Introduction
In this essay, I will give brief review notes for “Access to Capital Structure, and the Funding of the Firm” (Omer Brav 2009) which will be focused on the goal of this easy, how and why the theoretical hypotheses are tested and what are the findings. Some discussions about data, methodology used and theory defects will also be included in this essay for critical comment.
Content
Objective
Since earlier capital structure theories are usually subject to public companies, it is very interesting to see whether there is a big difference between public and private companies. The author concentrated on the capital structure difference between UK public and private companies. Based on the data sourced from FAME, it can be found that private firms have general higher gearing than public firms in the UK, 33.7% for Private vs 22.5% for Public; and short-term takes a higher proportion of total debt for the private company than for public company.
To clarify this difference, Barv(2009) raised up two effects: ”the level effect” and “sensitivity effect”. The first effect refers to relative cost of equity to debt (likelihood of choosing the debt over equity), and later one refers to absolute cost of accessing capital or stock market (likelihood of accessing external capital markets). Some other researchers’ evidence, such as Faulkender & Petersen (2006), supported “the level effect” theory. While some further examinations by Barv (2009) himself show gearing ratio for private companies are more sensitive to operating performance than to trade-off theory determinants. Furthermore, the adjusting frequency of gearing ratio for private companies is very low.
Barv (2009) tried to explain the difference from deviations of t...
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...ce between the capital structure of public and private firms which has been explained in the above parts; however, for public firms listed in immature market may have a similar financial policy with private firms.
In our opinion, there are still further questions for the capital structure difference: First, we are very interested in whether the stability of Marco-economics may affect
Capital structure of companies, the further researches may include the data over 2008-2009. Second, the author state the firms listed in undeveloped markets may have different policies, but we don’t get the conclusion which characteristic(s) may be most significant one(s) which affect the capital structure policies of public companies. Finally, we still want to know whether state-owned companies may have different policies even they are listed or cross-listed in developed markets.
Target Corporation: Report on Long-term Financing Policy and Capital Structure with an Acquisition Analysis Introduction This report will be based on the Target Corporation, and will consist of two sections: 1) long-term financing policy and capital structure, and 2) an acquisition analysis. The first section will include: Target's most recent long-term financing decision; an analysis of the economic, business, and competitive background in which the financing occurred; Target's book value and market value; possible changes that would occur to Target's finance policy and capital structure if it was forced to consider re-organization and bankruptcy strategies; and finally discuss Target's international investment and financing opportunities, as well as foreign exchange risks. The second section will be a report to the board of directors that identifies a synergistic acquisition candidate for Target.
There is no universal theory of the debt-equity choice, and no reason to expect one. In this essay I will critically assess the Pecking Order Theory of capital structure with reference and comparison of publicly listed companies. The pecking order theory says that the firm will borrow, rather than issuing equity, when internal cash flow is not sufficient to fund capital expenditures. This theory explains why firms prefer internal rather than external financing which is due to adverse selection, asymmetry of information, and agency costs (Frank & Goyal, 2003). The trade-off theory comes from the pecking order theory it is an unintentional outcome of companies following the pecking-order theory. This explains that firms strive to achieve an optimal capital structure by using a mixture debt and equity known to act as an advantage leverage. Modigliani and Miller (1958) showed that the decisions firms make when choosing between debt and equity financing has no material effects on the value of the firm or on the cost or availability of capital. They assumed perfect and frictionless capital markets, in which financial innovation would quickly extinguish any deviation from their predicted equilibrium.
Assessing the capital structure of any firm is important for investors attempting to determine if...
Modigliani & Miller applied their theories with two modules, one which doesn’t include the taxes and this is their first finding, and another one with taxes to make it more realistic. The First Proposition without taxes: In this part Modigliani & Miller stated that the firm’s value is not affected by the structure of the capital between Equity and Debt, They proved this by having an example of two firms that have got the same conditions in everything, same cash flow, same operational risks and same opportunity costs. One of the firm’s capital structure is all equity and the other firm’s capital structure is a mixture between equity and debt, since the form of financing (debt or equity) can neither change the firm’s net operating income nor its operating risk, the values of levered and unlevered firms will be the same. They have concluded that the value of the levered firm = the value of the unlevered firm, only if they have the same conditions, same risk levels, cash and opportunity cost.
al (2013), the company take into account what interest rate they get for different percentages of debt capital is known as capital structure. It is usually not difficult to get loans if they represent 20% or 30% of total investments (the rest being equity), not if the situation is reversed. In the latter case, who lend money will require a much higher interest rate in order to offset the higher risk that it will be running. In this case, Tesco is worth having a higher percentage of borrowed capital up to 40%, even with the highest interest rate, and to have a percentage higher than 40% is no longer recommended because the increased interest rate decreases the return on equity. This effect is not least because of the financial burden is deductible for tax purposes, i.e. a 6% interest rate becomes a real rate of 4%. In accordance of Brannen et. al (2013), leverage happens only when the return on investment is higher than the actual cost of the liability. In short, the company must choose the mix of financing that maximises the return on equity invested in the project. This demonstrates the percentage change in net results resulting from a percentage change in operating results. According to Brannen et. al (2013), Tesco used the existing infrastructure to keep costs down. Metzger (2014) said that the company spent enormous sums trying to build a brand and a customer base and used its existing brand and customers to drive its online business. In
There is a range of criteria relevant for a decision of financing a new venture. To construct my list for the evaluation of a new company as an opportunity I have selected to refer to t...
