Question

the static-tradeoff theory and the pecking order theory. To see which of these theories is more representative of how financial managers act, Graham and Harvey surveyed Chief Financial Officers (CFOs) of U.S. firms.

Prompt:  Do you think either theory represents how capital structure decisions are made in practice? If so, which theory is more closely aligned with CFO actions? If not, what do these theories fail to capture about the actions of financial managers. Support your arguments with specific findings from the survey. minimum 300 words

Answer 1

The static trade off theory argues that the company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits and the pecking order theory is the preferred, and empirically observed, sequence of financing type to raise capital which refers to firms first tap retained earnings finance, second source is debt and the last source is issuing new common stock shares. However, It depends on Managers to depend and decision making process of the Company.

Both the theories further represents the capital structure decision thatb has practical issues. But, pinpointing theories that are aligned with CFOs is difficult because both are trade-off and information based theories. I further suspect it all depends in a lot of firm specific and institutional factors reflecting macro level conditions in the economy. Both the theories depend on tade off and information based depends on the quality and Timing of Market firms are involved in conditions like type of assets, products, risk and reward rate.

However, Most of the times during high growth and sub prime growth information based theories in Capital market outperforms the static trade off theories because of fundamental analysis.

There are major problems with the theories for example there is no defined quantative measures how it will affects the cost of financing in capital market and no reliable variables can be predicted which may affect the decisions.