2. LITERATURE REVIEW2.1. Theoretical LiteratureCapital structure of a firm basically is the mix of debt and equity which the firms deems appropriate to enhance its operations in the midst of several constrains it face.
It is the choice between debt and debt equivalent sources of financing on one hand and the issuing of equity to finance the firm activity on the other. Hence, capital structure decisions have great impact on the firm CITATION Wan l 1033 (Wanjogu, 2014). The first study on capital structure which hashes out that the capital structure is immaterial in a corporate world without taxes, transaction costs or other market imperfectionsCITATION Mod58 l 1033 (Modigliani & Miller, 1958).
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Modigliani – Miller theoryModigliani & Miller (1958) was presented that study on an assumption that there is the existence of market perfection in capital market. Therefore, transactions in the market are free of cost and bankruptcy costs, and information available to all in the market. That means companies have the same tax rate as the financial decisions. As a result, the cost of equity for both leveraged and not-leveraged firms is the same. For the non-leveraged firm, premium is included for financial risk CITATION Jah15 l 1033 (Jahanzeb, et al., 2015). According to Modigliani & Miller, (1958), in perfect capital markets, financial leverage is unrelated to firm value.
It means that at a high or low level, stability cannot be influenced. This theorem does not impact the company’s value on the debt-equity ratio.Capital structure theory begins with the Modigliani ; Miller (1958) paradox of “capital structure irrelevance,” where firm value is not affected by its financing mix. Since then, corporate financial literature has grown enormously, and has identified a distinction between two theoretical approaches. (1) The trade-off theory, (2) The pecking order theory.
2.1.2. Trade-off theoryAlthough Miller ; Modigliani theory has some limitation of unrealistic assumptions but in extended version of this theory in 1963, they presented the trade-off theorem and stated that optimal capital structure comprises of full debts because of the associated tax benefits on interest expenses CITATION Nag16 l 1033 (Nagesha ; Murthy, 2016).
Miller (1977) argued that bankruptcy and agency costs were insufficient to overcome the benefits of the debt-sized tax burden. But considering the personal tax payments, this advantage is completely measured by the disadvantages of private tax rates. But Miller’s model was rejected by CITATION DeA80 l 1033 (DeAngelo & Masulis, 1980). They argued that even if bankruptcy, agencies and related expenses were ignored, the introduction of non-debt shields would be sufficient to maintain an optimum capital structure (Myers, 1984).It is further reported that if it is wrongly treated in the market, it will decide to give it a degree of justification. As a result, the IPO will cause investors to react negatively, and the management does not show a rights issue CITATION Jah15 l 1033 (Jahanzeb, et al.
, 2015).According to CITATION Tit88 l 1033 (Titman & Wessels, 1988) tangible assets end up helping companies to collect debts and if the investment proves a failure, the creditor will charge the guarantee provided. It too states that companies saddled with extra heavy debt – too much to pay down with a couple of years’ internally generated cash should issue equity or sell off assets to produce cash to rebalance the capital construction.2.1.
3. Pecking order theoryMyers (1984) explained by the Theory of the pecking order, suggests that investors would prefer to prefer the new investment. Firstly, when fund raising is done internationally, earnings retention is subsequently issued as a loan and end-point. According to Shyam-Sunder ; Myers (1999), the pecking order theory correctly anticipates the results of profits. According to this theory, there are three financing sources for firms: retained earnings, debts and equity.
Equity faces severe unfavorable selection problems, debt causes minor selection problem and retained earnings has as such not any unfavorable selection problem CITATION Nag16 l 1033 (Nagesha ; Murthy, 2016).Myers (1984) argues that bad choices mean that the remaining earnings are better than loans and loans. This theory seeks to deteriorate the cost of the asymmetric information. It is assumed that the company’s management is aware of the company’s future prospects than external personnel. It is a signal for the future of management expectations, which announces the issuance of loans or equity to the outsiders.2.2.
Empirical Literature2.2.1. Independent variablesMarket powerThe market structure is defined by market power. Market power means controlling the company’s output or price.
Market power is the company’s oligopoly, monopoly or competitive power in active statements CITATION Pan04 l 1033 (Pandey, 2004). The study of Krishnaswamy, Mangla, ; Rathinasamy (1992) find a positive relationship between debt and market structure, measured by the Lerner index. Chevalier (1995) provides evidence for a relationship between the capital structure and the market structure. This results in bankruptcy costs or asymmetric information / pecking orders. Phillips (1995) said that, the price structure and the quantity of data for the market structure have a positive relationship between the capital structure and the trading model, and the output and the limited liability impact are consistent with the model’s impact.
