1) The document discusses the relationship between capital structure and market values of companies. It notes that an optimal capital structure is important for maximizing shareholder wealth and market value.
2) The author reviews theories on how capital structure can impact firm value. While the Modigliani-Miller theory suggests capital structure is irrelevant, other research has found relationships between capital structure, growth opportunities, and firm value.
3) Debt financing can increase firm value through tax benefits and lower costs than equity, but it also increases financial risk which may offset these benefits. An optimal capital structure balances these costs and benefits.
Age of the publication firm as a factor influencing capital structure of insu...Gerishom Wafula Manase
Capital structure refers to the combination of debt and equity capital a firm uses to finance its long term operations. The capital structure decision can affect the value of the firm by changing the firm’s expected earnings, its cost of capital or both. One of the most important objectives of determining an optimal capital structure of the firm is to ensure the lowest cost of capital and to maximize shareholders wealth. This paper is on age as a factor affecting capital structure in the insurance sector companies. This study sought to establish the influence of age as a factor of capital structure of the insurance companies in Kenya. The study focused on the entire population of the registered insurance companies listed in the Nairobi Securities Exchange in Kenya. Expectedly, the result of the study is sufficient to give an insight into how age of insurance company influences its capital structure among the listed insurance companies in the Nairobi Securities Exchange in Kenya. This study employed univariate analysis to measure the impact of This factor on the company’s capital structure. The findings established a co efficient of correlation of 0.809 and a regression of 0.65 indicating a strong relation between age and the capital structure of insurance companies
This paper scrutinizes Determinants of Capital Structure: A study on some selected corporate firms in Bangladesh. We have taken 10 out of 37 listed companies of DSE dividing into two sectors i.e. Pharmaceuticals and chemicals and Tannery sector, five years data from 2013 to 2017 has been collected from respective annual reports. Total number of observations was 50. There are different factors that affect a firm's capital structure decision. We use leverage (D/E ratio) as dependent variable and independent variables are profitability, tangibility, tax, size, growth, non-debt tax shield (NDTS) and financial costs. By using Descriptive Statistical Analysis, Correlation Analysis and Regression Analysis tools we find that Tangibility, size, NDTS, and financial costs are positively related with leverage and Profitability, tax, and growth are negatively related with leverage. In our analysis we see profitability, tangibility of asset, growth and non-debt tax shield have significant association. So when we take capital structure decision of the above firms we should consider profitability, tangibility of asset, growth and non-debt tax shield because other independent variables are insignificant in the context of Bangladesh economy.
An Empirical Analysis on the Nature of Relationship between Capital Structure...iosrjce
The financing decision with regard to capital structure theory of finance has been a topic of many
theories and their conflicting output for past many years. This paper aims to analyse the nature of relationship
between the capital structure of a firm and its performance. The data of 40 firms excluding financial services
firms listed on Nifty indices on National Stock Exchange is studied (The composition of 50 firms on Nifty
represents a well branch out index reflecting precisely the overall market conditions). Financial services firms
have been excluded from purview of this paper, as they are in the business of collecting money and investing in
financial assets rather than producing goods, hence follow a unique business valuation model. Further financial
services sector being one of the most sensitive sectors. This paper analyzes a period of 13 years (2001-2014)
covering the phases of a business cycle starting from boom (2001/02-2006/07), recession (2007/08-2008/09)
and then recovery (2009/10-2013/14). The complete business cycle will aid to demonstrate the results more
accurately. This paper also surveys the topical developments in the empirical capital structure research. The
data for a period of 13 years is analysed using descriptive statistics, correlation and multiple regression
techniques. For research purpose, the ratios such as debt-equity ratio, debt-asset ratio and long term debt are
taken as independent variables whereas Net Profit, Net Profit Margin, ROCE, ROE and ROA are the ratios
taken as dependent variables.
