The trade-off theory cannot explain:

Question

Quizplus · Accepted Answer

The trade-off theory of capital structure suggests that firms balance the benefits of debt (such as tax shields) against the costs of potential financial distress. It cannot fully explain why financial leverage is similar across countries with different tax systems, as it would predict that firms in countries with higher corporate tax rates would use more debt to take advantage of the tax shield on interest payments. Differences in profitability or expansiveness in using debt finance can be rationalized within the trade-off theory framework by considering differences in firms' operations and risk profiles, but the similarity in leverage across diverse tax regimes is less easily accounted for.

The Trade-Off Theory Cannot Explain