...CapStrMktPower I M Pandey CAPITAL STRUCTURE AND MARKET POWER I. M. Pandey Indian Institute of Management Ahmedabad Vastrapur, Ahmedabad 380015 India E-mail: impandey@iimahd.ernet.in W. P. No. 2002-03-01 March 2002 i CapStrMktPower I M Pandey CAPITAL STRUCTURE AND MARKET POWER I M Pandey ABSTRACT This paper provides new insights on the way in which the capital structure and market power and capital structure and profitability are related. We predict and show that capital structure and market power, as measured by Tobin’s Q, have a cubic relationship. That is, at lower and higher ranges of Tobin’s Q, firms employ higher debt, and reduce their debt at intermediate range. This is due to the complex interaction of the market conditions, agency problems and bankruptcy costs. We also show saucer-shaped relation between capital structure and profitability because of the interplay of agency costs, costs of external financing and debt tax shield. To our knowledge, we are the first to uncover these results. Key words: capital structure; market structure; market power; Tobin’s Q; riskshifting; moral hazard; agency problems; pecking order; trade-off theory; asset substitution. ii CapStrMktPower I M Pandey CAPITAL STRUCTURE AND MARKET POWER INTRODUCTION In corporate finance, works of Modigliani and Miller (1958; 1963) about capital structure irrelevance and tax shield advantage paved way for the development of alternative theories and a series of...
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...Capital Structure Stewart C. Myers The Journal of Economic Perspectives, Vol. 15, No. 2. (Spring, 2001), pp. 81-102. Stable URL: http://links.jstor.org/sici?sici=0895-3309%28200121%2915%3A2%3C81%3ACS%3E2.0.CO%3B2-D The Journal of Economic Perspectives is currently published by American Economic Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/aea.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. The JSTOR Archive is a trusted digital repository providing for long-term preservation and access to leading academic journals and scholarly literature from around the world. The Archive is supported by libraries, scholarly societies, publishers, and foundations. It is an initiative of JSTOR, a not-for-profit organization with a mission to help the scholarly community take advantage of advances in technology. For more information regarding JSTOR, please...
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...In 1958, Franco Modigliani and Merton Miller revolutionized the whole area of corporate finance with their article “The cost of capital, corporate finance and the theory of investment”. Before Modigliani’s and Miller’s article, literature on the topic mainly focused on descriptions of methods and institutions. Theoretical analysis was very rare (Pagano 2008). Under the assumption of perfect capital markets, the Modigliani-Miller Proposition I states that “the average cost of capital to any firm is completely independent of its capital structure and is equal the capitalization rate of a pure equity stream of its class” (Modigliani, Miller 1958). In Proposition II, Modigliani and Miller argue that “that the expected yield of a share of stock is equal to the appropriate capitalization rate for a pure equity stream in the class, plus a premium related to financial risk equal to the debt-equity ratio times the spread between” the capitalization rate and the return on debt. The most important implication of this theory is that if there is an optimal capital structure for a firm, this has to be the result of market imperfections. The Modigliani-Miller Theorem has thus become a starting point for further research and a benchmark for testing new theories on capital structure, that incorporate the impact of different market imperfections. The following text will focus on two of these theories, the static trade-off theory and the pecking order theory. The first part will contain a description...
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...Vol. 2 No. 19 [Special Issue - October 2011] Perceived Relationship between Corporate Capital Structure and Firm Value in Nigeria Semiu Babatunde ADEYEMI Department of Accounting University of Lagos Lagos, Nigeria Collins Sankay OBOH Department of Accounting University of Lagos Lagos, Nigeria Abstract This study examined the empirical effects of corporate capital structure (financial leverage) on the market value of a selection of firms listed on the Nigerian Stock Exchange. Both primary and secondary data were obtained for analysis employing both descriptive and inferential statistics for analysis. A sample size of 150 respondents and 90 firms were selected for both primary data and secondary data respectively. Descriptive statistics was used to analyse the primary data, while Chi-Square was used to draw inference of perceived relationship between capital structure and firm value. The results of the study suggested that a positively significant relationship exists between a firm’s choice of capital structure and its market value in Nigeria. The study suggested that listed firms in Nigeria should strategically plan and manage their capital structure in order to maximize their market values. Keywords: Capital structure, market value, Nigeria, debt, equity. 1. Introduction 1.1 Background to the Study After the Modigliani-Miller (1958 and 1963) paradigms on firms’ capital structure and their market values, there have been considerable debates, both in theoretical and empirical...
