Introduction on Capital Structure……………………..5 Summary and Evaluation of Articles…………………6
Introduction On Capital Structure :-
In the field of finance capital structure means a way an organization or firms finances their assets by the way of some mix and match of Equity, Debt or Hybrid Securities. The modern thinking on capital structure is based on the Modigliani-Miller theorem given by Franco Modigliani and Merton Miller. The theorem suggests that in a perfect market the total value of the company remains the same depending upon how is that company financed. This theorem proves the importance of capital structuring by the firms throughout the globe. There are other reasons as well like bankruptcy costs, agency costs and asymmetric information. Also this paper has tried to explain the trade off theory and it also talks about the firm-specific and country-specific factors of capital structure.
Articles Relating to Capital Structure :-
There have been lots and lots of study, researches, arguments, and articles written on capital structures as it is one of the wide topics to discuss upon. For an Example, If a company sells £40bn pounds in equity and £60bn pounds as debt then the company is said to be having a capital structure with 40% equity finance and 60% debt finance. And the company’s Leverage Ratio which is given by dividing total debt to total financing i.e. 60% in this example.
Starting with a very informative article in which the writers have tried to analyze the importance of firm-specific and country-specific factors in the leverage choices of 42 different countries around the world. Past researches by [Demirgüç-Kunt and Maksimovic, 1999], [Booth et al., 2001], [Claessens, et al., 2001] and [Bancel and Mittoo, 2004] suggested that a firm’s capital structure is influenced by firm-specific factors and country-specific factors. The corporate leverages are affected directly and indirectly by country-specific factors. The researches in comparing the different capital structure around the globe started around past decade or so and [Rajan and Zingales, 1995] did the initial comparison of seven advanced industrialized countries. They came up with a remarkable discovery that in influencing a firm’s capital structure not only firm-specific factors but also country-specific factors play a vital role. [Demirgüç-Kunt and Maksimovic, 1999] came up with a different concept of comparing capital structure of firms in developed and developing countries. They suggested that institutional differences between such countries show a huge variation in long-term debt. Latest researches by [Graham and Harvey, 2001], [Bancel and Mittoo, 2004] and [Brounen, et al., 2006] have suggested that even among developed countries like U.S and European countries the institutional environment and internal operations influences financial policies and managerial behavior. This article basically emphasis on direct impact of countries characteristics on leverage. By analyzing 10 developing countries, [Booth, et al., 2001] found that capital structure in such countries are affected similarly as in developed countries but with a difference in the way leverage is affected by country-specific factors like GDP growth and capital market development. The other article relating to capital structure talks about different aspect relating to the financial distress cost, bankruptcy cost and most importantly it discusses about the trade off theory of capital structure. The article suggests about how a company can reach its optimum capital structure. It tries to explain how debt policy play a vital role in deciding the capital structure and the legal bankruptcy cost sometimes becomes time consuming, painful, and very expensive. It also points out that a situation of conflicts of interest may arise between the firm’s security holders and problems may arise by issuance...
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Graham, J. and Harvey, C. (2001) ‘The theory and practice of corporate finance: Evidence from the field’, Journal of Financial Economics, Vol.60, pp. 187–243.
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