According to the trade-off theory, more profitable firms should have more debt and thus higher debt ratios on average.

Question

Quizplus · Accepted Answer

The trade-off theory suggests that firms balance the benefits and costs of debt financing and aim to achieve an optimal level of debt that maximizes their value. More profitable firms can take on higher levels of debt because they have more cash flows to cover interest payments and are viewed as less risky by creditors. Therefore, higher profitability is positively related to higher debt ratios according to the trade-off theory.

According to the Trade-Off Theory, More Profitable Firms Should Have