Traditional Theories Of Capital Structure Research Articles

Capital Structure and Financing Decisions in Southeast Asia’s Property and Real Estate Sector: A Systematic Literature Review

This systematic literature review evaluates the existing research on capital structure and financing decisions within the property and real estate sector of Southeast Asia (ASEAN). Despite the sector's dynamic growth and substantial investments, the financial strategies specific to ASEAN remain minimally explored. A methodical review of scholarly articles from ScienceDirect, and Google Scholar spanning from 2000 to 2023. Our analysis identified prevalent themes and trends, notably the application of traditional capital structure theories such as pecking order and trade-off theories to more developed markets. However, the review highlights a significant gap in empirical research focusing on the unique economic, regulatory, and market conditions in ASEAN that crucially impact capital structure and financing choices in the region's property sector. The findings emphasize the need for more targeted empirical studies that account for the socio-economic diversity and specific institutional frameworks of ASEAN countries. These studies aim to enhance understanding of the financing behaviors in their property and real estate markets, thus aiding policymakers and investors in crafting informed strategies and policies.

Which Factors Play a Role in CoCo Issuance? Evidence from European Banks

This article explores the reasons why some banks issue Contingent Convertible (CoCo) bonds, but others do not. To this end, we use a binary logistic model and control for the determinants suggested by the literature. Our findings suggest that larger banks and those with higher Tier 1 capital, higher net loans, higher wholesale funding, lower levels of leverage, and lower risk-weighted assets have a higher tendency to issue CoCos and were the early adopters of this novel financing instrument. Our results also suggest that banks in countries with higher annual growth rate of GDP per capita and those listed as Globally Systematically Important Banks (G-SIBs) were more likely to issue CoCos. These results are difficult to explain by traditional capital structure theory, which assumes that companies voluntarily choose their optimal capital structures, but suggest that banks were more likely to be encouraged or nudged to issue CoCos by following regulators’ advice.

Correlation-and-regression analysis of the influence of macroeconomic factors on capital structure of Russian corporations under crisis conditions

The study reveals the influence of macroeconomic factors on decisions about the optimal capital structure formation under financial globalization, in view of ever-changing factors of the external economic and geopolitical environment. The study is aimed at empirical testing of hypotheses on how the level of financial leverage of corporations depends on traditional determinants during and after the financial crisis under the emerging market conditions in Russia. The study deals with a large data set of 49 public joint stock companies from 7 leading Russian economic sectors for the period from 2011 to 2017. According to the correlation-and-regression analysis results (1) the use of traditional theories of capital structure under the conditions of current financial globalization in a country with a developing economy proves to be ineffective for the optimal capital structure formation (2) the corporate capital structure formation is strongly influenced by macroeconomic factors, which is most evidently manifested during and after the crisis (3) the financial crisis exerts a strong influence on the corporate capital structure (4) the determinant of stock market development has a significant influence on leverage and plays a prominent role in making financial decisions after the financial crisis.

Formation of optimal capital structure of domestic corporations in times of crisis: Econometric analysis of determinants

Subject. The article addresses building the optimal capital structure in the face of financial globalization, taking into account the ever-changing factors of external economic and geopolitical environment, including the financial crisis. Objectives. The purpose is to perform empirical tests of hypotheses about the nature of corporate financial leverage dependence on traditional determinants during and after the financial crisis in Russia's emerging market. I used a large data set on 49 public companies in seven leading sectors of the Russian economy from 2011 to 2017. Methods. The study employs the correlation and regression analysis. Results. The results of correlation and regression analysis show that the application of traditional theories of capital structure in the current conditions of financial globalization in a developing country is ineffective for forming an optimal capital structure; macroeconomic factors have a significant impact on the formation of corporate capital structures, which is particularly reflected during and after the crisis; the financial crisis has a considerable impact on the capital structure of companies; the determinant of stock market development has a real impact on leverage and plays an important role in financial decision-making after the financial crisis. Conclusions. I revealed inverse relationship between the leverage and variable size of companies after financial crisis, which contradicts to the trade-off theory and corresponds to the pecking order theory. This supports the hypothesis that macroeconomic factors are crucial, but the variable of stock market development has increased essentially as compared to the pre-crisis period.