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...Global Economic Review Vol. 37, No. 1, 107Á123, March 2008 Performance and Capital Structure of Privatized Firms in Europe ´ ´ MARIA JOSE ARCAS & PATRICIA BACHILLER Faculty of Economics and Business Administration, Department of Accounting and Finance, University of Zaragoza, Zaragoza, Spain ABSTRACT The objective of this paper is to analyze whether there are differences in performance between private firms and recently privatized firms in the European Union, as well as to determine whether ownership (state-owned versus private) and regulation affect capital structure. Focusing on economic reasons that justify privatizations, we analyze whether there are differences between recently privatized state-owned enterprises (SOEs) and private firms in their profitability, leverage and efficiency during the period 1999Á2002. Also, we analyze the determinants of the capital structure of these firms. Contrary to previous studies, our results show that privatized firms are not less efficient than firms with private ownership. KEY WORDS: Privatization, efficiency, capital structure, regression, Wilcoxon test Summary In recent decades, the privatization of state-owned enterprises (SOEs) has been one of the most common policies carried out in economies worldwide and the Organization for Economic Cooperation and Development (OECD) countries have also been involved in this phenomenon. Many studies have focused on the impact of privatization on the performance of the privatized firms...
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...CAPITAL STRUCTURE DECISIONS Research Project Presented to MPSTME,NMIMS In Partial Fulfilment of the Requirements of 5 Years Integrated MBA (Tech) Program By Kritika Goel 334 Year of Graduation: 2013 ACKNOWLEDGEMENT This is not a mere formality, but a means to express my sincere gratitude to all who helped me and played an essential role throughout my endeavour, so that I could complete this research project in time and achieve success. I acknowledge from the bottom of my heart those who were solicitous and benevolent enough to guide me throughout the period. First and foremost, I am deeply grateful to my college and my research project mentor Prof. Kedar Subramanian whose profound encouragement, cooperation, guidance and keen supervision at every stage of my research paper inspired me in pursuing and completing it successfully and within schedule. I also heartily thank the Head of the Department Prof. RC Agrawal and the Respected Dean for the continuous help and encouragement and the friendly atmosphere of education provided by them. Kritika Goel ABSTRACT The paper is divided into two major segments- Introduction and Review of Literature. Former, gives a foundation of capital structure decisions with its purpose, significance and methodology. Later, provide the development of the present research by examining the earlier literature or secondary data on the same. Capital Structure is a basically a structure or mixture of different types...
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...Capital structure refers to the way a corporation finances its assets through some combination of equity and debt. A firm's capital structure is the composition of structure of its liabilities. According to Modigliani-Miller theorem, in a perfect capital market (no transaction or bankruptcy costs; perfect information); firms and individuals can borrow at the same interest rate; no taxes; and investment decisions aren't affected by financing decisions. Modigliani and Miller made two findings under these conditions. Their first 'proposition' was that the value of a company is independent of its capital structure. Their second 'proposition' stated that the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm, plus an added premium for financial risk. That is, as leverage increases, while the burden of individual risks is shifted between different investor classes, total risk is conserved and hence no extra value created. Under a classical tax system, the tax deductibility of interest makes debt financing valuable; that is, the cost of capital decreases as the proportion of debt in the capital structure increases. The optimal structure then would be to have virtually no equity at all. However, there is no such perfect market in real world. Under this situation, capital structure is necessary when scrutinize a company’s performance from finance perspective. And our project will examine the capital structure of Coca Cola Company from the aspects...
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...Mekelle University College of Business and Economics Department of Accounting and Finance THE DETERMINANTS OF CAPITAL STRUCTURE Evidence from Commercial Banks in Ethiopia By K i b ro m M e h a ri F i s s e h a Reg.No.-CBE/PR0025/01 Research Project Submitted to the Department of Accounting and Finance, College of Business and Economics, Mekelle University, for the partial fulfillment of the degree of Master of Finance and Investment Under the Guidance of Aregawi Gebremichael (Ph.D. Candidate) Assistant Professor May, 2010 Mekelle, Ethiopia i THE DETERMINANTS OF CAPITAL STRUCTURE Evidence from Commercial Banks in Ethiopia By Kibrom Mehari Fisseha Reg. No. CBE/PR0025/01 ii DECLARATION I, Kibrom Mehari Fisseha, hereby declare that the project work entitled “The Determinants of Capital Structure: Evidence from Commercial Banks in Ethiopia” submitted by me for the award of the degree of Master of Science in Finance and Investment of Mekelle University, is original work and it hasn’t been presented for the award of any other Degree, Diploma, Fellowship or other similar titles of any other university or institution. Place: Mekelle Signature: Date: May, 2010 ………………….. KIBROM MEHARI FISSEHA iii CERTIFICATION I certify that the project work entitled “The Determinants of Capital Structure” is a bona-fide work of Mr. Kibrom Mehari who carried out the research under my guidance. Certified further, that to the best of my...
