Project on Afa m.com(2)

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PROJECT REPORT

ON

CAPITAL STRUCTURE DECISION

MASTER OF COMMERCE

(2015-2016)

ADVANCED FINANCIAL MANAGEMENT

UNIVERSITY OF MUMBAI

UNDER THE GUIDANCE OF

PROF. DHANABALU R. NAIAR

SUBMITTED BY

MISS. REETU S. VISH!AARMA

ROLL NO. 5"

S.. SOMAIYA COLLEGE OF ARTS#

SCIENCE $COMMERCE

VIDYAVIHAR (EAST)

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S.. SOMAIYA COLLEGE OF ARTS# SCIENCE $ COMMERCE

VIDYAVIHAR (EAST)

CERTIFICATE

(201%-2015)

This is to certify that MISS. REETU S. VISHWAKARMA,

ROLL NO. 57 Of M.OM !II" !#$%5$%'" has s(ccessf())y co*+)ete the

+ro-ect o /A0ITAL STRUTURE 1EISION2 (er the 3(iace of0RO4. 1HANAALU R. NAIKAR.

1 ate6 0)ace6 M(*ai.

(D&. SANGEETA OHLI.) (P&'. RAVIANT SANGURDE.)

PRINCIPAL. COURSE CO-ORDINATOR.

(P&'. DHANABALU R. NAIAR.)

PROJECT GUIDE INTERNAL E*AMINER . E*TERNAL E*AMINER.

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DECLARATION BY STUDENT

I, REETU S. VISH!AARMA# ROLL NO. 5" , the

st(et of M.o* !II" ! #$%5$%'" herey ec)ares that I ha8e co*+)ete the

+ro-ect o / CAPITAL STRUCTURE DECISION + s(ccessf())y.

The ifor*atio s(*itte is tr(e a ori3ia) to the est of

*y 9o:)e3e.

Tha9 yo(,

;o(rs faithf())y,

REETU S. VISHWAKARMA

Ro)) No.57

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ACNO!LEDGEMENT

I :o() )i9e to tha9 a)) the +eo+)e :ho he)+e *e i (erta9i3 the st(y a

co*+)eti3 the +ro-ect, y i*+arti3 *e :ith 8a)(a)e ifor*atio a

3(iace that :as re


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INDE*

%. INTRO1UTION............................................................................................... $'#. 1E4INITION....................................................................................................... $=>. MEANIN?........................................................................................................... %$@. A0ITAL STRUTURE O4 A OM0AN;...................................................... %%5. 4ATORS INVOLVE1 IN A0ITAL STRUTURE....................................... %>'. 4EATURE O4 O0TIMAL A0ITAL STRUTURE......................................... %57. ONSTRAINTS IN 1ESI?NIN? O0TIMAL A0ITAL STRUTURE.......... %'. A00ROAHES TO ESTALISH AN A00RO0RIATE A0ITAL

STRUTURE......................................................................................................... %7=. A0ITAL STRUTURE IN A 0ER4ET MARKET......................................... %=%$. A0ITAL STRUTURE IN THE REAL WORL1............................................. #$%%. OR0ORATE 4INANE& 4ATORS THAT IN4LUENE A OM0AN;BS

A0ITAL STRUTURE 1EISION.................................................................. ##%#. A0ITAL STRUTURE AN1 RISK RETURN TRA1EO44.......................... #'%>. MACOR 0ARTII0ANTS IN SEURITIDATION 0ROESS........................... #7%@. A1VANTA?ES AN1 1ISA1VANTA?ES O4 A0ITAL STRUTURE

1EISION........................................................................................................... >>%5. A0ITAL STRUTURE O4 INTERNET OM0ANIES6 ASE STU1;....... >7%'. ONLUSION.................................................................................................... 5=%7. RE4ERENES..................................................................................................... '$

INTRODUCTION

I traitioa) cor+orate fiace, the o-ecti8e i ecisio *a9i3 is to *ai*iFe the 8a)(e of

the fir*. A arro:er o-ecti8e is to *ai*iFe stoc9ho)er :ea)th. Whe the stoc9 is trae

a *ar9ets are 8ie:e to e efficiet, the o-ecti8e is to *ai*iFe the stoc9 +rice. /Stoc9 +rice *ai*iFatio, fir* 8a)(e *ai*iFatio a stoc9ho)er :ea)th *ai*iFatio is ot the

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sa*e. Stoc9 +rice *ai*iFatio is the *ost restricti8e of the three o-ecti8e f(ctios. It

re#" :ith the *ore recet )iterat(re o fiacia) frictios i *acroecoo*ic

*oe)s a)so e*+hasisi3 its ro)e i the (siess cyc)e !e.3. era9e et a). !%==="". Ho: o

co*+aies eter*ie their ca+ita) str(ct(resG The t:o *ost if)(etia) theories of ca+ita)

str(ct(re are the trae off a +ec9i3 orer theories. The first, the trae off *oe), ar3(es

that co*+aies trae off the eefits of aitioa) et !ta e(ctii)ity of iterest e+eses,

re(ce a3ecy costs of free cash f)o:" a3aist the costs !a9r(+tcy ris9" a at the *ar3i

e


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i8est*et co*+oets of the fiacia) eficit. At this +oit the st(y ra:s o +re8io(s

:or9 y 4a*a a 4rech !#$$#" i cotrasti3 the e*+irica) i*+)icatios of the t:o cetra)

*oe)s of ca+ita) str(ct(re, (t re)ai3 the ass(*+tio of eo3eeity of the 9ey re3ressors,

cotro))i3 for fir*&s+ecific fie effects a +resets ie+eet e8iece o this s(-ect

for fir*s o+erati3 i t:o ifferet fiacia) syste*s. The S+aish fiacia) syste* has ee

cate3orise as /a9&ase2 :hi)st that of the Uite Ki3o* as /*ar9et&ase2 !e.3.

