Patterns of corporate financing: When debt is a good mode of financing?

Abstract

The studies on the effect of debt financing on investment and shareholders' wealth have reported diversified conclusions. One of the major reasons for complications in the assessment of the effects of equity and debt financing on investment and shareholders' wealth is the role of the agency. The majority of studies in finance literature consider debt the most beneficial external financing option because the tax-shielding benefits always justify debt financing as an appropriate option. The other academic theories emphasize debt financing with some caution. In financing decisions, the nature of business activities and operational requirements cannot be isolated. The debt financing, short-term liabilities, liquidity position, revenue, and operational costs are the interconnecting factors. Based on these interconnections, one of the important conclusions is that debt and equity are not alternative sources of finance; these are complementary sources. Globally it is noted that the aggregate value of listed companies in terms of market capitalization in a country has a strong relation with the size of domestic credit in the country. The corporate debts from international capital markets at a country level are also positively associated with the aggregate market capitalization of countries.