Capital Structure Determination, a Case Study of Sugar Sector of Pakistan Fa...inventionjournals
International Journal of Business and Management Invention (IJBMI) is an international journal intended for professionals and researchers in all fields of Business and Management. IJBMI publishes research articles and reviews within the whole field Business and Management, new teaching methods, assessment, validation and the impact of new technologies and it will continue to provide information on the latest trends and developments in this ever-expanding subject. The publications of papers are selected through double peer reviewed to ensure originality, relevance, and readability. The articles published in our journal can be accessed online
This research investigates the determinants of the capital structure of firms listed service sector on BIST(Borsa Istanbul) and the adjustment process towards this target. The econometric analysis employs the Generalized Method of Moments estimators (GMM-Sys, GMM difference) techniques that controls for unobserved firm-specific effects and the endogeneity problem. The findings of the paper suggest that firms have target leverage ratios and they adjust to them relatively fast. Consistent with the predictions of capital structure theories and the findings of the empirical literature, the results of this paper suggest that size, assets tangibility, profitability, growth opportunity except earnings volatility have significant effects on the capital structure choice of hotels and restaurants.The capital structure or leverage is measured by total debt ratio. Analysis results indicates that firms with high profits, sizable, high fixed assets ratio and high total sales and more growth opportunities tend to have relatively less debt in their capital structures.
Strategic management managing mergers and acquisitionsIJBBR
In this paper we have discussed what mergers and acquisitions are and how they are a part of any
organizations strategic planning policy. Organizations ‘merge’ generally with similar organizations or
‘acquire’ weaker organizations, and the essence as to why they do so is that the value of two is greater than
one. They basically merge with or acquire each other’s strengths and try to overcome one another’s
weaknesses thus leading to increased market shares and profitability. We have discussed the various
rationales for mergers and acquisitions like the strategic rationale, speculative rationale, management
failure rationale etc, along with their types that include vertical integration, horizontal integration and
conglomeration. We have also put light on how companies go strategically about mergers and acquisitions.
The merger and acquisition life cycle aided by real examples (case studies) will offer a vivid understanding
of these concepts to the reader.
Beware, never use golden or yellow color in your slide cause it flashes in projector. By the way, it isn't the best work I have done but it is among my first slides so I just love it. Hope you too...
Age of the publication firm as a factor influencing capital structure of insu...Gerishom Wafula Manase
Capital structure refers to the combination of debt and equity capital a firm uses to finance its long term operations. The capital structure decision can affect the value of the firm by changing the firm’s expected earnings, its cost of capital or both. One of the most important objectives of determining an optimal capital structure of the firm is to ensure the lowest cost of capital and to maximize shareholders wealth. This paper is on age as a factor affecting capital structure in the insurance sector companies. This study sought to establish the influence of age as a factor of capital structure of the insurance companies in Kenya. The study focused on the entire population of the registered insurance companies listed in the Nairobi Securities Exchange in Kenya. Expectedly, the result of the study is sufficient to give an insight into how age of insurance company influences its capital structure among the listed insurance companies in the Nairobi Securities Exchange in Kenya. This study employed univariate analysis to measure the impact of This factor on the company’s capital structure. The findings established a co efficient of correlation of 0.809 and a regression of 0.65 indicating a strong relation between age and the capital structure of insurance companies
This paper scrutinizes Determinants of Capital Structure: A study on some selected corporate firms in Bangladesh. We have taken 10 out of 37 listed companies of DSE dividing into two sectors i.e. Pharmaceuticals and chemicals and Tannery sector, five years data from 2013 to 2017 has been collected from respective annual reports. Total number of observations was 50. There are different factors that affect a firm's capital structure decision. We use leverage (D/E ratio) as dependent variable and independent variables are profitability, tangibility, tax, size, growth, non-debt tax shield (NDTS) and financial costs. By using Descriptive Statistical Analysis, Correlation Analysis and Regression Analysis tools we find that Tangibility, size, NDTS, and financial costs are positively related with leverage and Profitability, tax, and growth are negatively related with leverage. In our analysis we see profitability, tangibility of asset, growth and non-debt tax shield have significant association. So when we take capital structure decision of the above firms we should consider profitability, tangibility of asset, growth and non-debt tax shield because other independent variables are insignificant in the context of Bangladesh economy.
An Empirical Analysis on the Nature of Relationship between Capital Structure...iosrjce
The financing decision with regard to capital structure theory of finance has been a topic of many
theories and their conflicting output for past many years. This paper aims to analyse the nature of relationship
between the capital structure of a firm and its performance. The data of 40 firms excluding financial services
firms listed on Nifty indices on National Stock Exchange is studied (The composition of 50 firms on Nifty
represents a well branch out index reflecting precisely the overall market conditions). Financial services firms
have been excluded from purview of this paper, as they are in the business of collecting money and investing in
financial assets rather than producing goods, hence follow a unique business valuation model. Further financial
services sector being one of the most sensitive sectors. This paper analyzes a period of 13 years (2001-2014)
covering the phases of a business cycle starting from boom (2001/02-2006/07), recession (2007/08-2008/09)
and then recovery (2009/10-2013/14). The complete business cycle will aid to demonstrate the results more
accurately. This paper also surveys the topical developments in the empirical capital structure research. The
data for a period of 13 years is analysed using descriptive statistics, correlation and multiple regression
techniques. For research purpose, the ratios such as debt-equity ratio, debt-asset ratio and long term debt are
taken as independent variables whereas Net Profit, Net Profit Margin, ROCE, ROE and ROA are the ratios
taken as dependent variables.
