How Capital Structure Affects UK Cost of Capital

How Capital Structure Affects UK Cost of Capital Abstract Firms require a reasonable capital structure to meet the required target. To raise the finance, firms normally choose to review some different factors that are taken into account in considering. In this study, the author will examine the correlation between capital structure and the cost of the capital. As the cost will be a main factor for the firms to raise the finance. And different of capital structure will cause variable cost. This report will review the literature in capital structure and cost of finance. Along with the availability of source of finance, including the matching principle, a famous tools trade-off theory. As well as the argument follows, pecking order theory and agency cost theory. Drawing a conclusion based on the research survey data collection. Justify the relationship in how capital structure affects capital cost. Introduction The term capital structure refers to the mix of different types of funds which a company uses to finance its activities. Capital structure varies greatly from one company to another. For example, some companies are financed mainly by shareholders funds whereas others make much greater use of borrowings. Since the seminal publication of Modigliani and Miller (1958), corporate finance researchers have devoted considerable effort to investigating capital structure decisions (e.g. Myers, 1977 and 1984). Significant progress has been made in understanding the determinants of corporate capital structure with an increased emphasis on financial contracting theory (for example, Barclay and Smith, 1995; Mehran et al., 1999; and Graham et al., 1998 and, for an international view, Rajan and Zingales, 1995). This theory suggests that firm characteristics such as risk and investment opportunity set affect contracting costs. In turn, these costs impact on the choice between alternative forms of finance such as debt and equity, and between different classes of fixed-claim finance such as debt and leasing. The author will examine the relationship between the cost of capital and the structure of capital, and the effect of cost to raise finance in terms of making financial decision in the firms. Literature review 2.1 Theory of capital The origins of capital structure theory lie in the models of optimal capital structure that were developed in the wake of the famous Modigliani-Miller irrelevance theorem. These models later became to be known as the static trade-off theory (see e.g. Modigliani and Miller, 1958, 1963; Baxter, 1967; Gordon, 1971; Kraus and Litzenberger, 1973; Scott, 1976; Kim, 1978; Vinso, 1979). In this theory, the combination of leverage related costs (associated with e.g. bankruptcy and agency relations) and a tax advantage of debt produces an optimal capital structure at less than a 100% debt financing, as the tax advantage is traded off against the likelihood of incurring the costs. This theoretical result is now widely accepted in the profession. However, in seeking to model the wide diversity of capital structure practice, a number of additional factors have been proposed in the literature. 2.2 Factors that affect capital structure First, the use of debt finance can reduce agency costs between managers and shareholders by increasing the managers share of equity (Jensen and Meekling, 1976) and by reducing the free cash available for managers personal benefits (Jensen, 1986). Second, Myers and Majluf (1984) argue that, under asymmetric information, equity may be mispriced by the market. If firms finance new projects by issuing more equity, under pricing may cause les profit for existing shareholders in terms of the project NPV. Myers (1984) refers to this as pecking order theory of capital structure. The underinvestment can be reduced by financing the mispriced equity by the market. Internal funds involve no undervaluation and even debt that is not too risky will be preferred to equity. If external finance was required, firms tended first to issue the safest security, debt, and only issued equity as a last resort. Under this model, there is no well-define target mix of debt and equity finance. Each firms observed debt ratio reflects its cumulative requirements for external finance. Generally, profitable firms will borrow less because they can rely on internal resources and retain earnings. The preference for internal equity implies that firms will use less debt than suggested by the trade-off theory. Other factors that have been invoked to help explain the diversity of capital structures include: management behaviour (Williamson, 1988), firm-stakeholder interaction (Grinblatt and Titman, 1998), and corporate control issues (Harris and Raviv, 1988 and 1991). 