“Peer effects” in capital structure decision of Chinese firms-empirical investigation based on Chinese a-share listed firms

PurposeThe purpose of this paper is to identify if peer firms’ capital structure decision plays a role in determining focal firms’ capital structure decision, despite the fact that correlated effects can also lead to co-movement of financing behavior among firms from the same industry (i.e. industry-specific capital structure).Design/methodology/approachInstead of using relative measurement (of individual outcome variable over industry variable) as in previous work, this paper borrows the linear-in-means model and, after controlling for potential endogeneity problems, directly identifies the existence of peer effects with coefficient estimation. To deal with correlated effects, additional empirical investigations such as test of heterogeneity in direction and scale, social multiplier identification test and instrumental regression test based on another instrumental variable (that is less influenced by correlated effects) are performed.FindingsUsing data from Chinese listed firms, this paper, for the first time, identifies the presence of peer effects in capital structure and debt maturity decision. Further investigations show that first, focal firms react asymmetrically to peer firms’ debt adjustment of different direction and scale. Second, social multiplier, a unique attribute of peer effects, is identified in the leverage choices. Third, the significant correlation of capital structure decision remains even if we use another “correlated effects-immune” instrument. All these results point to the fact that peer effects, rather than correlated effects, play a significant role in determining capital structure.Practical implicationsThe empirical results of this paper provide strong evidence that firms, driven by motivations such as either learning or competition, will actively react to peers’ financial decisions. As the bridge between individual firms and the industry, social multiplier can be fully taken advantage of to induce positive spillover of good management practices and prohibit inefficient decisions from spreading.Originality/valueThis paper theoretically and empirically introduces peer effects – a well-acknowledged social concept – into capital structure decision of Chinese listed firms, thus both complementing the traditional capital structure theory and providing an empirical paradigm for peer effects research.

Market Value and Capital Structure: A Study of Indian Manufacturing Firms

India witnessed significant development in stock market in the post 1990s due to series of reform measures. As result, firms are able to raise market based capital which helped them to reduce their dependence on institution based finance. Consequently, market valuation of the firm has become an important variable in corporate finance decisions. However, traditional theories of capital structure fail to offer unambiguous explanation on the impact of market value on capital structure. To bridge this lacuna in capital structure literature, Baker and Wrugler (2002) propounded market timing theory which argues that firms’ time the market, that is, firms raise equity capital when market valuation is high and buy back when market valuation is lower and hence the current capital structure of the firm is the cumulative result of past attempts to time the equity market. In this study we attempt to understand the role of market value in influencing the capital structure decisions of the manufacturing firms in India. We find that market value negatively influences the debt ratio both in short term and long term indicating the practice of market timing. Further, we find that negative impact does indeed come from changes in equity issues rather than changes in retained earnings or debt retirement.

The determinants of Islamic bank capital decisions

We report new evidence on the bank and institutional determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia'a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize managers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.

Determinants of Bank Capital in Dual Banking Systems

We report new evidence on the bank and country-level determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia’a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize mangers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.

Determinants of Bank Capital in Dual Banking Systems

We report new evidence on the bank and country-level determinants of Islamic bank capital ratios in 28 countries between 1999 and 2013. Overall, we find that smaller, more profitable, and highly liquid Islamic banks are more highly capitalized. Additionally, improvements in the economic and financial environments and market discipline within a country correspond with higher Islamic bank capitalization. The results shed light on the impact that Sharia’a law restrictions have on Islamic banking capitalization. Our findings are most robust to banks that choose to hold capital well in excess of that required by regulators, consistent with traditional capital structure theory. Our results highlight the role that stable economic and political systems play in improving bank capitalization and reducing financial sector risk. By reducing political instability and corruption, improving legal systems, and encouraging access to capital markets, policymakers may incentivize mangers to make financing decisions that increase the capitalization of the Islamic banking industry in developing countries.

The Levered Returns of Leveraged Buyouts: The Impact of Competition

This paper investigates the relationship between leverage and returns in private equity buyout transactions. In contrast to the predictions of traditional capital structure theory, we find that transactions financed with large amounts of debt are associated higher transaction prices and lower returns to private equity sponsors. Consistent with the view that easy credit amplifies the intensity of bidding for deals, these relationships hold only when private equity buyers face competition from other funds, such as in deals sourced from investment bank auctions. Our results are distinct from changes in deal prices driven by private equity fundraising and the results are robust to alternative, plausibly exogenous, proxies for the competitiveness of deals. Finally, we show that the choice to pursue auction deals in particularly loose credit markets, when expected returns are low, is positively related to proxies for agency conflicts between fund managers and fund investors.

Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure, and the Low-Risk Anomaly

Traditional capital structure theory predicts that reducing banks' leverage reduces the risk and cost of equity but does not change the weighted average cost of capital, and thus the rates for borrowers. We confirm that the equity of better-capitalized banks has lower beta and idiosyncratic risk. However, over the last 40 years, lower risk banks have not had lower costs of equity (lower stock returns), consistent with a stock market anomaly previously documented in other samples. A calibration suggests that a binding ten percentage point increase in Tier 1 capital to risk-weighted assets could double banks' risk premia over Treasury bills.

Traditional theories of capital structure: trade-off versus pecking order

Traditional theories of capital structure: trade-off versus pecking order

Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts

ABSTRACTPrivate equity funds pay particular attention to capital structure when executing leveraged buyouts, creating an interesting setting for examining capital structure theories. Using a large, international sample of buyouts from 1980 to 2008, we find that buyout leverage is unrelated to the cross‐sectional factors, suggested by traditional capital structure theories, that drive public firm leverage. Instead, variation in economy‐wide credit conditions is the main determinant of leverage in buyouts. Higher deal leverage is associated with higher transaction prices and lower buyout fund returns, suggesting that acquirers overpay when access to credit is easier.

Foreign Ownership, Capital Structure and Firm Value: Empirical Evidence from Vietnamese Listed Firms

This paper examines the relationships among foreign ownership, capital structure, and firm value in the case of listed firms in Vietnam. Using fixed effect model on data of all listed companies (exclude financial firms and banks) in Hochiminh Stock Exchange during the period of 2008-2011, the research finds an interesting evidence that foreign ownership has negative impact on firm value while previous literature indicates controversal results. The result implies that foreign ownership in Vietnam is not concentrated and therefore it cannot play an monitoring role in corporate governance mechanism. The outcome also shows that there is a negative link between foreign ownership and capital structure due to the fact that foreign investors suffer from information asymmetric and increase debt for controlling agency problem. With regard to relationship between capital structure and firm value, increase in debt leverage of listed firms decrease firm value. Hence, traditional theories of capital structure should be adjusted while applying them in emerging markets. Apart of fixed effect method, simultaneous equations model is employed for controlling simultaneity problem.

A Theory of Net Debt and Transferable Human Capital*

Traditional theories of capital structure do not explain the puzzling phenomena of zero-leverage firms and negative net debt ratios. We develop a theory where firms adopt a net debt target that acts as a balancing variable between equityholders and managers. Negative (positive) net debt occurs in human (physical) capital intensive industries. Negative net debt arises because tradeable claims cannot be issued against transferable human capital. Heterogeneity in capital structure occurs when firms have debt that is not fully collateralized. Physical capital intensive firms take on high leverage but may underlever to avoid bankruptcy costs. This creates excess rents for managers (even if the supply of human capital is competitive) because wealth constraints prevent managers from co-investing.

Firm Profitability, Inventory Volatility, and Capital Structure

Traditional theories of capital structure imply a consistent relationship between firm profitability and firm leverage. Empirical data, however, suggest that the relationship is not monotonic. In the cross-section of firms, non-profitable firms become significantly more leveraged as losses decrease; profitable firms become significantly less leveraged as profits increase until a point where the most profitable firms have again significantly greater leverage as profits increase. In this paper, we present an extension of a model of Xu and Birge (2004) that is consistent with these observations. The model assumes that firms make debt and production scale decisions that depend on fixed costs necessary to maintain operations, variable costs of production, and volatility in future demand forecasts. In addition to predicting the convex relationship between profit margins and leverage that appears in the data, the model also predicts decreasing inventory volatility for non-profitable firms followed by increasing inventory volatility for profitable firms, which is also a statistically significant result in the data. These observations are consistent with a model of firms that make early price and quantity commitments in advance of demand realization as in the classical news vendor model of operations.