Capital Structure Determination, a Case Study of Sugar Sector of Pakistan Fa...inventionjournals
International Journal of Business and Management Invention (IJBMI) is an international journal intended for professionals and researchers in all fields of Business and Management. IJBMI publishes research articles and reviews within the whole field Business and Management, new teaching methods, assessment, validation and the impact of new technologies and it will continue to provide information on the latest trends and developments in this ever-expanding subject. The publications of papers are selected through double peer reviewed to ensure originality, relevance, and readability. The articles published in our journal can be accessed online
This research investigates the determinants of the capital structure of firms listed service sector on BIST(Borsa Istanbul) and the adjustment process towards this target. The econometric analysis employs the Generalized Method of Moments estimators (GMM-Sys, GMM difference) techniques that controls for unobserved firm-specific effects and the endogeneity problem. The findings of the paper suggest that firms have target leverage ratios and they adjust to them relatively fast. Consistent with the predictions of capital structure theories and the findings of the empirical literature, the results of this paper suggest that size, assets tangibility, profitability, growth opportunity except earnings volatility have significant effects on the capital structure choice of hotels and restaurants.The capital structure or leverage is measured by total debt ratio. Analysis results indicates that firms with high profits, sizable, high fixed assets ratio and high total sales and more growth opportunities tend to have relatively less debt in their capital structures.
Strategic management managing mergers and acquisitionsIJBBR
In this paper we have discussed what mergers and acquisitions are and how they are a part of any
organizations strategic planning policy. Organizations ‘merge’ generally with similar organizations or
‘acquire’ weaker organizations, and the essence as to why they do so is that the value of two is greater than
one. They basically merge with or acquire each other’s strengths and try to overcome one another’s
weaknesses thus leading to increased market shares and profitability. We have discussed the various
rationales for mergers and acquisitions like the strategic rationale, speculative rationale, management
failure rationale etc, along with their types that include vertical integration, horizontal integration and
conglomeration. We have also put light on how companies go strategically about mergers and acquisitions.
The merger and acquisition life cycle aided by real examples (case studies) will offer a vivid understanding
of these concepts to the reader.
Beware, never use golden or yellow color in your slide cause it flashes in projector. By the way, it isn't the best work I have done but it is among my first slides so I just love it. Hope you too...
Players of Money Market and Capital Market Pawel Gautam
financial market , functions of financial market , Characteristics Of Financial Markets, What Is Money Market ,Structure of Indian Money ₹ Market ,Functions of Money Markets,Players Of Money Market, Capital Market , Types of Capital Market , Structure of Indian Capital Market , Functions of Capital Market , Constituents/Components of Capital Markets, PLAYERS OF CAPITAL MARKET
Study of the Static Trade-Off Theory determinants vis-à-vis Capital Structure...inventionjournals
This paper investigates the application of the Static Trade-Off theory regarding the capital structure of the Pakistani Chemical Industry. We have used panel data analysis for the sample of 31 listed chemical firms from the period 2005 to 2013. The study is unique in its type as unlike to Shah & Hijazi (2005) who studied many industrial sections, this study only focuses on the listed Chemical Firms. We used five independent variables such as Profitability (P), Tangibility (T), Liquidity (L), Firm Size (FS) and Total Assets Growth (TAG) to study the effect on independent variable Financial Leverage (FG). The results confirmed the relationship of Profitability, Liquidity and Firm Size. However the results were not confirmed for Tangibility and Firm Assets Growth. Even though the results for Tangibility were positive, however the significance of the coefficients failed to support the hypothesis. This study hold a unique position for researchers for future research and also has significance for the investors helping them to make wise investment decisions when investing in Pakistani Chemical Industry since this industry holds a major portion of industrial GDP of the country
Corporate debt policy remained a significant, but a challenging decision for managers entrusted with the responsibility to improve the value of the firm. Thus, this study examines the factors influencing the capital structure decisions of firms in Nigeria. The study employs a panel data regression model to analyze data from firms in Nigeria for the period 2011 to 2015. The result of the empirical analysis reveals that firms in Nigeria have a preference to finance economic operations from retained earnings and the use of short-term debt on rollover basis. The finding of this study confirms that debt decreases with profitability and growth opportunities. The findings show that asset tangibility and firm size have a positive and significant relationship with debt policy of firms in Nigeria. The analysis also reveals that managerial ownership has a negative and significant relationship with debt ratio of firms in Nigeria. The study shows a non-significant positive relationship between non-debt tax shields and debt. The study demonstrates that the trade-off and pecking order theories both explains the factors influencing capital structure decisions of firms in Nigeria. Therefore, this study suggests the need for stakeholders to develop the financial markets and make it accessible for firms to obtain long-term financing for economic growth and development.
