Capital Structure

Tradeoff theory and pecking order theory show a negative correlation between leverage and business risk. However, the literature supports [Bennet and Donelly (1993), Huang and Song (2003), Booth et al. (2001) and Deemosak et al. (2004)] The results shown show that there is a strong and significant positive correlation between them for all leverage indices. From this relationship it can be proved that venture companies tend to use more debt as they can not transfer the bondholder's assets to shareholders (Bennet and Donelly, 1993). , 2003)).

Traditional capital structure theory based on observation and intuition suggests that there is an optimal capital structure (Cornelius, 2002). In other words, the company's capital structure affects capital cost. The more liability of the company's capital structure, the lower the WACC debt. According to UoS (2007), in all equity finance, debt finance was cheap, WACC ranked first. At higher debt levels (X and above), the increase in equity expenses is a trade-off between risk reduction and debt repayment. Therefore, after X, WACC will rise. X will be the optimal debt ratio, the company will minimize capital cost and maximize corporate value. In other words, the gearing ratio is very important as it affects the company's WACC, company value, and shareholder wealth.

The capital structure can be a mixture of the company's long-term borrowings, short-term borrowings, common stock and preferred stock. When analyzing the capital structure, our short-term and long-term debt ratios are taken into account. When analysts refer to capital structure, analysts may refer to company D / E ratios that provide insight into the company's risk profile. Companies that raise large amounts of money through debt often have a more aggressive capital structure and therefore pose a greater risk to investors. However, this risk may be the main cause of the company's growth.

The company's capital structure is the composition or "structure" of the liabilities. For example, companies with $ 20 billion capital and $ 80 billion debt are said to be 20% equity finance and 80% debt finance. In this example, the ratio of corporate bonds to the total amount of funds raised (80%) is called company leverage. Indeed, the capital structure can be quite complicated, including dozens of sources of funding. The Modigliani-Miller theorem proposed by Franco Modigliani and Merton Miller in 1958 is often considered purely theoretical as it ignores many important elements in the process of capital structure such as fluctuations, but the company's Uncertainty that may occur during the funding process. According to the theorem, in the perfect market, the company's financing method is irrelevant to its value.