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Capital Structure Determinants
- By Super Admin
- Published 17 March 2007
- Report, Assignment, Case Study and Term Paper
- Unrated
A firm’s major decision is it’s financing decisions which are analyzed
in the theory of corporate capital structure and based on the model
developed by Dodd (1986), capital structure is determined mainly by
three agency costs variables- agency-equity, agency-debt &
bankruptcy risk and other potential variables such as growth rate,
profitability and operating leverage.
The firm’s capital structure should result from balancing the costs of certain relationships between firm related groups. Sometime agent do not act in line with the set objectives of the principal.
• Shareholders are the owner of the firm. If shareholders value increases they will be benefited and vice-versa. Shareholders value maximization depends on managers activities. But as a rational being, managers try to maximize their own interest. As a result agency-equity cost arises which tend to discourage the use of equity.
• Debt holders have no voice on management issue. Managers are accountable only to the firm. So, they are trying to maximize the wealth of shareholders not debt holders. So, conflict arises between managers and debt holders. There is an agency-debt cost which discourages the issuance of debt.
• There is a possibility of bankruptcy if the firm taking more debt capital. Because the greater the firms debt capital, higher the possibility of default on interest and capital repayment.
Three other potential determinants of capital structure are also included in the model developed by Dodd. Firms growing at higher rates should have higher debt ratios than firms with lower growth rates. The relationship between debt ratios and growth rate is expected to be positive. Firms with higher profitability ratio may be expected to have more equity than firms with lower ratios. Management of companies with high operating leverage may use lower levels of financial leverage i.e, debt.
There are few specific areas where accounting principles and reporting principles for Japanese and Bangladeshi firms differ in some respect.
• Japanese firms use double declining or accelerated method of accounting for depreciation. Whereas, Bangladeshi firms is either use straight line or reducing balance depreciation.
• Comparability problems will arise when one country revalues assets in response to inflation at a different rate than the other.
• The Japanese accounting system allows for some additional entries that are not available for Bangladeshi firms.
• Another difference in accounting practices involves the requirements for and methods of preparing consolidated financial statement in each country.
According to the statistical results that are conducted using cross-sectional data for Japanese and Bangladeshi firms, both agency-equity and agency-debt variables were not significant determinants of capital structure in Japanese firms. While the bankruptcy risk variable was an important determinant. Due to the non availability of data for agency-equity, it is not possible to test this variable for Bangladesh. Out of five variables four are found significant. These variables are agency-debt, bankruptcy risk, profitability and operating leverage. Agency-debt and bankruptcy risk variable were found very important determinants of capital structure.
The firm’s capital structure should result from balancing the costs of certain relationships between firm related groups. Sometime agent do not act in line with the set objectives of the principal.
• Shareholders are the owner of the firm. If shareholders value increases they will be benefited and vice-versa. Shareholders value maximization depends on managers activities. But as a rational being, managers try to maximize their own interest. As a result agency-equity cost arises which tend to discourage the use of equity.
• Debt holders have no voice on management issue. Managers are accountable only to the firm. So, they are trying to maximize the wealth of shareholders not debt holders. So, conflict arises between managers and debt holders. There is an agency-debt cost which discourages the issuance of debt.
• There is a possibility of bankruptcy if the firm taking more debt capital. Because the greater the firms debt capital, higher the possibility of default on interest and capital repayment.
Three other potential determinants of capital structure are also included in the model developed by Dodd. Firms growing at higher rates should have higher debt ratios than firms with lower growth rates. The relationship between debt ratios and growth rate is expected to be positive. Firms with higher profitability ratio may be expected to have more equity than firms with lower ratios. Management of companies with high operating leverage may use lower levels of financial leverage i.e, debt.
There are few specific areas where accounting principles and reporting principles for Japanese and Bangladeshi firms differ in some respect.
• Japanese firms use double declining or accelerated method of accounting for depreciation. Whereas, Bangladeshi firms is either use straight line or reducing balance depreciation.
• Comparability problems will arise when one country revalues assets in response to inflation at a different rate than the other.
• The Japanese accounting system allows for some additional entries that are not available for Bangladeshi firms.
• Another difference in accounting practices involves the requirements for and methods of preparing consolidated financial statement in each country.
According to the statistical results that are conducted using cross-sectional data for Japanese and Bangladeshi firms, both agency-equity and agency-debt variables were not significant determinants of capital structure in Japanese firms. While the bankruptcy risk variable was an important determinant. Due to the non availability of data for agency-equity, it is not possible to test this variable for Bangladesh. Out of five variables four are found significant. These variables are agency-debt, bankruptcy risk, profitability and operating leverage. Agency-debt and bankruptcy risk variable were found very important determinants of capital structure.
