There is no such thing as a perfect capital structure

Résumé du document

The relevance of a company capital structure has been the subject of several theories and debate. The capital structure of a company is a mix of different securities. Capital structure refers to the way a corporation finances itself through a combination of equity sales, equity option, bonds and loans. So it is essentially a debate over the proportion of debt and equity financing the company. However capital structure is not just a question about debt and equity. There are multiple compositions of debt or equity and convertible bonds. The aim of every company is run a profitable business. An optimal capital structure refers to the particular combination which minimizes the cost of capital, and maximizing the stock price. It's an important financial decision undertaken by the managers of the company. It's necessary to assess the effect of the capital structure choice on the investor's behaviour. The proportion of debt and equity has an implication for stockholder value.

Extraits

[...] It's not possible to have a perfect financing mix. This mix depends on many assumptions like a perfect market, or the company's activities. Capital structure could be different in each company, because each company has specific characteristics. Capital structures may differ dependent upon investment opportunities. As shown by Schwartz and Aronson, capital structures may vary across markets due to risk exposure The traditional approach argues that a firm can lower its cost of capital and raise its total value through leverage. [...]

[...] Furthermore, debt has a lower cost of the capital than equity. But debt providers can force insolvency. Moreover a high level of debt could be recognizing like an important confidence of the company. So it could attract a lot of investors. Nevertheless debt could be link to a distress position of the company. There are some disadvantages to use debt. Debt can paralyze future investment of the company. When a company has a lot of loans, it's more difficult to give some guarantees for the other investment. [...]

[...] Capital structure is one of the several financial policies of a company. Every company would like to obtain a perfect capital structure. But is there a perfect capital structure? On the one and, it's relevant to recognize and to assess a capital structure through some determinants and some measurement methods. On the other hand, it's necessary to know how to choice a relevant financing mix thanks to the traditional view, and Miller and Modigliani theories. I - How recognize and assess a capital structure? [...]

[...] In theory, WACC is unaffected by capital structure changes. In practice it's different. Some elements could affect the WACC like the taxation, the cost of debt, the cost associated with financial distress. At a high level of gearing, WACC rise as the risk and the cost of financial distress becomes a relevant factor for capital providers. WACC shows which elements are affected when the level of gearing increases. It's affect credit rating, cost of debt, and leverage cost of equity capital. [...]

[...] Nevertheless these propositions assume a perfect market. And these assumptions are not possible in the real world. M&M added that under a perfect market firm value should increase linearly with the amount of debt in a capital structure (1963). This is because of the tax shield of debt. Reduction in profit reduces the tax payable. This suggests company value is maximised at 100% debt. Nevertheless this theory ignores bankruptcy costs and risk. In 1977, Miller did a revision on M&M theories. [...]