1e*ir3J&K(t a Ma9si*o8ic !%===, #$$#". 1oes e*+irica) s(++ort for either *oe)

e+e o the at(re of the fiacia) syste*G This is a f(rther #" :ith the *ore recet )iterat(re o fiacia) frictios i *acroecoo*ic

*oe)s a)so e*+hasisi3 its ro)e i the (siess cyc)e !e.3. era9e et a). !%==="". Ho: o

co*+aies eter*ie their ca+ita) str(ct(resG The t:o *ost if)(etia) theories of ca+ita)

str(ct(re are the trae off a +ec9i3 orer theories. The first, the trae off *oe), ar3(es

that co*+aies trae off the eefits of aitioa) et !ta e(ctii)ity of iterest e+eses,

re(ce a3ecy costs of free cash f)o:" a3aist the costs !a9r(+tcy ris9" a at the *ar3i

e


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:or9 y 4a*a a 4rech !#$$#" i cotrasti3 the e*+irica) i*+)icatios of the t:o cetra)

*oe)s of ca+ita) str(ct(re, (t re)ai3 the ass(*+tio of ero3eeity of the 9ey re3ressors,

cotro))i3 for fir*&s+ecific fie effects a +resets ie+eet e8iece o this s(-ect

for fir*s o+erati3 i t:o ifferet fiacia) syste*s. The S+aish fiacia) syste* has ee

cate3orise as /a9&ase2 :hi)st that of the Uite Ki3o* as /*ar9et&ase2 !e.3.

1e*ir3J&K(t a Ma9si*o8ic !%===, #$$#". 1oes e*+irica) s(++ort for either *oe)

e+e o the at(re of the fiacia) syste*G This is a f(rther


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DEFINITION of 'Capital Structure'

Accori3 to ?eresteer3, ca+ita) str(ct(re of a co*+ay refers to the co*+ositio or *a9e

(+ of its ca+ita)iFatio a it ic)(es a)) )o3 ter* ca+ita) reso(rces 8iF., )oas, reser8es,

shares a osB. Keo: et a). efie ca+ita) str(ct(re as, a)aci3 the array of f(s

so(rces i a +ro+er *aer, i.e. i re)ati8e *a3it(e or i +ro+ortiosB.

a+ita) str(ct(re refers to a co*+ayBs o(tstai3 et a e


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a+ita) Str(ct(re is referre to as the ratio of ifferet 9is of sec(rities raise y a fir* as

)o3&ter* fiace. The ca+ita) str(ct(re i8o)8es t:o ecisios&

a. Ty+e of sec(rities to e iss(e are e


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The assets of a co*+ay ca e fiace either y icreasi3 the o:ersB c)ai*s or the

creitorsB c)ai*s. The o:ers c)ai* icrease :he the fir* raises f(s y iss(i3 oriary

shares or y retaii3 eari3s the creitorsB c)ai*s icrease y orro:i3. The 8ario(s

*eas of fiaci3 re+reset the fiacia) str(ct(re or /3 9&44&, ' '7.

The ter* ca+ita) str(ct(re is (se to re+reset the +ro+ortioate re)atioshi+ et:ee et a

e


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its eet(res, the effecti8e cost to it co*es o)y ' :hi)e if the a*o(t is raise y

%# 0referece Shares, the cost of raisi3 the a*o(t :o() e %#. Th(s raisi3 the f(s

y orro:i3 is chea+er res()ti3 i hi3her a8ai)ai)ity of +rofit for shareho)ers. This

icreases the eari3 +er share of the co*+ay, :hich is the asic o-ecti8e of the fiace

*aa3er.

Optimum Capital Structure

A fir* sho() try to *aitai a o+ti*(* ca+ita) str(ct(re :ith a 8ie: of to

*aitai fiacia) stai)ity. The o+ti*(* ca+ita) str(ct(re is otaie :he the *ar9et 8a)(e

+er e


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F'&9 /;'3;,: / /3 9&44&, 8

What are the Components?

S,/'& D,


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iterest rates tha traitioa) et +ro8iers, a (s(a))y reser8e the ri3ht to trae so*e of

their et for e


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(siess after a)) other o)i3atios ha8e ee +ai off. 4or this reaso, it co*es :ith the

hi3hest ris9 a the hi3hest +otetia) ret(rs of ay tier i the ca+ita) str(ct(re.

F,4&,9 ' O/3 C/3 S&44&,8

A 9'4: '& &'&/, /3 9&44&, 9@'43: @;, @, '33'>/ ,4&,98

R,4&8 The ca+ita) str(ct(re of the co*+ay sho() e *ost a8ata3eo(s. S(-ect to other

cosieratios, it sho() 3eerate *ai*(* ret(rs to the shareho)ers :itho(t ai3

aitioa) cost to the*.

R/98 The (se of ecessi8e et threates the so)8ecy of the co*+ay. To the +oit et

oes ot a si3ificat ris9 it sho() e s(e, other:ise its (se sho() e a8oie.

