Optimal Capital Structure Decisions Research Articles

Underinvestment and optimal capital structure under environmental constraints

We develop a Q-theoretical model for levered firms subject to environmental constraints (regulations). The model highlights the implications of environmental constraints on dynamic investment and optimal capital structure decisions. We find that environmental constraints can lead equityholders to become endogenously risk averse. Moreover, environmental constraints give rise to underinvestment in capital and asset sales, which is attributed to the carbon abatement effect caused by environmental constraints. In addition, firms with environmental constraints use conservative debt for low business risk and choose high leverage for high business risk relative to firms without environmental constraints, which is governed by the trade-off between abatement cost effect and risk-aversion effect caused by environmental constraints. Firms with environmental constraints have high credit spreads. Our theoretical results are consistent with some empirical findings.

DEBT STRUCTURE AND FIRM PERFORMANCE IN VIETNAMESE STOCK MARKET

This study investigates the relationship between debt structure and firm performance among a comprehensive sample of 546 Vietnamese listed firms over the period 2010 to 2020. The purpose of the research carried out in the article is to establish the relationship between the debt structure and the results of the firm's activities. Employing a fixed-effect method, we analyze the intricate interplay between debt composition and various dimensions of firm performance within the unique economic and institutional context of Vietnam. Our findings reveal a significant and negative association between debt structure and firm performance, shedding light on the intricate dynamics that shape corporate financial decisions and outcomes in the Vietnamese market. Specifically, our analysis indicates that firms with a higher proportion of debt experience decreased levels of performance across multiple performance metrics, including profitability, growth, and operational efficiency. This negative relationship between debt structure and firm performance underscores the importance of optimal capital structure decisions and strategic financial management for Vietnamese listed firms. Our study contributes to the existing literature by providing empirical evidence that extends our understanding of the nuanced determinants of firm performance within emerging market economies. Moving forward, further research could delve deeper into the underlying mechanisms that drive the observed negative relationship. Additionally, exploring potential moderating factors, such as industry-specific characteristics or changes in economic conditions, could provide a more nuanced perspective on the interplay between debt structure and firm performance. Ultimately, this study contributes to the ongoing dialogue on optimal capital structure decisions and their ramifications for the long-term success and sustainability of Vietnamese listed firms, guiding them toward more informed and effective financial strategies.

Insights into Effective Corporate Financial Management Practices and Their Implications

Purpose: This study aims to analyze effective corporate financial management practices and their implications. The focus is on identifying key determinants, examining their impact on firm performance and shareholder value, and exploring moderating effects of contextual factors such as industry characteristics and regulatory environments. Practical implications for corporate managers, investors, policymakers, and stakeholders are also provided. Research Design and Methodology: A quantitative descriptive research design is employed, synthesizing insights from existing literature. Data is collected through comprehensive literature searches in academic databases, journals, books, and conference proceedings. Thematic analysis, content analysis, and narrative synthesis are used to identify key themes, theoretical frameworks, and empirical findings. Findings and Discussion: Findings reveal that strategic financial planning, capital structure decisions, effective risk management, and transparent financial reporting are crucial components of effective corporate financial management. Strategic financial planning guides decision-making and resource allocation. Optimal capital structure decisions balance debt and equity to maximize shareholder value. Effective risk management enhances financial stability and resilience, while transparent financial reporting fosters investor trust and market efficiency. Strong corporate governance mechanisms are essential for ensuring transparency, accountability, and ethical conduct in financial management practices. Implications: Practical implications include adopting an integrated approach to financial management, encompassing financial planning, capital structure decisions, risk management, and transparent reporting. Emphasizing strong corporate governance is crucial for ethical and accountable financial practices. Future research should explore emerging trends, challenges, and opportunities in corporate financial management, ensuring organizations remain resilient and adaptable in a dynamic business environment.

