. However it remains true that the determinants of a firm’s gearing decision, and its importance, are not yet fully understood.
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