F3,/


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Uer o+ti*a) ca+ita) str(ct(re the fiace *aa3er eter*ies the +ro+ortio of et a

e


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Approaches to Establish an Appropriate Capital

Structure

The fo))o:i3 are the > *ost co**o a++roaches to ecie ao(t a fir*Bs a++ro+riate ca+ita)

str(ct(re6

%. EBIT-EPS A&'@- The EIT&E0S aa)ysis is a i*+ortat too) i the has of

the fiacia) *aa3er to 3et a isi3ht ito the fir*Bs ca+ita) str(ct(re *aa3e*et. He

ca cosier the +ossi)e f)(ct(atios i the EIT a ea*ie their i*+act o E0S

(er ifferet fiacia) +)as. If the +roai)ity of eari3 a rate of ret(r o the fir*Bs

assets )ess tha the cost of et is isi3ificat, a )ar3e a*o(t of et ca e (se y the

fir* to icrease the eari3s +er share. This *ay ha8e a fa8o(ra)e effect o the *ar9et

8a)(e +er share. O the other ha, if the +roai)ity of eari3 a rate of ret(r o the

fir*Bs )ess tha the cost of et is 8ery hi3h, the fir* sho() refrai fro* e*+)oyi3 et

ca+ita). It *ay, th(s, e coc)(e that the 3reater )e8e) of EIT )o:er the +roai)ity

of o::ar f)(ct(atio, the *ore eeficia) is to e*+)oy et i the ca+ita) str(ct(re.

Ho:e8er, it sho() e rea)iFe that the EIT&E0S is a first ste+ i ecii3 ao(t a fir*Bs

ca+ita) str(ct(re.

#. C'9 ' C/3 : V34/' A&'@- The cost of a so(rce of fiace is the

*ii*(* ret(r e+ecte y its s(++)iers. The e+ecte ret(r e+es o the e3ree of

ris9 ass(*e y i8estors. A hi3h e3ree of ris9 is ass(*e y the shareho)ers tha the

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et&ho)ers. I case of et&ho)ers, the rate of iterest is fie a the co*+ay is

)e3a))y o( to +ay iterest :hether it *a9es +rofits or ot. The )oa of et&ho)ers is

ret(re :ithi a +rescrie +erio, :hi)e shareho)ers :i)) ha8e to share the resi(e

o)y :he the co*+ay is :o( (+. This )eas oe to coc)(e that et is a chea+er

so(rce of f(s tha e


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1isc(ssio of fiacia) )e8era3e has a o8io(s o-ecti8e of fii3 a o+ti*(* ca+ita)

str(ct(re )eai3 to *ai*iFatio of 8a)(e of fir*. If cost of ca+ita) is hi3h

I*+ortat theories or a++roaches to fiacia) )e8era3e or ca+ita) str(ct(re or fiaci3 *i

are as fo))o:s6

N, I', A&'@8 This a++roach :as s(33este y 1(ra a he :as i the fa8o(r of

fiacia) )e8era3e ecisio. Accori3 to hi*, cha3e i fiacia) )e8era3e :o() )ea to

cha3e i cost of ca+ita). I short, if the ratio of et i the ca+ita) str(ct(re icreases, the

:ei3hte a8era3e cost of ca+ita) ecreases a hece the 8a)(e of the fir*.

N, O,&/ I', A&'@8 This a++roach is a)so +ro8ie y 1(ra (t it is tota))y

o++osite to the Net Ico*e A++roach. It says that the :ei3hte a8era3e cost of ca+ita)

re*ais costat. It e)ie8es i the fact that the *ar9et aa)yses fir* as a :ho)e :hich

isco(ts at a +artic()ar rate :hich is ot re)ate to et&e


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are ot affecte y fiacia) (certaity. Moi3)iai a Mi))er *ae t:o fii3s (er

these coitios. Their first +ro+ositio :as that the 8a)(e of a co*+ay is ie+eet of

its ca+ita) str(ct(re. Their seco +ro+ositio state that the cost of e


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0ec9i3 Orer theory tries to ca+t(re the costs of asy**etric ifor*atio. It states that

co*+aies +rioritiFe their so(rces of fiaci3 !fro* itera) fiaci3 to e


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S&44&3 C'&'&, F/,

A acti8e area of research i fiace is that :hich tries to tras)ate the *oe)s ao8e as :e))

as others ito a str(ct(re theoretica) set(+ that is ti*e&cosistet a that has a ya*ic set

(+ si*i)ar to oe that ca e oser8e i the rea) :or). Maa3eria) cotracts, et cotracts,

e


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#. C'79 T E'94&,

1et +ay*ets are ta e(cti)e. As s(ch, if a co*+ays ta rate is hi3h, (si3 et as a *eas of

fiaci3 a +ro-ect is attracti8e eca(se the ta e(ctii)ity of the et +ay*ets +rotects so*e

ico*e fro* taes.

>. F//3 F3,/


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". S/=, O A F/&

There is a +ositi8e re)atio et:ee the ca+ita) str(ct(re a siFe of a fir*. The )ar3e fir*s are *ore

i8ersifie, ha8e easy access to the ca+ita) *ar9et, recei8e hi3her creit rati3s for et iss(es, a

+ay )o:er iterest rate o et ca+ita). 4(rther, )ar3er fir*s are )ess +roe to a9r(+tcy a this

i*+)ies the )ess +roai)ity of a9r(+tcy a )o:er a9r(+tcy costs. Therefore, )ar3er fir*s te to

(se *ore et ca+ita) tha s*a))er fir*s.

. G&'>@ I S3,9

Atici+ate 3ro:th rate i sa)es +ro8ies a *eas(re of etet to :hich eari3 +er share !E0S" of a

fir* are )i9e)y to e *a3ifie y )e8era3e. The fir* is )i9e)y to (se et fiaci3 :ith )i*ite fie

char3e o)y :he the ret(r o e


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e


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%. F//3 R/9 6 The fiacia) ris9 arise o acco(t of the (se of et or fie iterest

eari3 sec(rities i its ca+ita). A co*+ay :ith o et fiaci3 has o fiacia) ris9.

