Capital structure theory is a key area of corporate finance that analyzes how companies should fund their operations and investments — specifically, what the optimal mix of debt and equity should be.
Key theories:
Modigliani-Miller (M&M) Theory: In a world without taxes, capital structure doesn't affect firm value. But with taxes, the tax deductibility of interest payments makes capital structure important.
Trade-Off Theory: Companies must balance the benefits of debt (tax shields) against the costs (bankruptcy risk). Pecking Order Theory: Firms follow a preference hierarchy — internal funds first, then debt, and equity issuance as a last resort.
In Bangladesh, both the pecking order and trade-off theories influence how companies structure their capital.