Capital Structure

Capital Structure and Industrial Averages3

Corporate Debt4

Corporate Equity5

Propositions by Modigliani and Miller5

Effect of Taxes and Bankruptcy Costs7

The tax favours debt7

Influence of Asymmetric Information among Agents8

The Agency Conflicts between Shareholders and Creditors9

References10

Capital Structure

Capital Structure and Industrial Averages

The research study is focused on the capital structure and factors relating to it. According to the studies by Masulis (1999), if the study interprets the result that a > b, the corporation will be moving towards the industry average and its value would increase as it increases the debt in its capital structure. However, if b > a, the corporation will be moving away from the industry average and its value would increase only if it reduces its debt. Our analysis is based on the capital structure and its relationship with the industry average. It has been observed that the corporations operating in the similar industry have same leverage ratios as compare to the corporations operating in other industries. Thus, the corporations operating in different industry can have different leverage ratios.

This relationship has been proved empirically by different researchers that include the studies of Schwartz and Aronson (1998) and Harris and Raviv (1991). However, there has also been observed a fact that some industries have the same leverage ratios and it remains constant for some years.

The data for the research study has been collected through the DATASTREAM that is based on the 17 companies of the United Kingdom. The research study explores the impact of the characteristics of firm on its capital structure. There have been analyzed 17 listed companies that are operating in the United Kingdom.

There have also been taken the sample of 183 corporations that has announced the issuance of the new debts. In the sample, there were excluded the firms that issued debts for the refinancing of the debt that is matured. The reason for this is it would affect the debt ratios of the corporations. The firms that are operating in extremely synchronized industries were also excluded.

There has been compared the leverage ratios of the firm and the industry. The data for the industry and firm leverage ratios have been collected from the separate sources. These sources included Value Line Investment Survey and the Compustat tapes. Moreover, we have also determined two separate ratios. The leverage ratio that has been used is the long term debt to net worth (LTD/NW).

There have been conducted various studies by different financial analysts in order to derive relationship between the capital structure and the industrial average. According to Harris and Raviv (1991), it has been observed that the corporations operating in a specific industry has same leverage ratios as the industry they are operating in. However, they also suggested that the leverage ratio vary across the industries.

Corporate Debt

The corporate firms are either dependent on the debt or equity to finance its expenditures. However, it cannot be said definitely whether the corporate firms depend more on debt or equity to fulfil its capital ...