2.3 How to finance The conventional discussion on a firms choice between long-term and short-term debt has generally focused on three aspects: matching debt maturity with asset life; extending the term-to-maturity of loans to stretch the firms debt capacity; and concentrating long-term debt issues in periods of relatively low interest rates. Recent development in the financial research literature has advanced several economics concepts such as transaction and agency costs, tax-timing option, and information asymmetry, to the debt maturity choice paradigm. Brick and Ravid (1985) show that taxes can also imply an optimal debt maturity structure. Depending on the term-structure of interest rates, long-term (short-term) is optimal, since it accelerates the tax benefit of debt given an increasing (decreasing) term structure. When firms cannot reveal the true quality of their cash flows, i.e. when information asymmetry exists, they can prevent or abate undervaluation by using a variety of signalling devices, such as debt (leverage), dividend payments or the maturity structure of debt. Thus, information asymmetry gives firms an incentive to signal their quality and credibility by taking on more debt and shortening their debt maturity. A higher leverage, especially more short-term debt, signals favourable inside information to the market because it offers the possibility to renegotiate terms in the future, when more information has become available. Long-term debt entails higher information costs than short-term debt, because the market expects a stronger deterioration of quality than insiders do. Firms with a low level of information asymmetry are therefore more likely to issue long-term debt (Flannery, 1986). In the study of international capital structures, Rajan and Zingales (1995) argue that it is important to test the robustness of US finds in different environments. They identify as potentially important the cross-country differences in tax and bankruptcy codes, in the market for corporate control and in the historical role played by banks and security markets. Methodology This survey focuses primarily on the determinants of the capital structure policy of firms but also includes some questions on topics that are closely related to the capital structure. For example, the questions address their approximate cost of equity to the managers, how they estimate their cost of equity (with CAPM or other methods), and whether the impact on the weighted average cost of capital is a consideration in their capital structure choice. The survey was developed after a careful review of the capital structure literature pertaining to the U.S. and European countries. For ease of comparability, the author tried to keep the format and design the survey similar to that of Graham and Harvey (2001), but modified or simplified some questions that are likely to be relevant in the UK context. For example, literature suggests that there are strong differences in corporate objectives between American and UK financial systems since the former system focuses on maximizing shareholder wealth while the later emphasizes the welfare of all stakeholder including employees, creditors and even he government. To examine this difference, the author ask the CFOs about the extent to which different stakeholders influence their firms financial decisions, the author also ask the firms the percentage of their free float share and whether they have preference or common share. 3.1 Sampling The initial samples for mailing the survey consist of a total of 57 firms from UK. The choice of initial sample was based on selecting firms that are representative of the UK firms, are widely traded, are comparable across country, and are public limited with available information. These criteria are important to justify the firms specific difference. From this sample, 9 firms were deleted because of non-availability of addresses and another 17 firms were deleted because they declined to participate in the survey, leaving a final sample of 31 firms. The survey was anonymous as this was an important criterion to obtain honest responses. In the mailing a letter was included that was addressed to the CFO or CEO explaining the objective of the study and promising to send a copy of the findings to those who wished to receive. A total of 12 responses were received by mail, which represents a response rate about 38 percent. 3.3 Summary of findings The respondent firms represent a wide variety of industries with a larger concentration in manufacturing; mining; energy and transportation sector; high technology; and financial sectors. About three forth of firms have a target debt to equity ratios, and about half of these firms maintain a target debt to equity ratios of one. Further, many respondents have a large percentage of their total debt in short term. About 80 percent of respondents report that they calculate their cost of equity, and over 77% of them employ the Capital Asset Pricing Model (CAPM) to calculate this cost. The estimated cost of equity reported by respondents ranges between 9%-15% only few firms report cost of capital greater than 15% The correlations among the demography variables of this survey are