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...------------------------------------------------- An analysis of capital structure of NEXT Programme of Study: MSC INVESTMENT Module: International Treasury Management Tutor: Students ID Number: Date: 23/3/2016 Programme of Study: MSC INVESTMENT Module: International Treasury Management Tutor: Students ID Number: Date: 23/3/2016 Contents 1. Introduction 3 2. Capital structure 4 2.1. Theories 4 2.2. Types of capital 6 2.3. Sources of capital 7 2.4. Reasons of conducting different capital structure 9 3. Capital Structure of NEXT 11 3.1. Comparative analysis of internal and external financing of NEXT 11 3.2. Comparative analysis of debt capital and equity capital of NEXT 13 3.3. Comparative analysis of current debt and non-current debt of NEXT 15 3.4. Financial performance of NEXT 2013-2015 17 4. Conclusion 19 5. Reference 20 6. Appendixes 22 Appendix I 22 Appendix II 23 Appendix III 25 Appendix IV 27 Appendix V 29 Appendix VI 30 1. Introduction Capital structure of firms is arguably one of its most important choices, as Milken (2009) said “It doesn't matter whether a company is big or small, capital structure matters. It always has and always will”. Most companies pay much attention to their capital structure, NEXT is one of the good representative among those companies. NEXT, founded in 1864, now is the largest apparel corporation in UK, which currently operates more than...
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...This paper will discuss the choice of capital structure in markets where there is information asymmetry. Particular reference is made to how debt is used as a signalling tool along with a discussion on debt maturity structure. The pecking order theory is examined. Finally this paper reveals empirical evidence of capital structure. Arnold Musadziruma 210525268 Clint Kruger 209541568 Kemsley Grantham 209538112 i “Seminar 4- Capital structure and information asymmetry (2013)” Abstract This study is going to discuss capital structure choices of companies in an environment of information asymmetry. Firstly we discuss information asymmetry and how firms attempt to avoid a pooling equilibrium by signalling the quality of the firm. Quality can be signalled through the use of debt. The use of long term debt is a sign that a firm can make the payment obligations of the long term debt which is shown to signal good quality. The pecking order theory makes use of a hierarchy of financing sources and indicates internally generated funds should be used first. Following this, short term debt should be used before long term debt because of the risk and costs involved. Due to the costs involved in issuing equity in an environment of information asymmetry, firms should make use of equity as a last resort. The maturity structure of debt should also match the maturities of those firms’ assets to reduce costs. Empirical evidence suggests there is no common result for which theory is followed...
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...FINC 5000 LESSON NOTES – WEEK 7 CHAPTER 15 Capital Structure Introduction: Capital Structure Theory - Capital Structure refers to the proportion of debt and equity being used to finance a firm’s assets: Assets = Debt + Equity Capital Structure - In this lesson we will examine the notion that capital structure affects the value of the firm. That is, the value of the firm might change with the amount of debt that is present. - This would occur because the cost of financing with debt (AtRd) is normally lower than the cost of financing with equity (Rs), which means the WACC for the firm will be different at different blends of debt and equity financing (which means the value of the firm will be different at different blends of debt and equity financing) You can see the effect in the WACC formula: WACC = Wd(ATRd) + Ws(Rs) (no preferred stock in this example) If AT Rd = 6% and Rs = 12%: At zero debt: WACC = 0(.06) + 1.00(.12) = .12, or 12% At 50/50 debt and equity WACC = .50(.06) + .50(.12) = .09, or 9% - Furthermore, as the amount of debt financing in a firm rises, AtRd and Rs themselves will rise, because of the increasing degree of riskiness present: At zero debt: WACC = 0(.06) + 1.00(.12) = .12, or 12% At 50/50 debt and equity WACC = .50(.08) + .50(.14) = .11...