Debt and equity are the two important sources of finance for the firms. Basically, capital structure of the firm revolves around the judicious mix of the debt and equity. Upon Debt and equity mix much research has been done and many have designed the capital structure in a very different manner.
Capital structure theory can be said as the manner in which a company or organization finance its economic activities. Basically, capital structure of a firm is the combination of equity and debt. It is a very important decision for every organization or business house. This decision revolves around a question “How to make an optimal capital’s structure for the firm?” and what are the factors that influence the decision. Because the capital structure decision ultimately affects the management, investors and lenders. So, it becomes very crucial for the firms. Earlier many researchers have made investigation on the capital structure determinants but still there are loopholes to be filled up. The theory of Capital Structure began with the phenomenal work made by Modigliani and Miller (1958, 1963). It stirred the academic world to pour more thoughts into that and many interesting works came out.
Capital structure refers to the way a firm chooses to finance its assets and investments through some combination of equity, debt, or internal funds. It is in the best interests of a company to find the optimal ratio of debt to equity to reduce their risk of insolvency, continue to be successful and ultimately remain or to become profitable.
DETERMINANTS OF CAPITAL STRUCTURE:
The capital structure of a concern depends upon a large number of factors such as leverage or trading on equity, growth of the company, nature and size of business, the idea of retaining control, flexibility of capital structure, requirements of investors, cost of floatation of new securities, timing of issue, corporate tax rate and the legal requirements. It is not possible to rank hem because all such factors are of different important and the influence of individual factors of a firm change over a period of time.
1. Financial Leverage or Trading on Equity: Financial leverage is one of the important considerations in planning the capital structure of a company. One common method of examining the impact of leverage is to analyse the relationship between Earnings Per Share (EPS) and EBIT. The companies with high level of leverage can make profitable use of the high degree of leverage to increase return on the shareholders' equity.
2. Growth and Stability of Sales: The capital structure of a firm is highly influenced by the growth and stability of its sales. If the sales of a firm are expected to remain fairly stable, it can raise a higher level of debt. Stability of sales ensures that the firm will not face any difficulty in meeting its fixed commitments of interest payment and repayments of debt. Similarly, the rate of growth in sales also affects the capital structure decision.
3. Cost o
Impact of Firm Specific Factors on Capital Structure Decision: An Empirical S...Waqas Tariq
Abstract This study attempts to explore the impact of firm specific factors on capital structure decision for a sample of 39-firm listed on Dhaka Stock Exchange (DSE) during 2003-2007. To achieve the objectives, this study tests a null hypothesis that none of the firm’s specific factors namely profitability, tangibility, non-debt tax shield, growth opportunities, liquidity, earnings volatility, size, dividend payment, managerial ownership, and industry classification has significant impact on leverage using estimate of fixed effect model under Ordinary Least Square (OLS) regression. Checking multicollinearity and estimating regression analysis through Pearson correlation and autoregressive mode respectively this study found that profitability, tangibility, liquidity, and managerial ownership have significant and negative impact on leverage. Positive and significant impact of growth opportunity and non-debt tax shield on leverage has been found in this study. On the other hand size, earnings volatility, and dividend payment were not found to be significant explanatory variables of leverage. Results also reveal that total debt to total assets ratios are significantly different across Bangladeshi industries. Keywords: Capital structure, Leverage, Firm’s specific factors, Dhaka Stock Exchange Bangladesh.
