Capital Structure Theory

Capital structure theory has been well-developed during the years since it was first put forward by Modigliani and Miller in 1985. MM theory states that corporate capital structure does not influence corporate value in the perfect market environment. However, since MM theory eliminates a number of critical factors in the real world, such as, tax effect and transaction cost, etc., it is not applicable in real world. In practice, there are two main capital structure related theories. The trade-off theory (Kraus and Litzenberger, 1973) indicates that firm has to keep a balance between debt tax benefit and distress cost it may bring. On the other hand, modern research (Chen and Chen, 2011) shows a preference for the pecking order theory, which

This study sample is selected from the firms listed on the S&P 500 from a wide range of industries, and it shows that firm does pay to be green and a time lag exists between environmental initiation and corporate operating and financial performance improvement. What is more, the closer the company reaches to the zero pollution bottom line, the higher cost it will pay on capital rising or on technology improvement. On the other hand, this research also indicates that although the marginal cost will increase as the firm is approaching to its zero pollution line, the marginal cost never exceeds the marginal benefit among different firms in the research sample. However, this research has some limitations, since most of environmentally sensitive companies had not achieved their goals to reduce the emission pollution dramatically yet during 1988 to 1989. Although this very early research has its limitations, it does show the corporate environmental policy will influence firm operation and finance performance, then make further impact on company capital structure, more evidence will be presented in the following research

By testing 557 listed American companies in the United States based environmentally sensitive industries, the study put forward by Pled and Iatridis (2012) first indicates that firms with products that are harmful to environment and make negative public impact or if firms evolving in higher leverage performance will release more corporate social responsibility material to try to lower their cost of equity. Then by testing the relationship between the firm cost of equity, growth potential, company stock riskiness, and the firm corporate social responsibility information disclosure. It shows that the more corporate social responsibility information disclosure, the higher potential growth rate and the lower the cost of equity, since many public investors may treat stocks issued by firms with higher social responsibility as lower risk ones. Thus, firms are usually willing to release more information on the corporate social responsibility to show that they are concerned about the environment and social sustainable development (Chapple et al.,