DETERMINANTS OF CAPITAL STRUCTURE
Introduction
Modern theory of capital structure instigated with the seminal paper of Modigliani and Miller [1]. In brief, the MM theory states that the market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent from its corporate financing decisions. In fact, the MM theory provided conditions under which a firm’s financial decisions do not affect the value of the firm. The fundamental conditions under which a firm’s leverage becomes irrelevant to its market value, hence the MM proposition hold includes: * No taxation * No transaction costs exist * No default risk * Perfect and frictionless markets * Firms and investors can borrow at the same interest rate
The MM theorem might seem extraneous but it provides cornerstone for corporate finance. However, the classic question “How do firms choose their capital structure?” remain unanswered. In finance, the term ‘capital structure’ refers to the technique followed by corporations to finance its assets through combination of equity, debt, or hybrid securities [2]. In simple terms, a firm's capital structure is the symphony of its liabilities. For example, a firm that possesses $40 billion in equity and $60 billion in debt is said to be 40% equity-financed and 60% debt-financed. The firm's ratio of debt to equity that is 60% is referred to as the ‘firm's leverage’.

Leverage and Gearing are two terms that are often used interchangeably, gearing ratio is the proportion of the capital employed by the firm which comes from outside of the business finance, e.g. by taking a short term loan etc. In reality, capital structure may be highly complex and include dozens of sources. There are different factors that affect a firm's capital structure, and a firm should attempt to determine the optimal mix of financing.