Determinants of Capital Structure Evidence from Saudi Arabia

This study aims toinvestigate the most important determinants of capital structure in non-financial Saudi Arabian firms listed in Saudi Stock Exchange (TADAWUL) from 2010-2021, using a fixed effect with robust standard regression. Theories of capital structure have different views and conclusions as well as the empirical works. Thus, determining the factors affecting the capital structure in a different context like Saudi Arabia that has a unique feature such as the absence of corporate tax, undeveloped and illiquid bond market, will add to the existing literature. The study finds a positive relationship between each size, asset tangibility, and market- to book with firm leverage On the other hand, there is a negative relationship is found between profitability and sales growth. Some of the findings are consistent with the trade-off theory such as firm size while some of the findings support the picking order theory. Empirical findings should help corporate managers understand the nature of the market and make optimal capital structure decisions.

Entrepreneurial investment and financing with third-party guarantees under present-biased preferences

Some guarantors in China promise to make equity investments to finance entrepreneurial firms’ future expansion investment, beyond guaranteeing their existing bank debt. This paper employs a real options model to study entrepreneurial firms’ expansion investment decisions, the valuation of the fair guarantee premium, and guarantors’ equity investment policies when entrepreneurs exhibit present-biased preferences. We show that as the degree of present bias increases, entrepreneurial firms invest later and guarantors make smaller equity investments. We demonstrate an inverted U-shaped relationship between the fair guarantee premium and the degree of present bias. Finally, present-biased entrepreneurs’ optimal capital structure decisions are discussed.

A methodology to estimate the optimal debt ratio when asset returns, and default probability follow stochastic processes

The purpose of this paper is to propose a methodology that allies both theoretical and empirical aspects to model and solve the problem of finding the optimal market-based corporate financial structure in a risky environment; the firm's asset value follows a geometric Brownian motion with a return adjusted by the probability of default which is stochastic and follows an Ornstein-Uhlenbeck process. We consider a decision manager to optimize the financial structure of his company, maximizes the expected utility of the shareholders' final wealth by solving a dynamic programming problem. The value function obeys a quadratic Hamilton-Jacobi-Bellman (HJB) equation and the explicit solution gives the optimal debt ratio. The Kalman filter approach is used to estimate the model parameters. We empirically examined the implications of the credit ratings on the optimal capital structure decision. The data used are daily, obtained from the 'Data Stream' database and cover a sample of 16 U.S companies of various sectors and different rating categories over the period from January 01, 2015, to December 31, 2015. The estimated average optimal debt ratios are relatively high showing different patterns between and within investment and speculative-grade firms. In fact, the evolution of the optimal debt ratio according to the rating is influenced by a restrictive or an easy entry into the debt market and by the value of the estimated rate of return.

Determinants of Debt Financing: An Empirical Analysis of Non-Financial Listed Companies in Sri Lanka

The purpose of this study is to identify the factors which determine the level of debt financing over the equity financing of the non-financial companies in Sri Lanka. The study is conducted on a sample of 30 companies from non-finance companies listed on the Colombo Stock Exchange (CSE). The sample consists of 20 companies that are selected based on the highest market capitalization and 10 companies which have issued debentures in the market. The data are obtained from the annual reports of sample companies for the years 2015 to 2018 for this purpose. A panel data regression analysis is conducted to analyze whether the firm performance, age, size, agency cost of debt, tangibility, sales growth, liquidity, and tax shield have an impact on the debt financing decisions of the firm. The pecking order theory, agency theory, and trade-off theory are used to explain the impact of determinants on debt financing. The findings of the analysis show that the firm performance, size, liquidity, tangibility, sales growth, and agency cost of debt have generated an inverse association with the firm leverage. Age and non-debt tax shield positively correlated with leverage according to the analysis. Findings are in line with the hypotheses developed except for firm size, tangibility, and non-debt tax shield. The size of the firm and tangibility deviate from the hypotheses developed while the non-debt tax shield is found to be insignificant in influencing its decision to apply for financing. This research has provided the basis to explore the determinants of debt financing in the overall capital structure of Sri Lankan firms. The results are useful for the managers and the policymakers to have knowledge about the firm-specific determinants of debt financing, and it should help corporate managers to make optimal capital structure decisions. This study contributes to enhancing the existing literature by analyzing the impact of determinants of debt financing in listed non-financial companies in Sri Lanka.

Capital Structure Decisions and Corporate Performance: Does Firm’s Profitability Matter?