largely as predicted in the literature. These correlations will be discussed in detail in the next section. Analysis Three sets of factors in managers opinion that are likely to influence capital structure of firms are selected based on a review of literature. The first set is based on the implications of different capital structure theories such as the trade-off theory, the pecking order theory, and the agency cost theory. Generally the managers will make the financial decisions based on theories and through these decisions to affect their cost of capital. The second set relates to the managers timing of debt or equity issues since literature suggests that managers are concerned about financial flexibility. With evidence support in the findings, most of managers within all industries consider the financial flexibility as the most important issue when raise finance. Finance by short term may give the company advantage in changing their status to meet the changing world environment and provide less risks in investments. Finally, the last set of factors is based on common beliefs among managers about the impact of capital structure changes on financial statements such as the potential impact of equity issue on earnings. This factor shows the important of experience in managers mind and how it will be impact on the decisions. In summary, to analyse a companys capital structure, we assume that the company is only financed by two ways, either by shareholders equity or borrowings. It is just to consider how cost of capital affect the different proportion of debt in capital structure. Figure 8: Two advantages and two disadvantages of borrowing Advantages Disadvantages 1. Cheap direct cost because debt is less risky to the investor 1. Financial leverage causes shareholders to increase their cost of capital 2. Cheap direct cost because interest is a tax deductible expense. 2. Bankruptcy risks if borrowings are too high. The main advantage of borrowing is that the debt has a cheaper direct cost than equity. Debt is less risky to the investor than equity (low risk result a low required return) Interest payments are tax deductable whereas dividends are not. However, borrowing has two distinct disadvantages. Firstly it causes shareholders to suffer increased volatility of earnings. This is known as financial leverage. The increased volatility to shareholders returns resulting from financial leverage causes shareholders to demand a higher rate of return in compensation. The second disadvantage of borrowing is that if the company borrows too much, it increases its bankruptcy risks. At reasonable levels of gearing this affect will be imperceptible, but it becomes significant for highly geared companies and results in a range of risks and costs which have the effect of increasing the companys cost of capital. Limitation and Ethical issue The research focus on the UK market and respondents are from different areas of industry. The limitation has been carried out. First will be the time of the research. As a three months research, the data was not examined as correct enough to support the authors point. The data collection should be carrying continually in a long period of time and often reviewed at some certain time. Second, the way of collecting these data is limited by mailing. The survey may not represent the whole market as the limited number of respondents. A research should conduct all the possible methods including quantitative and qualitative. Finally, as this is not a professional research, lots of objectives in the research declined to give feedback in judging their financial structure in the case some of this could be their classified information. The ethical issue has been raised in this research; this will be honesty in the feedbacks from the respondents. As this survey is anonymous research, the managers may not give the right information in case of rising threats in competition. The importance of financial structure in firms causes the mangers to think before they actually answer the questions. The privacy issue in their mind raised that they may not want to share all the information regarding to the financial statement. Conclusion The purpose of this article is to supplement the existing literature with an analysis of the factors determining the financial structure affecting the cost of capital. The analyses give rise to the following conclusions. The study presents a dynamic model to address the possibility of adjustment costs incurred in reaching an optimal capital structure. And examine the literature in the factors in capital structure in affecting the cost of financing a firm through the facts in reality. The conclusion can be drawn as the cost of capital is a key factor that firms taken into account when raise finance along with the financial flexibility. On the other hand, the capital structure of a firm will affect the firms cost in both short term and long term. The firms raise the finance to meet the required target, there