Pandey (2002) finds that, Capital structure and market power are linked to the density. That is, in lower and higher ranges of Tobin Q, companies reduce their debt in intermediate range in high debt. This was due to the complex interaction of market conditions, agency costs and bankruptcy costs.The capital structure of organizations was studied in the context of market power in the market. Market power is controlling a company based on products or products. Under operating conditions, market power is a competitive business, oligopoly or monopoly in a business establishment.
Companies are expected to go through a monopoly or oligopoly to compete with companies CITATION Nag16 l 1033 (Nagesha & Murthy, 2016). Moreover, developing economies, prices and data of different stocks cannot be obtained for calculating X. This research also includes calculating the market power that assumes a positive relationship in the market power and capital structure. ProfitabilityTrade off theorem says that most profitable firms are looking to increase debt burden. Moreover, high profitability reduces the risk of a severe financial slump and bankruptcy. Potential investors will be interested since the risk of default is low.
Therefore, there is a positive relationship between the profitability of a company and its leveraged entities CITATION Hus16 l 1033 m Xia13(Hussain, et al., 2016; Xiaomeng Xu, 2013). The principle of the pecking order command that points out that external sources are interested in internal financial sources CITATION AlN l 1033 (Al & Shubiri, 2011).
Top-priced companies may generate cash internally. Depending on the pecking order theory, companies will issue lower loans when there are sufficient internal fund funds Rajan & Zingales, (1994) concludes that the relationship between the profit and the loan’s ratio is negative? The emergence of financial disasters due to the cost of debt issuance has a low level of low-income companies.Agency Theory and Tradeoff Theory, on the other hand, have a positive relationship between profitability and leverage. Debt managers find a solution under agency theory-Shareholders’ solution is a solution.
Managers believe that the conflict between their counterparts leads to lower investment opportunities, which are the result of cheaper and less profitable companies. In this situation, debt is managed as a pragmatic tool to manage, manage, manage, or invest in unprofitable funds or invest in non-profitable projects CITATION Har91 l 1033 (Harris & Raviv, 1991). GrowthThe firms that experience high growth rates often need more aggressive financing. From a pecking order perspective, once these firms exhaust their internally generated funds, they will resort to debt financing. Therefore, for two firms with the same profitability, we should expect that the firm with a higher growth rate will be more leveraged CITATION For13 l 1033 (Forte, et al., 2013).
Highly levered companies are more likely to pass up profitable investment opportunities CITATION Mye77 l 1033 (Myers, 1977).Therefore, firms expecting high future growth should use a greater amount of equity finance. As suggested by Myers, Rajan & Zingales (1994) also use the ratio of the market value of assets to the book value of assets as a proxy for growth opportunities. The negative relationship between growth and leverage is also expected from the viewpoint of Agency Theory.
Loans might not be the preferred source of finance in this case, because they transfer a firm’s wealth to debt holders. This fact constitutes a problem if we are considering high growth firms. Fast growing companies often owe their rapid development to the many investment opportunities that may need to be foregone if debt holders gain control over assets CITATION Mye77 l 1033 (Myers, 1977).
It is also a fact that SMEs usually face greater growth and usually have less money of their own than larger and more mature companies. Therefore, leaving all the financing preferences aside, SMEs simply are more in need of external funds CITATION Kuc08 l 1033 (Kuciak ; Bartholdy, 2008). They expect growth to be positively related to leverage.TangibilityTangible assets consist of fixed and current assets, such as buildings, machinery and inventory.
It is not difficult to insure the essential assets when comparing the essential assets or physical assets. According to both trade-off and pecking order theorem, tangibility and leverage are positively affecting, companies with a higher attrition rate than the conventional system are also high. The liquidity ratio may have a mixed impact on the decision of the capital structure. On the one hand, companies with high liquidity ratios will support relatively high debt ratios, as they are more likely to fulfill short-term obligations.
This indicates a positive relationship between the company’s liquidity and debt ratio. On the other hand, large liquid assets can use these assets for their investment money. Therefore, firm’s liquidity position should exert a negative impact on its leverage ratio CITATION Bas l 1033 (Basu ; Rajeev, 2013). Moreover, higher intangible assets face lower credit costs and less likelihood of bankruptcy. Firms with which you can most likely get more credit than companies with intangible assets.
Therefore, a higher ancestor indicates high credit capacity. The relationship between tangible assets and debt ratio is expected to be positive CITATION Har91 l 1033 (Harris ; Raviv, 1991). Tangibility cause to arise lower cost of debt and less probability of bankruptcy.
Thus, tangible assets are mostly meant to be of high credit capacity. The relationship between tangible assets and debt ratio is expected to be positive CITATION Xia13 l 1033 (Xiaomeng Xu, 2013).