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Recommended Readings: Finance

 

Capital Structure by Stewert C Myers | Journal of Economic Perspectives, Spring 2001

In this article, a well known scholar examines the tradeoffs underlying the use of debt and equity. Contrary to what Miller and  Modigliani mentioned, capital structure does matter because of taxes, differences in  information and agency costs. Accordingly,  Myers examines three theories in detail. The trade off theory tries to balance the tax  advantages of debt and the possibility of distress. The pecking order (differences in  information ) theory states that firms will first borrow rather than raise equity when they are short of funds. The free cash flow (agency costs) theory argues that cash flows belong to equity holders. Even dangerously high levels of debt can create value for shareholders if the free cash flows are more than the investment opportunities.