Capital structure: professional management guidance

PurposeCapital structure decisions rely on a complex array of theoretical foundations and practical considerations. At the managerial level, it is impractical to base decisions purely on theory. While one can develop a perception of an optimal capital structure, the decision is often obscured by practical limitations to the theoretical base. In order to be useful to practicing managers, policies and decision techniques need to be efficiently accomplished and based on available information. This paper seeks to provide that practical framework.Design/methodology/approachThis paper recounts the simple theoretical base for capital structure, highlights some of the problems encountered when applying the theory to reality, and suggests a framework for practical managerial decisions about capital structure. This exposition is especially useful in undergraduate business curricula, in particular for finance majors considering professional management as a career.FindingsWhile application of traditional capital structure theory is often impractical, numerous tools are available for use by professional managers to make informed decisions about capital structure.Practical implicationsThe conclusions from this paper provide a framework for current and prospective professional managers for making appropriate capital structure decisions in their management careers.Social implicationsProper managerial techniques and considerations for leverage and capital structure can potentially benefit society through more prudent use of debt, based on the variety of measures presented in this paper.Originality/valueTopics discussed in this paper have been in development since the 1950s. The contribution of this paper is the creation of a framework for understanding and applying these topics, for pedagogical and management training purposes.

Borrow Cheap, Buy High? The Determinants of Leverage and Pricing in Buyouts

Private equity funds pay particular attention to capital structure when executing leveraged buyouts, creating an interesting setting for examining capital structure theories. Using a large, detailed, international sample of buyouts from 1980-2008, we find that buyout leverage is unrelated to the cross-sectional factors – suggested by traditional capital structure theories – that drive public firm leverage. Instead, variation in economy-wide credit conditions is the main determinant of leverage in buyouts, while having little impact on public firms. Higher deal leverage is associated with higher transaction prices and lower buyout fund returns, suggesting that acquirers overpay when access to credit is easier.

'Flying with Heavy Loads' Capital Structure Considerations for the US Airline Industry

The paper discusses a hidden aspect of a firm's capital structure through the use of a real options application. It is applied to the US airline industry, characterized by over levered balance sheets, and one which on some estimates, has made zero cumulative profit taking the years of the last century together. The paper introduces the notion of flexibility, defined as the freedom (or flexibility) enjoyed by a conservatively geared firm to respond quickly and secure positive NPV projects, as opposed to an over levered firm. This is then valued as a real option using a model based on arithmetic Brownian motion involving a path dependant option pricing framework. It analyses the implications of debt financing in the US airline industry and develops a capital structure model that incorporates the value of enjoyed by conservatively geared carriers. This model essentially balances the quantified value of financial flexibility enjoyed by conservatively geared carriers against the relevant cost of obtaining this flexibility (i.e. the cost of carrying a sub optimal capital structure) and factors in the implications of fire sales (Pulvino, 1998) which is specific to the US airline industry. In its application to South West Airlines the paper concludes that the optimal capital structure, if the value of financial flexibility is incorporated - should move closer to the origin. A methodology of integrating the value of financial flexibility into the traditional theories of capital structure is proposed and demonstrated that (at least) in the US airline industry, failure to do so can result in a significant misstatement in a firm's value and its optimal capital structure. This paper makes two key contributions to the existing body of academic literature. The notion of valuing financial flexibility as a real option has been introduced previously by Beneda and Nelson (2003). However their quantification of the option value is through a standard Black Scholes equation where the underlying assumptions of this are not valid in quantifying a real option of this nature and this chapter makes a modification of the standard Black Scholes equation to reflect reality. Furthermore the paper applies the concept of financial flexibility specifically to the US airline industry and develops a conjecture on how this can be incorporated into the traditional theories of capital structure which is another contribution to the academic literature.

An Analysis of REIT Security Issuance Decisions

This article tests the ability of traditional capital structure theories to explain the issuance decisions of real estate investment trusts (REITs). For issuances made between 1997 and 2006, we find strong support for the market timing theory of capital structure. Controlling for past returns and growth, a REIT is more likely to issue equity when its price-to–net asset value ratio is high. This suggests that REITs issue equity in public markets when the cost of equity capital is lower in the public market than in the private market. Consistent with traditional market timing, REITs are more likely to issue equity after experiencing large price increases. We also find some support for REITs following the trade-off theory of capital structure. REITs are less likely to issue debt when proxies for expected bankruptcy costs are high.