International Journal of Business and Management Invention (IJBMI)inventionjournals
International Journal of Business and Management Invention (IJBMI) is an international journal intended for professionals and researchers in all fields of Business and Management. IJBMI publishes research articles and reviews within the whole field Business and Management, new teaching methods, assessment, validation and the impact of new technologies and it will continue to provide information on the latest trends and developments in this ever-expanding subject. The publications of papers are selected through double peer reviewed to ensure originality, relevance, and readability. The articles published in our journal can be accessed online.
Mercer Capital | Valuation Insight | Capital Structure in 30 MinutesMercer Capital
Capital structure decisions have long-term consequences for shareholders. Directors evaluate capital structure with an eye toward identifying the financing mix that minimizes the weighted average cost of capital. This decision is complicated by the iterative nature of capital costs: the financing mix influences the cost of the different financing sources. While the nominal cost of debt is always less than the nominal cost of equity, the relevant consideration for directors is the marginal cost of debt and equity, which measures the impact of a given financing decision on the overall cost of capital. The purpose of this whitepaper is to equip directors and shareholders to contribute to capital structure decisions that promote the financial health and sustainability of the company.
Similar to Capital structure and market values of companies (20)
1. European Journal of Business and Management www.iiste.org
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online)
Vol 4, No.21, 2012
Capital Structure and Market Values of Companies
Dr. Uche ugwuanyi
Department of Accountancy, Enugu State University of Science and Technology, Enugu, Nigeria
Abstract
The topic for the research has been selected with special interest to reveal the effect or benefit of capital structure and
market value of companies. An appropriate capital structure is a critical decision for any business organization and this
decision is very important not just because of its need to maximized Shareholder’s wealth or increase the market
value of companies but also because of the impact such decision has on the company ability to deal with the
competitive environment. Furthermore, the institutional composition of the market was reviewed and it was revealed
that the Nigeria stock exchange amongst all other participants is the live wire of the medium for the mobilisation of
long funds for long term investment. Also the listing requirement of small and medium scale enterprises in the second
tier securities market of the NSE equally highlighted. This project encompasses a comprehensive survey of companies,
however, the prospect of the market appears to be bright considering the current position of the government and players
in the industry in the area of formulation and implementation of favourable policies. The market could assume the
expected role of providing long-term financing for the development of small and medium scale enterprises in Nigeria if
the institutional frameworks guiding the effectiveness of the operators are strengthened and the profound
recommendation by the researcher are religiously implemented.
1. Introduction
One of the cornerstones of the modern corporate finance theory is the Capital Structure irrelevancy proposition
(Modigliani-Miller 1958). Modigliani and Miller (1958) conclude that the market value of any firm is independent of
its capital structure. It is observed that the optimal capital structure is closely related to the growth potential of the firms
(Mc Connel and Servaes 1995; Jung, Kim and Stulz 1996) and some other variables such as the size and the industry
characteristics. Debt policy and equity ownership structure matter, and the way in which they matter differs between
firms (Mc Connel and Servaes). Leland and Pyle (2007) propose that managers will take debt/equity ratio as a signal,
by the fact that high leverage implies higher bankruptcy risk (and cost) for low quality firms since managers always
have information advantage over the outsiders, the debt structure may be as a signal to the market.
According to Stulz (1990), Mc Connel and Servaes (1995), Jung, Kim, (1996), the influence of the debt on the firms
value depending on the presence of growth opportunities. For firms facing low growth opportunities, the debt ratios are
negatively related to the firm value.
Pandy (2005:5) posited that the mix of debt and equity is known as a firm capital structure. The manager should
rigorously strive to obtain the optimum capital structure for the organizational well being. It should be noted that the
firm’s capital structure is seen as optimal when its market value of shares is maximized or when it weighted average
cost is minimized. In other developing countries of the world and Nigeria in particular not much has been written on the
conceptual linkage between market value of companies and capital structure, therefore the financial manager should
seek that capital structure which maximizes the value of the firm(optimal capital structure) are brought to bear. The
firm optimal capital structure should represented a balanced between debt and equity. Such advantage that comes from
using cheaper debt is just matched by the increase in the financial risk that comes from debt.
2. Capital Structure and Market Values of Companies
Capital structure is said to be the mixture of permanent sources of funds a firm uses in financing its operations
primarily represented by long term debt, preference debt, preference stock, common equity, debenture which exclude
all short term credit i.e. over draft. The amount of debt that a firm uses to finance it asset are called leverage. A firm
with a lot of debt in its capital structure is said to be highly levered while a firm with no debt is to be unlevered. The
primary aim of financial leverage is to maximize shareholder wealth or increase the market value of the firm.