When starting a business an important question arises, how to finance the company. The steady economic growth combined with low interest rates has produced a lot of liquidity in debt and equity markets. For example, in 2005, non-financial corporate business borrowing increased dramatically to $289 billion, compared to the mere $174 billion it was in 2004 and the $85 billion it was in 2003 (Chung). The outcome of using only debt financing or only equity financing is mostly direct. Businesses run ino the issue when a company’s finance requires both debt and equity characteristics, changing the tax effects greatly (Hanke).
Some managers are more aggressive than others; hence some firms are more inclined to use debt in an effort to boost profits. This factor does not affect the true optimal or value maximizing capital structure, but it does influence the manager in determining target capital structure.
Finding the perfect capital structure in terms of risk and reward can ensure a company meets shareholder expectations and protects a firm in times of recession. Capital structure refers to how a business puts its money to “work”. The two forms of capital structure are equity capital and debt capital. Both have their benefits and limitations. Striking that perfect balance between the two can mean the difference between thriving versus trying to survive.
The Net Income Approach to the relationship between leverage cost of capital and value of the firm. It suggest that there is relationship between capital structure and the value of the firm and therefore, the firm can affect its value by increasing or decreasing the debt proportion in the overall financing mix.
The development of the theory of capital structure begins with the capital structure theory of miller and Modigliani. Dividend irrelevance comes from the MM model, that there is no transaction & flotation cost, taxes, identical rate of interest and information. It is stated that the income from dividend and capital gain will be the same. There is no difference between the two options. If dividend gain is not enough, shareholder can sell the share for liquidity of cash and vice versa. Theory states that policy of the dividend payout is not relevant.
The source of asymmetric information is the manager-investor relationship, because, while managers can be assumed to have in-depth knowledge of the firm they are running whereas investors are unknown to the internal information of the company. For example, A and B are the potential buyer and seller of shares of company XYZ. If the seller knows the one of the manager in the company and has heard that the company is facing undisclosed financial problems, then the seller has asymmetric information. The capital structure decision, taken by managers, may then work as an indication to communicate insider information to external investors. Management often utilise the information to increase their own wealth, whereas, outside investors do not have access to that information. Managers learn how and when to make maximum profits from control of the firms’ operations which may establish them and pursue self-serving actions at the expenses of shareholders. Due to information asymmetry, shareholders do not have adequate information to assess if managers have satisfied their contractual
First, issuing body is different, as a means of financing, whether the country, local public group and enterprises can issue bonds but stock can only be issued by a joint-equity enterprises. Second, the stability of earning is different. From the proceeds, the bond’s interest rate are fixed before the purchase, and the fixed interest rate can be obtained at maturity regardless of whether the company issuing the bonds is profitable or not. On the other hand, stock won’t have a fixed dividend yield before the purchase, the dividend income follow with the profitability of the stock company to changes. Third, bond can take back the principal at maturity, also people can get both the principal and interest in the maturity date. But, stock has no expiration date, once the principal of the stock is giving to the company, it can not be recovered. And also, the risk is different. Bond is only the general investment object, the turnover rate of the transaction is lower than the stock, however, the stock is not only an investment object, it is the main investment object in the financial market, the turnover rate of transaction is high even it has low security and high risk, but will obtained a high expected income, which also attracting a lot of
While Bhide (1990) suggests that the difference lies in the dealings of customers, suppliers, lenders, and tax authorities with the diversified firm are affected by the aggregated fortunes of its constituent businesses and the additional level of administrative or corporate overhead, we see that there are three main reasons for diversification. First, Lewellen’s financial theory of corporate diversification (1971) argues that diversification at the firm level leads to a reduction in variance of future cash flows thus increasing the debt capacity of the diversified firm. He concludes that as long as debt capacity adds value, diversification is a source of added value. Secondly, diversified firm’s cash flows provide a superior means of funding an internal capital market which offers a number of possible sources of value to the firm’s owners as internally raised equity capital is cheaper than funds raised in the external capital market and this gives the firm’s managers superior decision control over project selection, rather than forcing them to base the firm’s investment decisions to perceptions less-informed investors in the external capital market. This was formally put forth by Stein (1997), who suggests that managers select better projects as they have superior information. Finally, Khanna and Palepu (1999) propose
Structure of the Capital, the mixture of a firm's debt and equity, is important because it costs a company money to borrow. Capital structure matters because of the different tax implications of debt vs. equity and the impact of corporate taxes on a firm's profitability. Firms must be very prudent in their activities that include borrowing to avoid risk and the possibility of bankruptcy.