Capital Structure Essay Example | Topics and Well Written Essays - 1500 words

Capital Structure - Essay Example 1963. 441-442). Many theorists didn't like their theorems but finally did find evidence in their applicability in many cases. Stiglitz (1969. pp784) however emphasized that the theorem was framed with some limitations in mind pertaining to existence & distribution of risk classes, competitiveness in the markets and clarity of effect of bankruptcy on the validity of the theorem. Stiglitz (1969. pp789) proved that under given risk classes the primary objective of firm management is to maximize firm value and hence they shall tend to choose the most appropriate capital structure that can achieve maximum value of the firm given certain implying factors that vary from firm to firm. But what could be such implying factors Let us focus on another empirical generalization established by Borch (1969. pp6-7) regarding conflict of interest in firm capital structure. If an organization has started with a capital and have achieved value addition over the capital, the shareholders will expect divi dend payments from the value addition. Payment of dividends to shareholders will conflict with the interest of creditors as the latter would like to continue with long term interest payments. Hence, the creditors will tend to establish certain terms of agreement that indirectly impacts the dividend policy of the management thus affecting the capital structure of the organization as non-payment of dividends may end up reducing shareholder interest and hence can reduce equity financing. Another factor that affects the Capital Structure is the rate regulation by regulatory commissions. Spiegal and Spulber (1994. pp424-425) proved that rate regulations generates an incentive for the regulated firms to increase their debt levels. Thus regulated firms tend to have high leverages than unregulated firms. Chaganti & Damanpour (1991. pp488-490) and Brav (2009. pp265) argued that the firm's ownership determines capital structure to a large extent. Institutional investors or managers tend to reduce debt to equity ratio whereas shareholders that are "sensitive" to changes in performance tend to increase debt to equity ratio. This may be described using agency theory that the owners willing to take higher risks to maximize shareholder value will tend to reduce leverage while the owners willing to take lesser risks to maximize shareholder value will tend to increase leverage. Balakrishnan and Fox (1993. pp7-8) related firm Capital structure with asset specificity in which the investments are made. They argued that the firm's leverage would be positively related to investments in tangible assets or redeployment of existing assets but would be negatively related to investments in intangible assets. For example, a firm investing heavily in R&D will be more inclined towards equity finance because the outcome of R&D is normally intangible assets that do not form promising collaterals for debt