According to Jerry and Gordon (2005) financial leverage increase variability of the market value of the firm, they are
of the view that considerable controversy remains over whether imperfections like bankruptcy, agency cost etc
determine optimal capital structure of the firm that increase the wealth of shareholders.
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2. European Journal of Business and Management www.iiste.org
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online)
Vol 4, No.21, 2012
Richard and Robins (2006), observe that the objective of the firm is to maximize the current wealth of shareholders but
that equity is more risky than debt and that a rational investor will expect a higher rate of return on equity or market
value that ignoring taxation and cost of financial distress that any financial decision taken will affect the capital
structure of the company.
The role of an optimal capital structure is very important in maximizing share holder wealth, it is also very important in
maximizing market value or share price of a firm. Pandy (2005) opines that the primary motive of a company using
financial leverage is to magnify the shareholder fund under favourable economic condition. The basis of his
assumption is that fixed charged fund such as loans from financial institution and bank can be obtains at a cost lower
than the firm’s rate of return on net assets. Thus when the different between the earnings generated by assets financed
by debt funds and the cost of these funds is distributed to the shareholders, the earnings per share (EPS) or return on
equity (ROE) increases there by increasing the market value of the company.
Modigliani and Miller (1958) in another submission posited that, the value of the firm remains constant regardless of
the debt level stating that as the debt level is increased the cost of equity also increase just enough to have weighted
average cost of capital (WACC) constant therefore causing the cash flow generated to be only influence on the value of
the firm thereby rendering capital structure irrelevant. According to them the firm can only increase the wealth of
shareholder by making good investment decision.
Manager should choose a capital structure that maximizes the market value of the firm’s shareholders. In the view of
William (2006), corporate managers should always ensure that their companies are being financed at the lowest
possible cost, so that shareholders could confidently entrust their saving to companies that guarantee maximum return
for minimum risk. He further explained that existing shareholders should consider the uses of debt to be good news and
not using debts to be bad news. He opines that major empirical study have shown that stock price rise when a firm
announces leverage increasing events, such as debt for equity exchange affect debt financed, cash tender offers to
acquire control of another company. On the other hand, leverage decreasing involving payment with a firm’s owns
share is always associated with share decline. The distinct but separate issues of the relevance of capital structure
decision on a firm’s value have received considerable attention in recent literature.
According to Donald Tuttle Wayne and banker (2001), they are of the view that from the result of studies carried out by
them, have re-established that in a perfect and complete contingent claims market, financing decision will have no
impact on a firm’s value. Stated differently, the value of a sum income stream arising from addition of partitions is
always equal to the value of the original income stream.
3. Debt Financing
Financing a business by borrowing most often seem to be cheaper than using equity due to the following reasons.
1. Low rate of returns to lender than shareholders. Debt financial security provides a lower risk for the financial
providers due to the fact that they have prior claim on annual income and on liquidation.
2. Service as a means of tax reduction since the debt interest can be offset against pre tax profits.
3. The issuing and transaction cost associated with getting and servicing debts are less than ordinary shares.
Financials gearing relates to the aspect of debt in the capital structure, and it is usually measured in relation to the
balanced sheet figures.
There is a school of thought which subscribes to the argument that changes in the capitalization rate share prices and
corporate value are concomitant of the firm distribution policy, (Hill, 1998).
However, it would be noticed that the total risk associated with investment policies is a part of the determinants of a
company’s weighted average cost of capital and the firm’s value, risk is inter-related with two variables, business risk
and financial risk. The impact of financial risk tends to be serious with the influx of debt into firm’s capital structure
and this financial risk is the increase risk of equity holders due to financial gearing. It does not arise from a company’s
investment; it is due solely to the capital structure or more specifically to the level of gearing. When a company
introduces fixed interest debt into its capital structure it increases its financial risk, this is partly because the interest
must be paid whatever happens to earnings. If the company is in default it runs the risk of compulsory winding up, this
is particularly so where the providers of debt finance have security for their investment. The financial risk of a
company’s capital structure can be measured by a gearing ratio. Business risk is variability in earnings before interest
and tax (EBIT) associated with a company’s normal operations. It is the risk of the company’s operation without regard
to how the company is financed. This risk varies considerably between industries and even between companies within
the same industry and may alter significantly over time as consumer taste and technology change.
