Tradeoffteorien

Tradeoffteorien, or the trade-off theory of capital structure, is a central framework in corporate finance that explains how firms choose their mix of debt and equity by balancing competing forces. The core idea is that debt provides a tax shield, reducing after-tax financing costs, but higher leverage raises the expected costs of financial distress and various agency costs.

Key components include the tax advantage of debt, which makes debt cheaper than equity on an after-tax basis, and the costs of high leverage, such as bankruptcy and financial distress, as well as agency costs between debt and equity holders (for example, underinvestment or asset substitution). Firms weigh these benefits and costs to determine an optimal or target leverage level. In practice, other factors such as issuance costs, liquidity, and financial flexibility also play a role.

The theory can be framed in static or dynamic terms. In the static view, a firm has a single target debt ratio where marginal tax benefits equal marginal distress and agency costs. In dynamic formulations, the target can change over time in response to profits, investment opportunities, and macroeconomic conditions, with firms adjusting their leverage accordingly.

Empirical evidence is mixed and it varies across industries, firm size, asset structure, and growth options. While many studies find patterns consistent with a target leverage, many firms deviate due to market timing, taxes, regulatory differences, or financing constraints. The trade-off theory is often contrasted with the pecking-order theory, which emphasizes information asymmetry and financing hierarchies, and is seen as a cornerstone of discussions on capital structure alongside related models.