The capital structure question is concerned with the factors that determine the optimum balance (if any) of equity and debt used to finance companies. It is one of the key areas in the economics of corporate finance, since it has implications for new security issues, the financing of takeover and buyout activity, and also dividend policy, since retained earnings - the profits retained by a firm after payment of dividends - are a major source of equity funding. The considered view prior to the modern analytical approaches pioneered by Modigliani and Miller in the late 1950s was that a moderate amount of debt finance (in the form of corporate bonds, debentures or loan stock) was beneficial, but that higher levels were not prudent - indeed, high corporate debt levels had been cited as one of the factors causing the great stock market crash of 1929. Their analysis pointed initially to the irrelevancy of the debt- equity split, and in later work to advantages to debt finance as a result of corporate tax effects. Miller subsequently integrated personal taxes into the framework and argued that the tax advantages of borrowing were small. In addition to this 'fundamental' analysis of the problem, there have been numerous other theoretical approaches based on information economics, agency theory, ad hoc theories such as the 'pecking order hypothesis' and other ideas. Empirical evidence is weakly supportive of a tax effect but the evidence for the existence of a generalized optimal level of gearing or leverage is weak.

The main conclusion to be drawn form the diverse literature on capital structure and financing decisions is the absence of any universal consensus on optimal financing structure. The four principal theoretical perspectives which emerge are (1) the fundamentalists, who do not agree on any optimal course of action when choosing between debt and equity, (2) agency theory, in which the optimal capital structure is obtained by trading off the agency cost of debt against the benefit of debt, (3) the 'pecking order' theory, whose proponents argue that firms should finance investment through retained earnings as a first choice, then debt and lastly equity, and (4) signalling theory, where information asymmetry is assumed between management and shareholders thus in theory favouring debt over equity.