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...corporations in the US, approximately 30-40% are estimated to be family owned (Anderson and Reeb, 2003; Anderson, Duru and Reeb, 2009) Researchers have found similar statistics for family firms around the world (Dreux, 1990; Martinez, 1994; Owens, 1994). Therefore, a better grasp of the unique characteristics of family firms is a basis for understanding a significant part of the world’s economy several papers have been written about the unique characteristics of family businesses and their performance compared to that of non-family businesses. Most research done in the field focused on corporate governance measures, family relationships, succession, and performance indicators of family owned businesses. This research article also deals with capital structure & performance of family businesses in India. Article 1: (Kim & Gao) Does Family involvement increase business performance Family involvement in business management attracts much scholarly attention in the field of family business. This paper's main objectives are answering two questions. They are 1) how does family involvement in management affect firm performance? 2) Is the relationship between FIM & Firm performance contingent on a firms goals? This study defines family business as a firm owned and managed by a family or family clan (litz, 1997). This study employs snowball sampling as it is difficult, the study also asked the respondents to indicate whether the firm was owned and managed by a family through...
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...FINC 5000 LESSON NOTES – WEEK 7 CHAPTER 15 Capital Structure Introduction: Capital Structure Theory - Capital Structure refers to the proportion of debt and equity being used to finance a firm’s assets: Assets = Debt + Equity Capital Structure - In this lesson we will examine the notion that capital structure affects the value of the firm. That is, the value of the firm might change with the amount of debt that is present. - This would occur because the cost of financing with debt (AtRd) is normally lower than the cost of financing with equity (Rs), which means the WACC for the firm will be different at different blends of debt and equity financing (which means the value of the firm will be different at different blends of debt and equity financing) You can see the effect in the WACC formula: WACC = Wd(ATRd) + Ws(Rs) (no preferred stock in this example) If AT Rd = 6% and Rs = 12%: At zero debt: WACC = 0(.06) + 1.00(.12) = .12, or 12% At 50/50 debt and equity WACC = .50(.06) + .50(.12) = .09, or 9% - Furthermore, as the amount of debt financing in a firm rises, AtRd and Rs themselves will rise, because of the increasing degree of riskiness present: At zero debt: WACC = 0(.06) + 1.00(.12) = .12, or 12% At 50/50 debt and equity WACC = .50(.08) + .50(.14) = .11...
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...Miller's Capital-Structure Irrelevance Proposition Modigliani and Miller, two professors in the 1950s, studied capital-structure theory intensely. From their analysis, they developed the capital-structure irrelevance proposition. Essentially, they hypothesized that in perfect markets, it does not matter what capital structure a company uses to finance its operations. The MM study is based on the following key assumptions: * No taxes * No transaction costs * No bankruptcy costs * Equivalence in borrowing costs for both companies and investors * Symmetry of market information, meaning companies and investors have the same information * No effect of debt on a company's earnings before interest and taxes In this simplified view, it can be seen that without taxes and bankruptcy costs, the WACC should remain constant with changes in the company's capital structure. For example, no matter how the firm borrows, there will be no tax benefit from interest payments and thus no changes/benefits to the WACC. Additionally, since there are no changes/benefits from increases in debt, the capital structure does not influence a company's stock price, and the capital structure is therefore irrelevant to a company's stock price. However, as we have stated, taxes and bankruptcy costs do significantly affect a company's stock price. In additional papers, Modigliani and Miller included both the effect of taxes and bankruptcy costs. The MM Capital-Structure Irrelevance...
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...Lecture 13: Capital Structure Theory Exercises Question 1 Levered Inc. and Unlevered Inc. are identical in every respect except for capital structure. Both companies expect to earn $150 million in perpetuity, and both distribute all of their earnings as dividends. Levered’s perpetual debt has a market value of $300 million and the required return on its debt is 7%. Levered’s stock sells for $100 per share, and there are 5 million shares outstanding. Unlevered has 8 million shares outstanding worth $90 each. Unlevered has no debt. These firms operate in the Modigliani-Miller world with no taxes. How can you take advantage of this scenario? Question 2 Consider the problem of estimating the cost of equity for Crab Inc., a non-listed chain of restaurants specializing in crab meals. Crab has a debt-to-equity ratio of 2 and pays an interest rate of 5% on its debt. Crab’s operations are highly similar to those of the publicly traded Lobster Inc. and Shrimp Inc., which specialize in lobster meals and shrimp meals, respectively. Assume that none of these companies pays taxes. The risk free rate is 2% and the expected return on the market is 10%. Lobster has a debt-to equity ratio of 1, an equity beta of 2, and a cost of debt of 3.6%. Shrimp has a debt-to-equity ratio of 1.5, an equity beta of 3, and a cost of debt of 4.4%. a. Are the debts of Crab, Lobster, and Shrimp risk free? What does this imply for their debt betas? b. Estimate Crab’s cost of equity. Be careful to do it using...
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