The etet of fiacia) ris9 e+es o the )e8era3e of the fir*Bs ca+ita) str(ct(re. A fir*

(si3 et i it ca+ita) has to +ay fie iterest char3es a the )ac9 of ai)ity to +ay

fie iterest icreases the ris9 of )i


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Sec(ritiFatio is the +rocess :herey re)ati8e)y i))i


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S,/ 4 @, SPV

The )e3a) stat(s of the S0V e+es o the -(risictio :here it is esta)ishe. I *ay

-(risictios it is a thi)y ca+ita)iFe cor+orate etity !that is, a co*+ay that has a 8ery )o:

e


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is, ifferet c)asses of sec(rities :ith ifferet +ay*et +riorities a characteristics, s(ch as

ifferet creit rati3s or iterest rates.

The sec(rities *ay e +ri8ate)y or +()ic)y iss(e, e+ei3 o the ii8i(a) circ(*staces

of a trasactio. Ho:e8er, if +()ic)y )iste, 8ario(s )isti3 re


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are or3aiFe to (y rate sec(rities that are f(e thro(3h the str(ct(re of the +ro3ra*,

rather tha y the (er)yi3 assets. That is, the co(it *(st e str(ct(re so as to es(re a

steay if)o: of e: assets or o)i3atios. The assets !c(rret or f(t(re recei8a)es" are

trasferre fro* a ori3iati3 !s+osor" a)ace sheet to the a)ace sheet of a S0V

%. I;,9'&9

Ty+ica))y, fiacia) istit(tios, is(race co*+aies, +esio f(s, he3e f(s,

co*+aies, hi3h et :orth ii8i(a)s. I8estors +(rchase the sec(rities iss(e y the S0V

accori3 to their ris9ret(r +refereces. Trachi3 offers i8estors the o++ort(ity to

i8ersify their i8est*et +ortfo)io y +(rchasi3 sec(rities :ith ifferet seiority a yie).

Mar9et )i


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a rate sec(rity, the ecisio to i8est t(rs ito cosieratio of *ar9et or iterest rate ris9,

a aa)ysis of (ratio a co8eity of the (er)yi3 istr(*et.

There are three *ai creit rati3 a3ecies6 !i" Staar 0oorBs !ii" MooyBs I8estor

Ser8ices a !iii" 4itch Rati3s.

". E@,, P&';/:,&9

I8estors (s(a))y e*a 8ery hi3h i8est*et 3raes for asset&ac9e sec(rities !AS". The

assets the*se)8es o ot ear these 3raes :itho(t ehace*ets that re(ce ris9s of creit,

)i


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trasfer of c(sto*er ifor*atio acco*+ayi3 the trasfer of recei8a)es.

34


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ADVANTAGES AND DISADVANTAGES OF CAPITAL

STRUCTURE DECISION8

o*+aies ofte (se et :he costr(cti3 their ca+ita) str(ct(re, :hich he)+s )o:er tota)

fiaci3 cost. I aitio to the re)ati8e)y )o:er cost of et fiaci3, (si3 et has other

a8ata3es co*+are to e


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+ay*ets. ?i8e the sa*e a*o(t of e


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certai +erio of ti*e )i9e et. Oce the )oa is +ai off, the creitor has o ri3ht to yo(r

eari3s. 1et fiaci3 is a)so easier to e3otiate a ha)e a*iistrati8e)y tha e


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D/9:;,9 ' D,


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C/3 S&44&, ' I,&, C'/,98 C9, S4:7

ABSTRACT

We aa)yFe the fiaci3 ecisios a ca+ita) str(ct(re of iteret co*+aies a re)ateoser8e fii3s to the co**o ca+ita) str(ct(re theories. Lar3e iteret co*+aies (s(a))y

ha8e )o: et a s*a)) iteret co*+aies ha8e hi3h et. We fi that the trae&off theory

of ca+ita) str(ct(re, +ec9i3 orer theory, *ar9et ti*i3 theory a other theories caot

ii8i(a))y e+)ai a fir*Bs ca+ita) str(ct(re. Ho:e8er, they ca co*+)i*et each other i

escrii3 so*e +atters of oser8e eha8ior. We a)so s(33est a (*er of

reco**eatios for ca+ita) str(ct(re theory a +ractice.

I&':4/'

The *oer theory of ca+ita) str(ct(re e3a :ith the fa*o(s +ro+ositio of Moi3)iai a

Mi))er !%=5" that escrie the coitios of ca+ita) str(ct(re irre)e8ace. Sice the, *ay

theories of ca+ita) str(ct(re ha8e ee e8e)o+e ic)(i3 trae off theory, +ec9i3 orer

theory, a3ecy cost theory, )ife cyc)e theory a f)eii)ity theory. After so *ay io8atios,

ca+ita) str(ct(re re*ais oe of the *ost cotro8ersia) a eata)e iss(e i cor+orate

fiace.

The 9ey iss(es are as fo))o:s. 4irst, a i**ese 3a+ eists et:ee theories a +ractice.

?raha* a Har8ey !#$$%" fo( that )ess tha 5$ of theoretica) ieas fi so*e s(++ort

a*o3 *aa3ers. Seco, there are i3 iffereces i the researchersB o+iio. 4or ea*+)e,

hiri9o a Si3ha !#$$$", Leary a Roerts !#$%$" a 4ra9 a ?oya) !#$$>" c)ai*

that trae&off theory ri8es ca+ita) str(ct(re ecisios :hi)e Shya*&S(er a Myers !%==="

a Le**o a Deer !#$$" c)ai* that +ec9i3&orer theory ri8es ca+ita) str(ct(re.

