Final answer:
Empirical tests of capital structure theories have produced mixed results. The trade-off theory suggests that firms choose a balance between debt and financial distress. The pecking order theory proposes that firms prefer internal financing before external financing.
Step-by-step explanation:
The empirical tests of the capital structure theories have produced mixed results. Different studies have found support for different theories, and no single theory has been universally confirmed.
One of the most well-known theories, the trade-off theory, suggests that firms choose a capital structure that balances the tax advantages of debt with the costs of financial distress. Empirical evidence has supported this theory in some cases, showing that firms with higher tax rates are more likely to have higher levels of debt.
Another theory, the pecking order theory, proposes that firms prefer to finance their investments internally and only resort to external financing, such as debt or equity, when internal funds are insufficient. Empirical evidence has also supported this theory, showing that firms tend to rely more on internal financing when they have higher cash flow.