The effects & theory thread

Mordosky effect? Static trade off? Pecking order?

Static trade-off: as debt increases in capital structure, costs of financial distress will increase, and eventually offset (and exceed) the gain from the tax benefit from debt. The equilibrium point (where the costs of financial distress equal the tax savings) sets the optimal capital structure, and minimum WACC. Pecking order theory: Managers prefer to raise capital in a way that won’t send any signals to the market. The hierarchy from least likely to signal the market to most is - internally generated funds (residual income) < external debt < external equity. The capital structure should be a culmination of all the individual financing decisions. What I don’t know is where bank financing (line of credit) would fall in this… Do you mean Molodovsky for the first one? I think it was P/E’s are highest at the trough of market cycle (lowest earnings) and lowest at the peak (highest earnings). This leads to incorrect indicators for fundamental investors.

Molodovsky - business cycle high P/E at the bottom of the cycle due to low earning and low PEs at the top of the cycle Percking order choice of mgt to use internally generated funds and then debt and then equity- less visible to more visible signals Static trade off- option capital structure debt and equity. point where the benefits of debt tax savings are not greater that the cost of financial distress resulting from increased equity cost.