The capital structure and investment decisions of the. The goal of this chapter is to discuss the various theories that help to explain the determination of capital structure. The impact of capital structure on risk and firm performance mdpi. They mm pointed the direction that such theories must take by showing under what conditions capital structure is irrelevant. Modigliani and miller 1958 were the first ones to landmark the topic of. Capital structure policy involves a tradeoff between risk and return 1 using more debt raises the riskiness of the firms earnings stream. It is the permanent financing of a firm represented by longterm debt, preferred stock and net worth. Determinant factors of the capital structure of a firm an empirical. Keywords capital structure, profitability, panel data, equity, debt. The capital structure puzzle is unravelled and a clear. The relationship between capital structure decisions and firm value has been. Capital structure is also referred to as the degree of debts in the financing or capital of a business firm.
The impact of capital structure on firms performance in. Taxbased theories include bankruptcy and tradeoff theory. Chapter iii concepts and theories of capital structure and profitability. The determinants of capital structure decisions sciencedirect. Since capital structure is the amount of debt or equity or both employed by a firm to fund its operations and finance its assets, capital structure is typically expressed as a debttoequity ratio. The impact of capital structure on financial performance. So far, researchers have not yet reached a consensus on the optimal capital structure of firms by simultaneously dealing with the agency problem. Aswath damodaran 3 the objective in decision making n in traditional corporate finance, the objective in decision making is to maximize the value of the firm. Most companies are funded by a mix of debt and equity, including some shortterm debt, some longterm debt, a number of shares of common stock. A study on determinants of capital structure in india. The paper identifies the most important determinants of capital structure of 870 listed indian firms comprising both private sector companies and government companies for the period 20012010. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Capital structure is the proportion of all types of capital viz. Debt, equity or preferred stock b the cost of each component n in summary, the cost of capital is the cost of each component weighted by its relative market value.
It can be argued that an optimal capital structure really doesnt exist since changing the mix of. The purpose of this paper is to investigate whether capital structure affects the performance of nonfinancial firms in pakistan. Capital structure is the mix of ownersupplied capital equity, reserves, surplus and borrowed capital bonds, loans that a firm uses to finance business operations. This is an open access article under the cc byncnd. Capital structure and financial performance have the negative relationship. Capital structure list of high impact articles ppts. In this article, we focus on analyzing the balance sheet based on a companys capital structure.
Previous studies indicate asset tangibility, tax, risk, liquidity and inflation as capital structure determinants in. Since then, many economists have followed the path they mapped. Capital structure and its 4 important theories ni, noi. Ownership structure, corporate governance and capital. The impact of capital structure on firms performance in nigeria. Capital structure theory the theory behind capital structure is to find the right mix of longterm funds that minimizes the costs of capital and maximizes the value of the organization. Here the data is described, measures of institute of economic studies, charles university, prague and idet, department of eco. The impact of capital structure on financial performance of the firms. When the stock is traded and markets are viewed to be efficient, the objective is. The explanatory variable which has the highest impact on the capital structure choices is profitability. This is an open access article under the cc bync nd. The debt capital in a companys capital structure refers to borrowed money that is at work in the business.
The alternative o ered by conventional wisdom is that informal capital dominates the capital. Debt comes in the form of bond issues or longterm notes payable, while equity is classified as common stock, preferred stock or retained earnings. In an attempt to progress this issue, the current paper looks at some of the issues influencing the demand for finance in small firms which are ownermanaged. Most of the research on capital structure has focused on the proportions of debt vs. In the burgeoning literature on small firm financing, the problem of underidentification in respect to the supply of, and demand for, capital has not been fully resolved. Capital structure articles scientific research publishing. Thus, the findings of the study would enhance the literature on capital structure and is relevant for the indian manufacturing industry in taking its capital structure decisions as it is based on the most recent data and covers the period of both pre and postrecession of 20082009.
The cost depends on the health of the companys balance sheeta triple aaa rated firm can borrow at extremely low rates vs. Analyzing a companys capital structure investopedia. We find both corporate and personal income taxes to be significant determinants of capital structure. Corporate finance agency costs, risk management, and capital structure hayne e. The reliable determinants for leverage are firm size, tangibility, industry leverage, profits, and inflation. Critical reexaminations on the relationships among capital structure, costs of capital, and firm value. Based on ex post observed summary statistics, across organisation for economic cooperation and development oecd countries, taxes appear to be as important as other traditional variables in explaining capital structure choices. The paper is primarily exploratory in nature and argues that a. Capital structure management a companys capital structure refers to the combination of its various sources of funding. Capital structure, credit risk, and macroeconomic conditions. This article examines the international determinants of capital structure using a large sample of firms from 37 countries. Capital structure and stock returns journal of political.
Myers he study of capital structure attempts to explain the mix of securities and financing sources used by corporations to finance real investment. The impact of capital structure on financial performance of commercial banks in ethiopia by mathewos woldemariam birru jimma university. A firms judicious use of debt and equity is a key indicator of a strong balance sheet. Taxes and capital structure journal of financial and. In theory, it may be possible to reduce capital structure to a financial calculation to get the most tax benefits by favoring debt, for example, or to boost earnings per. The cost of capital curve is a useful concept to think about capital structure, but is just one of many inputs to the capital structure decisionmaking toolbox. Ogebe, patrick and ogebe, joseph and alewi, kemi 27 march 20 online at mpra paper no. Capital structure, profitability, debt to equity ratio, debt to.
Corporate finance agency costs, risk management, and. Capital structure is also referred as financial structure of a firm. It is the employment of an asset source of finance for which. Our results suggest that legal requirements are significant determinants of the capital structure of reits. Debt comes in the form of bond issues or longterm notes.
There is a significance impact of capital structure on. Article information, pdf download for the effect of capital structure on. Introduction capital structure refers to the different options used by a firm in financing its assets bhaduri, 2002. Ten independent variables and three dependent variables have been tested using regression analysis. Although corporate net issuing activity is lively and although it can explain 60 percent of debt ratio dynamics long. So it relates to the arrangement of capital and excludes shortterm borrowings. The paper explores a vast body of literature in articulating critical issues in capital structure decision. This ideal mix is called the optimal capital structure. Abstract capital structure decisions are among the most important and crucial decisions for any business because of their effect on the performance of firms. The most important arguments for what could determine capital structure is the pecking order theory and the static trade off theory. The capital structure decisions of new firms nber working.
The purpose of this paper is to examine the effect of ownership structure and corporate governance on capital structure decisions of firms on the ghana stock exchange gse. An oftcited survey exemplifies the range of factors cfos consider when making capital structure decisions figure 3. The capital structure of a company is made up of debt and equity securities that comprise a firms financing of its assets. The capital structure indicators refer to longterm debt, shortterm debt. We investigate firmspecific and countryspecific factors, and account for the unique legal requirements that reits face in each country. Given the plethora of forces and issues that capital structure. The empirical results show that h 0 is rejected because there is positive relationship in capital structure and financial performance.