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3. European Journal of Business and Management www.iiste.org
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online)
Vol 4, No.21, 2012
Generally, business risk depends on:
1. The state of the economy
2. Government’s action
3. Competitor’s action
4. Labour relations
5. Fire and accidents
Specifically business risk is influenced by the following factors:
1. Demand Variability: The most stable the demand for a company’s product (other factors remaining the same) the
lower is its business risk.
2. Sales price variability: A company with relatively stable prices is expected to have lower business rise –all other
factors remains the same.
3. Input price variability: The more stable the input prices, the lower the level of business risk.
According to Hill (2001) says there will naturally evolve a question as to why extreme leverage is an exceptional
observable phenomenon rather than the rule in the real world. And in a reply, he said that when a firm introduces more
debt into the capital structure, equity holders feel exposed to high financial risk. Thus the demand for equity falls so
that the market value also falls so that the equity capitalization rate increase even when the cost of debt is seen to be
constant and EPS is not being compromised.
4. Income Gearing
The capital gearing measures rely on the appropriate valuation of net assets in the balance sheet. It is often quite faulty
to rely only on assets when trying to judge a company’s ability to pay back debts, thus, a more appropriate measure of
gearing is one concerned with the level of a firm’s income relative to the interest cover ratio the greater the chance of
interest payment ratio, default and eventual liquidation. The inverse of interest cover measures the proportion of profit
paid out as interest and this referred to as income gearing.
Some factors that has bearing on the general level of capital structure
4.1 A Financial Distress
The higher the level of debt, the higher the financial distress and eventually liquidation and this does not sound nice for
the shareholders and the debt holders.
The cost of financial distress usually comes with a risk that poses an effect on the firm’s value that seems to offset the
tax relief of the increased debt level. Even if firms try as much as possible to avoid liquidation. Its relationship with
external parties would be damaged such parties as suppliers, customers, banks and other lenders, would want to take a
safety – first approach.
Some factors that could significantly influence the risk of a firm’s financial distress cost are:
1. The sensitivity of the firm’s revenues to general levels of economic activities
2. The proportion of fixed to variable cost.
3. The liquidity and marketability of the firm’s asset.
4. The ability of the firm to generate cash.
4.2 Agency cost
This cost usually arises from what people see as the principal-agent problem. Finance providers of most firm are not
able to manage the firm’s, so they employ agent (managers) and these acts in the way or interest of the finance
providers or shareholder. Therefore the agency cost pass on as higher interest rate and the loss of value that is cost by
marginal act.
4.3 Borrowing Capacity
It has a relationship with agency cost. Lenders tend to prefer secured lending which set an upper limit on gearing. They
like to have assurance that even if the worst happen that the firm can not meet the interest obligations, they would like
to hold on to an assets which when sold will set off the loan. The gearing level may not be determine by theoretical
inform management decision but by the limit of total borrowing imposed by leaders.
4.4 Marginal preferences
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4. European Journal of Business and Management www.iiste.org
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online)
Vol 4, No.21, 2012
It may be noticed that managers, are quite cautious of borrowing. Liquidation affects not only shareholders but
managers and other employee as well as the general public.
1. The external finance function: it identifies all sources of funds, evaluate the investor’s opportunity returns
expected and eventually select the optimal mix which minimizes the combine cost.
2. The internal control function: it allocated funds among products, service and market by selecting those
investment opportunities that maximizes NPV and share price.
In other words the cost of capital incorporates both the financing and investing decision (debt and equity) and it does
not represent the cost incurred by employing funds and it does not restrict itself to the explicit returns to shareholders
and interest on borrowing.
There also exist some implicit opportunity costs to be considered apart from that associated with retained earning
which should be included in the cost of calculation and this includes financial risk confronting providers of capital. In
addition, there are implicit cost also associated with depreciation and other non cash expenses. There also exists
corporate expenditure that does not necessarily produce demonstrative result.
5. Behaviour of Share Prices
The following analysis could be very useful in explaining the behavior of share prices.
5.1. Technical Analysis:
The premises of technical analysis are derived from empirical observations of financial market over hundreds of years.
It is the use of numerical series generated by market activity to predict future trends. The analysis does not even
concern itself with whether it is moving on a particular direction or not.
Technical analysis believe that if a particular stock is rising steadily, than an analyst will buy such stock and continue to
process it until it is certain that such stock price up tend has revised or ended. The belief of technical analysis is that
price action in a market discounts everything i.e. because every possible bit of information is immediately included in
the price of a security. It is not necessary to explicitly analyze the fundamental economic and political factor that might
influence the price.