This study aims to investigate the relationship between financing decisions and firm performance. It particularly investigates the heterogeneous effects of capital structure ratios on financial profitability. The study employs the Quantile regression methodology on a sample of 120 non-financial companies listed on Tadawul stock exchange during the period 2017–2020. Financial performance was measured using return on assets, return on equities and Tobin’s Q variables in order to assess accounting and market performance. Data on the various variables is obtained from the companies’ annual reports. Quantile regression results show that debts to equity ratio hamper firms’ performance where as equity financing ratio increases business profitability. Additionally, findings demonstrate that this relationship is nonlinear. Particularly, a debt to equity ratio has a greater negative effect on performance of high-profitable firms. However, the positive effect of the equity financing ratio seems to be higher in high profitable companies than low ones. These results would help managers of non financial firms regarding optimal capital structure decisions. Indeed, managers of non-financial firms could use results of this study as a benchmark to make efficient decisions related to the structure of the capital such as reducing the proportion of debts in the capital and increasing the weight of equity financing. Particularly, enterprises in the early stages of development, with lower profits reflected in return on assets, return on equities, and Tobin’s Q should carefully avoid debt, whereas firms with big earnings are encouraged to raise their capital by issuing new shares in the financial market.

Interdependent capital structure choices and the macroeconomy

This study shows that capital structure choices of US corporations are interdependent across time. We follow a two-step estimation approach. First, using a large cross-section of firms we estimate year-by-year average capital structure choices, i.e., the average firm’s percentage of new funding that is secured through debt, its term composition, and the percentage of new equity represented by retained earnings. Second, these time series are included in a Factor Augmented Vector Autoregressive model in which three factors representing real economic activity, expected future funding conditions, and prices, are included. We test for the interdependence between optimal capital structure decisions and for the influence exerted by macroeconomic conditions on these decisions. Results show there is a hierarchical order in which firms make capital structure decisions. They first decide on the share of debt out of total new funding they will hire. Conditional on this they decide on the term of their debt and on their earnings retention policy. Of outmost importance, macroeconomic factors are key for making capital structure decisions.

Research on the refinancing capital structure of highway PPP projects based on dynamic capital demand

PurposeWith the majority of highway projects in China having entered their operational phases, the maintenance and repair of the pavement is receiving increasing attention. One problem that needs to be addressed urgently is that of how to raise the proper funds for highway maintenance to ensure the sustainable operation of the project. To this end, the aim of this study is to investigate the capital demand for operation and maintenance of a project by means of a refinancing scheme, in order to reduce the possibility of project bankruptcy and to enhance the economic value of the project.Design/methodology/approachBased on an analysis of the dynamic complexity of the highway pavement maintenance system, a Markov model is used to predict pavement performance, and an optimal capital structure decision model is proposed for highway public–private partnership (PPP) project refinancing, using the method of system dynamics (SD). The proposed model is then applied to a real case study.FindingsResults show that the proposed model can be used to predict accurately the dynamic changes in the demand for road maintenance funds and refinancing during the period of operation, before making the optimal decision for the refinancing capital structure.Originality/valueAlthough many scholars have studied the optimal refinancing capital structure of PPP projects, the dynamic changes inherent in the demand for maintenance funds for highway PPP projects are seldom considered. Therefore, in the approach used here the influence of the dynamic change of road maintenance capital demand on refinancing is investigated, and SD is used for the optimal capital structure decision-making model of highway PPP project refinancing, to make the decision-making process more reasonable and scientific.

A revisit of capital structure puzzle: Global evidence and analysis

The ongoing debate on optimal capital structure is one of the core issues of corporate finance literature since it is initially and academically presented by Modigliani and Miller (M-M theorem 1958 & 1963). Nonetheless, the existing corporate finance literature hardly provides global empirical evidence on the impact of financial leverage on firm value. To address the issue, based on cross-country panel testbed as of Dec. 2004–Dec. 2018 for high and low geared firms, the test results indicate that the overall firm performances of high geared firms are significantly lower than those of low geared firms. We document that high geared firms are financially less stable, and thus subject to lower value as compared to counterpart ones, because additional debt can cause value destruction due to bankruptcy. Interestingly, our finding is consistent across different dimensions: cross-country, cross-industry, size group, and period analysis. However, this empirical evidence is inconsistent with M-M propositions on capital structure irrelevance theory (1958; 1963). The underlying probable reason could be that M-M theory is based on the assumptions of a perfect world which makes the theory idealistic, impractical & dead in real world. Hence, by addressing a core issue of corporate finance, the study notably contributes for providing a global evidence of the impact of leverage on firm performance. Therefore, this study significantly contributes to deeply rethinking the proposition of financial gearing on firm value; and thereby to design the optimal capital structure decision for sustainable finance and responsible investments for wealth maximization.

