Does the Capital Structure Really Matter? A Study from the United Kingdom

Abstract

Among other things, the study employs time series and cross-sectional regressions to shed some intuitive light on the relevance of the Modigliani and Miller (1958) irrelevance hypothesis. Based on the principal objective of the study, I attempt to empirically examine the relationships between explanatory variables: capital structure (gearing ratio), debt tax shields, non-debt tax shields, asset structure and bankruptcy probability and the dependent variable: firm value. Based on the analysis of a set of ten UK industries, my findings are not compatible with the Modigliani and Miller (1958) propositions. The evidence is highly consistent with the Modigliani and Miller (1963) theoretical predictions about tax benefits. Therefore, capital structure really matters if firms judiciously use corporate debt. The study also sheds some insightful light on the inter-industry capital structure differences. Using a one-way ANOVA test, I find that various industries, subject to various nature of business, have developed characteristically different capital structures. Another persuasive and interesting findings that I have uncovered through this study are that, costs of debt are similar across a set of industries studied regardless of the capital structure.