What are the variables that enter compromise theory?

What is the effect of each on the optimal debt-equity mix?

In compromise theory, the value of a levered firm equals the value of the same firm without leverage modified by the impact of three factors:

(1) Corporate income taxes the bias toward debt in the corporate income tax code adds value to companies with debt financing.

(2) Bankruptcy costs – the increased probability of loss should a company be unable to service its debt subtracts value from companies with debt financing.

(3) Agency costs – the increased difficulty of aligning management actions with shareholder needs in a company with debt subtracts value from companies with debt financing.