Question

The entity theory of equity implies that there should be no need for financial statements to distinguish between debt and equity. Alternatively, proprietary theory implies that such a distinction is necessary and yields information vital to owners and potential stockholders. Is entity theory or proprietary theory consistent with modern theories of finance—that is, does the firm’s capital structure make a difference? Explain.

Answer 1

Capital Structure is an important decision for any organisation. Debt may create Financial Leverage to any organisation if used in the write mix.

The firm's capital structure makes a lot of differnce. It is important to bifurcate between the Equity and Debt so thah the Earnings Attributable to Equity Holders can be clearly distinguished.

Also the expectations of Debt Holders and Equity Holders vary which is why Capital Structure needs to be clearly defined to obtain information as to meeting of their expectations.