The Determinants of Capital structure in Ethiopian Private Commercial Banks: A Panel Data Approach

A wrong capital structure decision causes business frailer. However, still, what determinants optimal capital structure decision of companies remain the puzzles of many research scholars. This study is, therefore, aimed to investigate the determinants of the capital structure decision of private commercial banks in Ethiopia. The secondary data were obtained from audited annual financial reports of ten private commercial banks and the National Bank of Ethiopia covering the period of 2010-2018. The panel data were analyzed with a clustered robust random effect regression model. The study reveals that there is a significant positive relationship between earning volatility, size of banks, and taxation with leverage while profitability and asset tangibility are found to have a significant negative effect on the banks' leverage decision. The empirical findings of the study imply that the two capital structure theories, static trade-off and pecking order, are essentially explaining the capital structure decision of Ethiopian private commercial banks. Private commercial banks in Ethiopia should pay due attention to the microeconomic variables without overlooking the macroeconomic condition while articulating their optimal capital mix which can minimize the weighted average cost of capital and enhance the value of the company.

Why Don't Banks Short Banks?

We find that the volatility of bank equity returns can be reduced by 34% if banks hedge their exposure to bank-index risk. We then investigate the joint optimal hedging and capital structure decisions of banks when bank-industry risk is hedged using a convertible forward contract. Compared to the no-hedge benchmark, optimally hedged banks increase equity valuations, lower default probabilities (in spite of choosing higher leverage), and mostly eliminate systemic risk. That banks choose not to hedge bank index risk is consistent with managers internalizing bank bailouts. Governments can eliminate bailouts by forcing firms to insure against industry-risk.

Determinants of Capital Structure:An Empirical Study on Ethiopian Insurance Industry

The aim of this study was to examine the firm-specific, industry-specific and macro-economic determinants of Ethiopian insurance companies’ capital structure decision with the sample size of nine insurance companies, covering the period of 2005-2016.To achieve this objective quantitative research approach and quantitative data were used. The data was obtained from the annual audited financial statement of insurance companies and from NBE. In comply with this objective the study applied panel data model with fixed effect Ordinary Least Square regression. To test the hypotheses those were formulated through the review of available literature, the collected data was organized and checked for the fulfillment of OLS linear regression assumptions and then analyzed using fixed effect linear regression. The finding of the study shows that age of the firm, firm size and growth rate of real GDP have statistically significant and positive relationship with insurance company’s capital structure decision. On the other hand, variables like business risk, tangibility of asset and liquidity have a negative and statistically significant relationship with capital structure of insurance companies However, the relationship to exchange rate, profitability, growth opportunity and non-debt tax shield appear to be statistically insignificant. Depending up on the finding the study recommends that insurance companies in Ethiopia should not focus only on firm specific factors but also on macroeconomic environment so as to make an optimal capital structure decision and also the management of those insurance companies has to be focused on reducing factors that causes earning volatility to enhance earning sustainability. Finally the regulator (NBE) need to address problem of information asymmetry through setting up of rules that will ensure effective disclosures of the insurance companies audited financial statements. Keywords: Capital structure, firm specific factors, macro-economic factors, industry specific factors DOI: 10.7176/RJFA/11-9-02 Publication date: May 31 st 2020

DETERMINANTS OF CAPITAL STRUCTURE: AN EMPIRICAL EVALUATION OF OMAN’S TOURISM COMPANIES

Purpose: The purpose of this research is to investigate the determinants of the capital structure of tourism companies in Oman. This study uses the trade-off theory and pecking order theory to postulate hypotheses related to determinants of capital structure. Methodology: In line with extant literature, size, liquidity, tangibility, growth opportunities, and risk are used as the determinants of the capital structure. The sample in this study includes nine listed tourism companies for the period 2007 to 2016, which aggregates to 90 firm-year observations. Main findings: The results show that the capital structure of tourism companies is influenced by size, growth, and risk. The trade-off theory and pecking order theory are useful for partially explaining the leverage decisions of Oman's tourism companies. Implications: The empirical findings of this research imply that tourism companies' corporate managers can make optimal capital structure decisions based on determinants. Novelty: To the best of the author's knowledge, this study is a first for examining the determinants of capital structure for Oman's tourism companies using data over ten years. It lends support to the determinants identified in prior literature for developed and developing countries.