Prices moves in trends the analyst relies on empirical evidence to say that trend upward, downward or sideways.
That history tends to repeat itself, they believe that investors often tend to repeat their attitudes and as a result investor
actions in the market place are often repeated as well. Therefore, price movement pattern will develop on a chart that a
technical analyst believes will have predictive qualities.
The proponents of technical analysis believe or hold that fundamental factors are indeed pertinent and reflected in the
price behavior of stock in the market. Therefore it is possible to predict the future prices behavior of a stock by a
diligent study of historical price movement of stock market.
According to Graham (1962), technical analysis agrees that stock prices do indeed fluctuate around their intrinsic value
but also contend that fundamental impact of investor’s emotions often demonstrated on an unscientific and sometimes
irrational manner.
5.2. Fundamental Analysis:
The analysis here believes that there are some differences between the true values and market prices of share that can
be exploited by inventors to beat the market.
They considered fundamentals such as company related factors, industry related factors, economic and political factors
etc in determining the behavior of stock prices in the market. These sets of analyst believe that there exists at any point
in time a basic intrinsic value force particular stock based on certain variables. Therefore it is on this ground that the
value of stock is obtained. They also believe that a stock would be bought when the market price is below the intrinsic
value and vise versa.
6. The Random Work Hypothesis
Essentially the hypothesis claims that stock price movement follow a Browain motion with either independent or
uncorrelated increments. The hypothesis may thus be generated from the weak or efficient market hypothesis, which is
based on the assumption contained in the price movement. The assumptions of the efficient market hypothesis imply
that price adjustment is independent and random. The random work also argues that the successive price movement of
stock in the market remains independent of each other because as said earlier there is no serial correlation between
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5. European Journal of Business and Management www.iiste.org
ISSN 2222-1905 (Paper) ISSN 2222-2839 (Online)
Vol 4, No.21, 2012
price changes from one period to another. Hence they say it is the force of demand and supply on the floor of the stock
market that actually causes price movement.
7. Summary of Findings
This study examines the relationship that exists between capital structure and market value of companies. In this
research work, theoretical and literature issue were discussed. In addition, regression analysis was used to investigate
the impact of capital structure on the value of a company. Below are listed finding from the research carried out.
1. It was observed that the variable of equity (shareholder fund) has significant relationship with the market value.
Which agree with the findings of Richard and Robbins (2006). They observed that the objective of the firm is to
maximize the current wealth of shareholders but that equity is more risky than debt and that a rational investor will
expect a higher rate of return on equity or market value, than ignoring taxation and cost of financial distress that
any financial decision taken will affect the capital structure of the company.
2. It was observed that the increase of debt in the capital structure increases shareholders wealth and also increases
shareholders risk. This agree with Jerry and Gordon (2005), financial leverage increases the variability of the
market value of the firm, they are of the view that considerable controversy remains over whether imperfections
like bankruptcy, agency cost etc determine optimal capital structure of the firm that increase the wealth of
shareholders.
8. Recommendations
From the finding above, the following recommendations are hereby suggested to aid the management of Nigerian
companies in capital structure decision that maximize the market value and increase it shareholder’s wealth.
1. Nigerians companies should try to ascertain the optimal capital structure to be adopted as a policy in order to
create a balance in satisfying the shareholders’ desire and management of capital structure decision.
2. Even with the possibility of factor limiting against most companies in developing countries like Nigeria from
getting loans, it has been found out that cost of debt is often cheaper than cost of equity so we recommend that
companies consider the use of debt capital thoroughly, especially at the early growth stage of the company.
3. It also recommends that strategic planning culture should be imbibed in order to ascertain the long term financial
mix capital structure should be beefed up through gradual retention of profit which could be long term benefit to
shareholder in terms of returns and retention of control.
4. It also recommends that there should be reinvestment of more of a company retained earnings in profitable
investment so that in the long run share price will be on the rise as the level of capital structure will significantly
influence it.
9. Conclusion
This research work has succeeded in bringing to light that, there actually exists a conceptual linkage between capital
structure and market value of companies and that companies should however strive to ascertain capital structure that
increases the market value of company. Most companies use debt to finance their activities as well as equity or
shareholder’s funds. But in line with the traditionalist view of capital structure theory, there is a point where a company
reaches when using debt to finance its operation. At this point it becomes unreasonable for a company to employ
further use of debt. The need to attain an optimal capital structure is very important to Nigerians companies because
their market values are directly boosting the Nigerian economy.
References
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