Thir, there is ifferece a*o3 o+iios ao(t the irectio that f(t(re :or9 o ca+ita)

str(ct(re sho() ta9e. 4or istace, Harris a Ra8i8 !%==%" ar3(e that asy**etric

ifor*atio theories of ca+ita) str(ct(re are ot +ro*isi3. Ho:e8er, the strea* of research

re)ate to asy**etric ifor*atio has ot sto++e sice the. 4(rther*ore, the fiacia)

crisis (ri3 #$$ a #$$= sho:e that cor+orate *aa3ers a++eare to )ac9 a

(erstai3 of the ro)e of asy**etric ifor*atio. The *ar9et for *ort3a3e&ac9e

sec(rities, :hich *ay e)ie8e :as at the core of fiacia) crisis, i8o)8e asy**etric

ifor*atio et:ee i8estors a iss(ers. Vario(s scaa)s, s(ch as the oe i8o)8i3 erie

Maoff, i))(strate the e+th of asy**etric ifor*atio +ro)e*s et:ee fir*sB isiers a

i8estors.

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The +reset +a+er atte*+ts to aa)yFe iss(es escrie ao8e. We )oo9 at c(rret +ractices of

iteret co*+aies a co*+are the* to eisti3 theories. We aa)yFe the c(rret +ractice of

7% co*+aies ic)(i3 #= )ar3e co*+aies a @# s*a)) co*+aies. The siFe of the

co*+aies is fro* @$ *i))io to ##>.@ i))io. With the he)+ of s+reasheet aa)ysis :e first

fi a o+ti*a) ca+ita) str(ct(re for a 3i8e co*+ay. S+reasheet aa)ysis is *ost)y ase

o the trae&off et:ee ta a8ata3es of et a icreasi3 ris9 fro* et fiaci3. This

aa)ysis i*+)ies that )ar3e co*+aies i the Iteret i(stry are (er)e8era3e. 4or

ea*+)e, for ?oo3)e Ic., the o+ti*a) et ratio is %'.# a the c(rret et ratio is -(st

.. We a)so fi that *ost s*a)) co*+aies i the Iteret i(stry are o8er)e8era3e. 4or

ea*+)e, the o+ti*a) et ratio for Eiets.o* Ic is $, (t the c(rret et ratio is as hi3h

as 5=.5@.

We the escrie other factors that ha8e ot ee ta9e ito cosieratio i the s+reasheet

aa)ysis, :hich affect *aa3ersB ecisios o co*+ayBs ca+ita) str(ct(re. We fi that o

si3)e theory of ca+ita) str(ct(re ca e+)ai the oser8e +atters of ca+ita) str(ct(re i

iteret i(stry. The trae&off theory of ca+ita) str(ct(re is (a)e to acc(rate)y e+)ai :hy

o)y a s*a)) fractio of fir*s that are icreasi3)y +rofita)e (ti)iFe et as a so(rce of

fiaci3. S+reasheet aa)ysis sho:s that fir*Bs c(rret ca+ita) str(ct(res are istat fro*

their o+ti*a). A)so :e fi that the +ec9i3 orer theoryBs +rioritiFatio of so(rces of

fiaci3 is o)y *aitaie i certai sit(atios. 4or ea*+)e, :e see that yo(3er fir*s a

fir*s :ho (er3o hi3h&3ro:th +erios :ith et )osses o ot (ti)iFe et efore e


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Iteret co*+aies see* to +(t a es+ecia) e*+hasis o f)eii)ity :he *aa3i3 their

ca+ita) str(ct(res 3i8e the io8ati8e at(re of their i(stry.

There is a /ho*e ias2 i ca+ita) str(ct(re for *ost co*+aies i o(r sa*+)e.

Iteret co*+aies ca (se iteratioa) fiaci3 *ore efficiet)y. So*e reasos for that

ic)(e the a8ai)ai)ity of )o:er iterest rates, f)ei)e re3()atio for ya*ic co*+aies, o

ca+ita)iFatio restrictios, re(ci3 iterest rate ris9 y (si3 f)ei)e iterest rates i *ar9ets

:hich ha8e )o: corre)atio et:ee each other, (si3 *oer fiaci3 arra3e*ets )i9e

iteratioa) +ro-ect fiaci3 or o&reco(rse et to *iti3ate a3ecy +ro)e*s.

S*a)) iteret co*+aies sho() ha8e )ess et. Usi3 a )ot of et y s*a)) co*+aies is

icosistet :ith a)*ost ay eisti3 theory of ca+ita) str(ct(re.

reit rati3 cocers are (e+)ore area of ca+ita) str(ct(re theory. The ca+ita) str(ct(re

*aa3e*et of )ar3e iteret co*+aies is stro3)y cosistet :ith the 8ie: that *aa3ers

are ee+)y cocere ao(t rati3s.

With re3ar to eisti3 theories o(r aa)ysis re8ea)e that ay si3)e theory has *a-or

+ro)e*s i e+)aii3 ca+ita) str(ct(re *aa3e*et of iteret co*+aies. It s(33ests that a

(ifie a++roach sho() e e8e)o+e i ear f(t(re. A)so :e isa3ree :ith Harris a Ra8i8

!%==%" that asy**etric ifor*atio theories are )ess +ro*isi3.

