Companies face the challenge of determining whether to issue debt or equity for financing needs. Issuance of debt or equity both have advantages and disadvantages.

Advantages of Issuing Debt
1. Issuance of debt has a tax benefit because of the debt tax shield. The interest payments to debt owners are expensed, causing a reduction taxable income. A company with a higher tax rate thus has a higher tax benefit from debt issuance

2. Some assert that debt adds discipline to management because interest expenses cause lower left over cashflows, which makes management more likely to be efficient and non-complacent. Also, future debt obligations can be easily forecasted and planned for.

Disadvantages of Debt
1. Debt issuance increases bankruptcy risk because debt owners can take control of the company if interest payments are not made.

2. Debt owners have different wants than stockholders. Issuing debt may increase this separation between debt and stockholders.

3. Future financial flexibility may be reduced by issuance of debt. Lenders must make consistent interest payments on issued debt, reducing financial flexibility. In addition, issuance of debt may reduce the amount or increase the cost of future debt financing.

Advantages of Equity
1. Equity financing increases management flexibility in contrast to the third disadvantage of debt.  Companies may issue dividends to shareholders but are not required to.

Disadvantages of Equity
1. Equity decreases control of management and current shareholders because issuance of new equity increases the number of shares outstanding. Thus, issuing equity should normally result in a decline in stock price because each old share is less valuable.

2. Dividend payments are not tax deductible.

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