DETERMINANTS OF CAPITAL STRUCTURE: AN EMPIRICAL EVALUATION OF OMAN’S TOURISM COMPANIES

Purpose: The purpose of this research is to investigate the determinants of the capital structure of tourism companies in Oman. This study uses the trade-off theory and pecking order theory to postulate hypotheses related to determinants of capital structure.
 Methodology: In line with extant literature, size, liquidity, tangibility, growth opportunities, and risk are used as the determinants of the capital structure. The sample in this study includes nine listed tourism companies for the period 2007 to 2016, which aggregates to 90 firm-year observations.
 Main findings: The results show that the capital structure of tourism companies is influenced by size, growth, and risk. The trade-off theory and pecking order theory are useful for partially explaining the leverage decisions of Oman's tourism companies.
 Implications: The empirical findings of this research imply that tourism companies' corporate managers can make optimal capital structure decisions based on determinants.
 Novelty: To the best of the author's knowledge, this study is a first for examining the determinants of capital structure for Oman's tourism companies using data over ten years. It lends support to the determinants identified in prior literature for developed and developing countries.

Foreign ownership and capital structure dynamics

This study explores the relationship between foreign investors and the dynamics of capital structure. Using a sample of listed firms in Taiwan during the period from 1997 to 2016, our results reveal that firms with higher foreign ownership are less likely to issue debt, indicating that foreign investors serve as a direct substitute for debt by enhancing corporate governance. Moreover, foreign investors help reduce leverage adjustment costs, which in turn increases the speed of adjustment toward target leverage. Overall, this study highlights the important role played by foreign investors in shaping firms’ optimal capital structure decisions and shareholder wealth maximization, and thus provides evidence in supporting a positive view of foreign ownership in emerging markets.

Optimal capital structure and bankruptcy choice: Dynamic bargaining versus liquidation

We model a firm’s optimal capital structure decision in a framework in which it may later choose to enter either Chapter 11 reorganization or Chapter 7 liquidation. Creditors anticipate equityholders’ ex-post reorganization incentives and price them into the ex-ante credit spreads. Using a realistic dynamic bargaining model of reorganization, we show that the off-equilibrium threat of costly renegotiation can lead to lower leverage, even with liquidation in equilibrium. If reorganization is less efficient than liquidation, the added option of reorganization can actually make equityholders worse off ex-ante, even when they liquidate on the equilibrium path.

Intellectual Property and Leverage: The Role of Patent Portfolios

This paper analyses the importance of intellectual property in determining capital structure decisions. We argue that firms can use their patent stock as collateral and thereby relax possible debt financing restrictions. Using data from the European Patent Office and balance sheet data of European companies, we find that larger and more valuable patent stocks lead to higher debt-ratios - controlling for well-established capital structure determinants. We further assess variation across as well as within industries and show that effects are mainly driven by tech-oriented and research intensive firms. Drawing on a legislative change in EU- law, allows us to establish a causal relationship between firms' patent portfolio and their use of debt. Results provide a new perspective on optimal capital structure decisions. From a policy perspective, our findings suggest to further harmonize enforcement rules on intellectual property to support financially constrained, innovative firms.

Detecting Determinants of Capital Structure

The determinants of the leverage of firms are widely used as a means to study optimal capital structure decisions. However, empirical studies do not agree on the importance of several commonly proposed determinants. We provide a dynamic capital structure model which endogenously generates the indeterminacy found in empirical studies, and thus we explain why such studies are inherently deemed to be problematic. Specif cally, we demonstrate how interdependence between leverage determinants can cause us to falsely reject important correlations. Our findings add to the insights of the challenges attached to understanding how firms choose their capital structure.