We fi that asy**etric ifor*atio is i*+ortat i e+)aii3 *ay +atters of ca+ita)

str(ct(re eha8ior of iteret co*+aies (t *aa3ers o ot ha8e a +ractica) too) to (se it

*ore efficiet)y. At the sa*e ti*e 3i8e that the 3a+ et:ee theory a +ractice is 8ery

)ar3e, :e a3ree :ith Harris a Ra8i8 !%==%" i that the oor is sti)) :ie)y o+e for e:

theory of ca+ita) str(ct(re :hich ca e he)+f() to *a9e a ri3e et:ee theory a +ractice

of ca+ita) str(ct(re.

The rest of this +a+er is or3aiFe as fo))o:s. Sectio # escries iteret i(stry. Sectio >

+resets a re8ie: of ca+ita) str(ct(re theories. Sectio @ escries i etai)s the aa)ytica)

*etho (se i the +a+er a the s+reasheet (se to aa)yFe fir*Bs ca+ita) str(ct(re. Sectio

5 +ro8ies etai)e ea*+)es of so*e fir*s ca+ita) str(ct(re aa)ysis. Sectio ' +resets the

res()ts of fir*Bs ca+ita) str(ct(re aa)ysis a the coc)(sio is ra: i Sectio 7.

T@, /,&, /:49&7The iteret starte o(t as a A*erica *i)itary +ro-ect i the %=5$&'$s a has e8o)8e ito

a *oer *aistrea* +heo*eo. It is (se y co**o (siesses for *ar9eti3 a sa)es,

for searchi3 a shari3 of fi)es !ic)(i3 oc(*ets, a(io a 8ieo fi)es" y (siesses

a ho(seho)s, a it is e8e (se to faci)itate o)ie co**(ities :ith for(*s a/)o33i32 :ith +o+()ar :esites s(ch as 4aceoo9, T:itter a ;o(t(e. The Iteret has

41


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re8o)(tioiFe the co*+(ter a co**(icatios :or) )i9e othi3 efore. The Iteret is at

oce a :or)&:ie roacasti3 ca+ai)ity, a *echais* for ifor*atio isse*iatio, a a

*ei(* for co))aoratio a iteractio et:ee ii8i(a)s a their co*+(ters :itho(t

re3ar for 3eo3ra+hic )ocatio. The Iteret re+resets oe of the *ost s(ccessf() ea*+)es

of the eefits of s(staie i8est*et a co**it*et to research a e8e)o+*et of

ifor*atio ifrastr(ct(re. e3ii3 :ith the ear)y research i +ac9et s:itchi3, the

3o8er*et, i(stry a acae*ia ha8e ee +arters i e8o)8i3 a e+)oyi3 this

eciti3 e: techo)o3y.

I the techo)o3y i(stry, oe 9i of the co*+aies is +retty fa*o(s :hich is ca))e

ifor*atio +ro8ier co*+aies. It *ay so( (fa*i)iar for *ost +eo+)e. Ho:e8er, *ost

+eo+)e are fa*i)iar :ith Iteret search e3ie co*+aies )i9e :or):ie ?oo3)e, ;ahoo,

ai( a so o. May +eo+)e +roa)y e+e o these iteret search e3ie co*+aies

:he they (se iteret to search. These iteret search e3ie co*+aies are a)so ca))e

ifor*atio +ro8ier co*+aies :hich +ro8ie ifferet ifor*atio to 8ario(s c(sto*ers.

4or istace, the fa*o(s search e3ie co*+ay ?oo3)e ca +ro8ie a too) to he)+ c(sto*ers

to ac$.@. O the cotrary, so*e s*a)) co*+aies )i9e, VRQ Wor):ie, Ic, Ar*aa

1ata or+, A)+hiat Ic. ha8e re)ati8e)y s*a)) *ar9et ca+ of P%.$ M, P%.M a P%.=M. 0E

is a)so 8ery ifferet a*o3 ifferet co*+aies. 4or istace, 4aceoo9 that he) its iitia)

+()ic offeri3 !I0O" o May %, #$%#, has a 0E of %$5.>>. ?oo3)e has its 0E ratio of

#5.'#. Most of the i3 co*+aies ha8e hi3h et +rofit *ar3i. 4or istace, ?oo3)e has the

et +rofit *ar3i of #$, a ;ahoo has the si*i)ar et +rofit *ar3i of #$.#>.

o*+are to ?oo3)e a ;ahoo, ai( has the hi3hest et +rofit *ar3i of @@.%#.

S*a)) co*+aies ha8e the 8ario(s et +rofit *ar3i so*e co*+aies ha8e re)ati8e)y hi3h et

+rofit *ar3i. Atrisic, Ic. has a *ar9et ca+ of P$.%>M a has a et +rofit *ar3i of

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>'.7. eMeia Net:or9s a)so has a re)ati8e)y s*a)) *ar9et ca+ of P$.@M. Ho:e8er, it has a

'.7.

C/3 9&44&, @,'&/,9

This sectio escries ca+ita) str(ct(re theories. We a)so isc(ss so*e cha))e3es face y

each theory that +ro8ies a asic for f(rther isc(ssios ao(t eisti3 +ractices i ca+ita)

str(ct(re theory a *aa3e*et.

T&:,-' @,'&7

I cotrast to i8ies, iterest +ai o et re(ces the fir*Bs taa)e ico*e. 1et a)so

icreases the +roai)ity of a9r(+tcy. Trae&off theory s(33ests that ca+ita) str(ct(re

ref)ects a trae&off et:ee the ta eefits of et a the e+ecte costs of a9r(+tcy

!Kra(s a LitFeer3er, %=7>". Mi3)o !#$%$" s(33ests a *oe) :here o+ti*a) et )e8e) is

3i8e y the fo))o:i36

1TR

TK !%"

Here R stas for *ai*a) eari3s, T is cor+orate ta rate a k *eas(res a9r(+tcy costs.

