Determinants of Capital Structure
Assignment No. 2
Determinants of capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm 's capital structure is then the composition or 'structure ' of its liabilities. Simply, capital structure refers to the mix of debt and equity used by a firm in financing its assets. The capital structure decision is one of the most important decisions made by financial management. The capital structure decision is at the center of many other decisions in the area of corporate finance. These include dividend policy, project financing, issue of long term securities, financing of mergers, buyouts and so on. One of the many objectives of a corporate financial manager is to ensure the lower cost of capital and thus maximize the wealth of shareholders. Capital structure is one of the effective tools of management to manage the cost of capital. An optimal capital structure is reached at a point where the cost of the capital is minimum. Whether or not such an optimal capital structure exists? What are the potential determinants of such optimal capital structure? These are the questions to be answered by a researcher.
Related Literature
The first paper on capital structure was written by Miller and Modigliani in 1958. They conceptually proved that the value of firm in not dependent upon the capital structure decision given that certain conditions are met. Because of the unrealistic assumptions in MM irrelevance theory, research on capital structure gave birth to other theories. The trade off theory says that a firm’s adjustment toward an optimal leverage is influenced by three factors namely taxes, costs of financial distress and agency costs. Baxter (1967) argued that the extensive use of debt increases the chances of bankruptcy because of which creditors demand extra risk premium. He said that firms should not use debt beyond the point where the cost of debt
Determinants of capital structure
In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm 's capital structure is then the composition or 'structure ' of its liabilities. Simply, capital structure refers to the mix of debt and equity used by a firm in financing its assets. The capital structure decision is one of the most important decisions made by financial management. The capital structure decision is at the center of many other decisions in the area of corporate finance. These include dividend policy, project financing, issue of long term securities, financing of mergers, buyouts and so on. One of the many objectives of a corporate financial manager is to ensure the lower cost of capital and thus maximize the wealth of shareholders. Capital structure is one of the effective tools of management to manage the cost of capital. An optimal capital structure is reached at a point where the cost of the capital is minimum. Whether or not such an optimal capital structure exists? What are the potential determinants of such optimal capital structure? These are the questions to be answered by a researcher.
Related Literature
The first paper on capital structure was written by Miller and Modigliani in 1958. They conceptually proved that the value of firm in not dependent upon the capital structure decision given that certain conditions are met. Because of the unrealistic assumptions in MM irrelevance theory, research on capital structure gave birth to other theories. The trade off theory says that a firm’s adjustment toward an optimal leverage is influenced by three factors namely taxes, costs of financial distress and agency costs. Baxter (1967) argued that the extensive use of debt increases the chances of bankruptcy because of which creditors demand extra risk premium. He said that firms should not use debt beyond the point where the cost of debt