If k is hi3her i !%", the e


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A)tho(3h trae&off theory +reicts that the *ar3ia) ta eefit of et sho() e e ?oro a Lee, #$$7" eca(se ta rates o the ret(r fro* e


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i8est*et, (t the ret(rs fro* the i8est*et *ay e ca+t(re *ai)y y the et ho)ers

!/et o8erha32".

O the other ha, so*e a3ecy theories fa8or hi3her et. 4or ea*+)e, Cese !%='"

ar3(es that et i*+ro8es the isci+)ie of a etreche *aa3er !so ca))e /et a

isci+)ie2 theory".

F3,/


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M,@': ' &,9,&@.

The choice of case st(y a++roach is *oti8ate y the fo))o:i3. 4irst, there are a (*er of

researchers ca))i3 for *ore case st(ies i ca+ita) str(ct(re *aa3e*et !?raha* a

Har8ey, #$$%". Seco, case st(y is a effecti8e :ay of research i areas :hich ic)(e

se8era) )ayers of aa)ysis a ifferet a++roaches a theories. Sectio > s(33ests that

ca+ita) str(ct(re *aa3e*et re+resets s(ch a area. There is a )ot of co*+eti3 theories of

ca+ita) str(ct(re. 4(rther*ore oe of o(r *ai o-ecti8es is to fi fir*sB o+ti*a) ca+ita)

str(ct(re +o)icies !as o++osite to eisti3 +o)icies". So*e of the theories are etter

for*a)iFe a *a9e it *ore si*+)e for *aa3ers to (se i rea) )ife sit(atios !s(ch as trae&

off theory" :hi)e others are far fro* that !s(ch as asy**etric ifor*atio". The case st(y is

si*+)y the est research strate3y eca(se the +ro)e* (er st(y is to reach (erstai3

i a co*+)e cotet !Si3)eto, Straits, a Straits !%==>", Mertes !%=="". a*+e))

!%==" a8ocates a case st(y esi3 for i8esti3ati3 rea)&)ife e8ets, ic)(i3

or3aiFatioa) a *aa3eria) +rocesses. Thir, a8ai)a)e sa*+)e for ca+ita) str(ct(re

*aa3e*et aa)ysis of )ar3e co*+aies is s*a)) so o(r sa*+)e co8ers a 3oo fractio of

fir*s.

We aa)yFe co*+aiesB ca+ita) str(ct(re (si3 the fo))o:i3


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(estios %, # a @ ea) :ith fiacia) ca)c()atios. y oi3 so, :e ca fi o(t the

co*+ayBs 1etE


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serio(s if it fai)s (e to a )ar3e a*o(t of et. The +ri*ary reaso is the co*+ayBs )ar3e

+ro+ortio of ite))ect(a) +ro+erty :hich caot e


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>. (rret sit(atio

@. a+ita) str(ct(re a cost of ca+ita) ca)c()atio

5. Mai res()ts.

We fi *ost ata ao(t the co*+ay !eari3s, e+eit(res, e+reciatio etc." fro* yahoo

fiace a e(*ar9etisi3ht :esite !e(catioa) 8ersio of Staar a 0oors ata ase"

for :hich :e ha +ass:ors +ro8ie to3ether :ith tetoo9s !(s(a))y it :as /0rici+)es of

cor+orate fiace2 y rea)ey a Myers". 1efa()t s+reas, ris9 +re*i(*s a other

ifor*atio for +oit # co() e fo( o oso)ie :esite or o 4eera) Reser8e

:esite. 0oits >&5 re+reset ca)c()atios.

We ca)c()ate 1!1E" ratio, eta of the fir*, cost of e

(rret a+ita)

Str(ct(re

O+ti*a) a+ita)

Str(ct(re

ha3e

1!1E" Ratio @.$# %$.$% 5.==

eta for the Stoc9 %.$> %.$7 $.$@ost of E


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ac9 i %==5 :ith ha8i3 a 3ara3e office a ee (+ ao(ci3 Iitia) 0()ic Offeri3 of

%=,'$5,$5# shares of )ass A co**o stoc9 that too9 +)ace o Wa)) Street o A(3(st %,

#$$@ :hich :as hi3h)y a:aite ecisio for +()ic a as a res()t, the co*+ayBs )i%, #$$@, ?oo3)e ha P#,%>#.> *i))io of cash, cash e>@.7 *i))io a P%@'.> *i))io at the year&es of

#$$> a #$$# res+ecti8e)y. Sice this ti*e ?oo3)e has *ai)y he) o to these aitioa)

cash f)o:s ho)i3 o8er P>.5 i))io i cash a cash e


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O oe ha, the a3ecy cost theory fa8o(rs )o: et i*+)yi3 )o: a9r(+tcy cost a hi3h

)e8e) of cofiece for i8estors. This is cosistet :ith ?oo3)eBs +o)icies. O the other ha,

the a3ecy cost theory states hi3her et is 3oo for a co*+ay eca(se it ca sti*()ate

*aa3er to +erfor* etter. This +art is ot cosistet :ith ?oo3)e case. I ?oo3)eBs case, the

cof)ict et:ee shareho)ers a *aa3ers has )o: i*+ortace as the co*+ay is 8ery

+rofita)e. I the )o3 ter* the thi3s *ay cha3e. A i*+ortat iicator of +otetia)

cof)ict et:ee shareho)ers a *aa3ers is the fractio of shares o:e y *aa3ers. I

?oo3)e case it is @ !see Ta)e #" that is *(ch s*a))er tha for ea*+)e i Microsoft case. At

the sa*e the tota) (*er of shareho)ers is


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fiaci3 eca*e etter sice #$$@. I #$$@ ?oo3)e has %7$, '$% shares 8a)(e at P>@M a

i #$$5, ?oo3)e ac$.5M of cash. ?oo3)e coti(e :ith the ac.

Accori3 to )ife cyc)e theory for 3ro:i3 a *at(re fir*s it is *ore )i9e)y to ha8e hi3her

)e8era3e ratio :hich :o() res()t i )o: f)eii)ity. It is o++osite i ?oo3)eBs case as it oes

ot (se a )ot of et. The 1ete.

The si3a))i3 theory states that fro* the i8estorsB +ers+ecti8e, the *ar9et reactio o

iss(ace of et is e(tra) a of e$=%>%5>7%7&7#=&:he&

3oo3)e&:et&+()ic

Y@'' I.

Ta)e >. Res()ts fro* ;ahoo Aa)ysis #$%>

1!1E"

Ratio

eta for

the

Stoc9

ost of

E@,'#'

;ahoo first a++eare o)ie i %==@ :hi)e the co*+ayBs fo(ers, 1a8i 4i)o a Cerry

;a3, :ere sti)) st(ets at (i8ersity. The o*+ay :as )ater icor+orate i March %==5

a co*+)ete its iitia) +()ic offeri3 o A+ri) %# %=='. ;ahoo is the seco )ar3est fir* i

the iteret ifor*atio +ro8iers i(stry a is the *ai ri8a) of the i(stry )eaer

?oo3)e. ;ahoo c(rret)y is a hi3h)y +rofita)e a esta)ishe co*+ay.

The i3 iteret co*+aies )i9e ;ahoo starte )ife coser8ati8e)y, +referri3 to a8oi et

a (se the eor*o(s a*o(t of free cash f)o: that their (siesses thro: off e8ery year to

3ro: their (siesses.

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%. Is ;ahooBs c(rret ete


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*eeti3s. ;ahoo a)so a))o:s i8estors the ai)ity to si3 (+ to ha8e a)) SE fi)i3s, s(ch as

the %$&K, a(a) re+orts a 0roy state*ets +rite a *ai)e to their ho(seho) so they

ha8e harco+ies of the ifor*atio.

Ho:e8er, factors )i9e ita3i)e assets, f)eii)ity, a +ec9i3&orer theory ca he)+ to

e+)ai ;ahooBs +o)icy. Sice a 3oo +ortio of ;ahoo[ Ic.Bs assets are ita3i)e it has a

hi3her ris9 a hi3her a9r(+tcy costs. The co*+ay sho() ot ha8e as *(ch et as other

co*+aies :ith *ore ta3i)e assets. This co() e oe reaso that e+)ais ;ahoo[ Ic.Bs

)o:er tha o+ti*a) ete


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Ho: :e)) ca this fir* forecast its f(t(re i8est*et o++ort(ities a eesG Ho: *(ch

oes it 8a)(e f)eii)ityG

The fir* 8a)(es f)eii)ity 8ery *(ch. As recet)y as the e of the thir ,

;ahoo 3eerate free cash f)o: of P#@= *i))io a ret(re a aitioa) P%.7 i))io to

shareho)ers thro(3h (yac9s. Their a)ace sheet ha P>.# i))io i cash a sec(rities,

:hich *ae the* :e)) +ositioe :ith a*+)e )i


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years. We thi9 that oe of the reasos :hy *aa3ers o ot (se et ta shie) is that they

thi9 that the ca+ita) cost of (si3 itera) f(s is )o:er tha iss(e et. ase o this 8ie:,

*aa3ers :i)) o8er(se the itera) f(s. 4or those co*+aies, o(r reco**eatio :i)) e

iss(e *ore et to icrease the co*+aiesB +rofitai)ity. There are a)so so*e at(ra) reasos

for ot (si3 et. These *ay ic)(e a3ecy cost of et a )oss of f)eii)ity. Ho:e8er,

*ay co*+aies are (er)e8era3e e8e ta9i3 other factors ito cosieratio.

#. Most s*a)) co*+aies i the Iteret i(stry are o8er)e8era3e. So they sho() ha8e )ess

et. 4or so*e s*a)) co*+aies, the cost of iss(i3 e: e


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aa)ysis" (s(a))y iffers fro* the act(a) fiaci3 *i :e oser8e i the i(stry. The

+ec9i3 orer theory ca e+)ai :hy s*a)) fir*s :ith o )ar3e cash reser8es +refer et to

e


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e8iro*ets eco*e *ore co*+etiti8e, those :ho *a9e the ti*e to reach a++ro+riate

ecisios :i)) e the oes )eft stai3.

7. We fee) that the Traitioa) Theories ha8e a )ot of roo* for i*+ro8e*et. The +ec9i3

orer theory caot e+)ai :hy *ay fir*s i iteret i(stry o ot +refer et o8er

e


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acc(rate)y (t ca co*+)i*et each other to he)+ e+)ai oser8e eha8ior. We a)so s(33est

a (*er of reco**eatios for ca+ita) str(ct(re theory a +ractice.

CONCLUSION

The fir*s are *ore +referre the etera) et fiaci3 o8er the itera) et. Traeoff

theory (r3es that itera) fiace are )ess a8ai)a)e (e to )o: )i


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asis of Ifor*atio Asy**etry theory. ?ro:th ha8i3 e3ati8e re)atio :ith the et&e>7='.+f

htt+s6fac()ty.f(=

:::.efiace*aa3e*et.co*.../3&9&44&,&theory&*oi3)iai&a...

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