is no such a way to limit firms financial structure. They may want to choose a short term loan to meet flexibility of cash flow, in the contrast; the long term finance may require more information and satisfaction of the firms. The cost of capital depends on how firms finance their capital structure. Reference and bibliography Barclay, M.J. and C.W. Smith (1995), The Priority Structure of Corporate Liabilities, Journal of Finance, Vol. 50, No. 3 (July) Baxter, N. D. (1967) Leverage, the Risk of Ruin and the Cost of Capital, Journal of Finance, 22 Brick, I. and Ravid, A. (1985) On the relevance of debt maturity structure, Journal of Finance, 40 Flannery, M. (1986) Asymmetric information and risky debt maturity choice, Journal of Finance, 41 Gordon, M. (1971) Towards a theory of financial distress, Journal of Finance, 26 Graham, J.R., M.L. Lemmon and J.S. Schallheim (1998), Debt, Leases, Taxes and The Endogeneity of Corporate Tax Status, Journal of Finance, Vol. 53, No. 1 (February) Graham, J.R. and C.R. Harvey (2001), The Theory and Practice of Corporate Finance: Evidence from the Field, Journal of Financial Economics, Vol. 60, Nos. 2/3 (May) Grinblatt, M. and S. Titman (1998), Financial Markets and Corporate Strategy (Irwin/McGraw- Hill, USA) Harris, M. and A. Raviv (1988), Corporate Control Contests and Capital Structure, Journal of Financial Economics, Vol. 20 Harris, M. and A. Raviv (1991), The Theory of Capital Structure, Journal of Finance, Vol. 46, No. 1 (March) Jensen, M.C. (1986), Agency Costs of Free Cash Flow, Corporate Finance and Takeovers, American Economic Review, Vol. 76, No. 2, Jensen, M.C. and W. Meckling (1976), Theory of the Firm: Managerial Behaviour, Agency Costs, and Capital Structure, Journal of Financial Economics, Vol. 3, No. 4 Kim, E. (1978) A mean-variance theory of optimal capital structure and corporate debt capacity, Journal of Finance, 23 Kraus, A. and Litzenberger, R. (1973) State preference model of optimal leverage, Journal of Finance, 28 Mehran, H., R.A. Taggart and D. Yermack (1999), CEO Ownership, Leasing and Debt Financing, Financial Management, Vol. 28, No. 2 Modigliani, F.F. and M.H. Miller (1958), The Cost of Capital, Corporation Finance, and the Theory of Investment, American Economic Review, Vol. 48, No. 3 (June) Myers, S.C. (1977), Determinants of Corporate Borrowing, Journal of Financial Economics, Vol. 5, No. 2 (November) Myers, S.C. (1984), The Capital Structure Puzzle, Journal of Finance, Vol. 39, No. 3 (July) Myers, S. and Majluf, N. (1984) Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics, 13, Rajan, R.G. and L. Zingales (1995), What Do We Know About Capital Structure Choice? Some Evidence from International Data, Journal of Finance, Vol. 50, No. 5 Scott, J. (1976) A theory of optimal capital structure, Bell Journal of Economics, 7 Vinso, J. (1979) A determination of the risk of ruin, Journal of Financial and Quantitative Analysis, 14 Williamson, O.E. (1988), Corporate Finance and Corporate Governance, Journal of Finance, Vol. 43, No. 3 (July) Advantage and disadvantage of borrowing, available on website www.accaglobal.com, access on 28.04.2010 How Capital Structure Affects UK Cost of Capital How Capital Structure Affects UK Cost of Capital Abstract Firms require a reasonable capital structure to meet the required target. To raise the finance, firms normally choose to review some different factors that are taken into account in considering. In this study, the author will examine the correlation between capital structure and the cost of the capital. As the cost will be a main factor for the firms to raise the finance. And different of capital structure will cause variable cost. This report will review the literature in capital structure and cost of finance. Along with the availability of source of finance, including the matching principle, a famous tools trade-off theory. As well as the argument follows, pecking order theory and agency cost theory. Drawing a conclusion based on the research survey data collection. Justify the relationship in how capital structure affects capital cost. Introduction The term capital structure refers to the mix of different types of funds which a company uses to finance its activities. Capital structure varies greatly from one company to another. For example, some companies are financed mainly by shareholders funds whereas others make much greater use of borrowings. Since the seminal publication of Modigliani and Miller (1958), corporate finance researchers have devoted considerable effort to investigating capital structure decisions (e.g. Myers, 1977 and 1984). Significant progress has been made in understanding the determinants of corporate capital structure with an increased emphasis on financial contracting theory (for example, Barclay and Smith, 1995; Mehran et al., 1999; and Graham et al., 1998 and, for an international view, Rajan and Zingales, 1995). This theory suggests that firm characteristics such as risk and investment opportunity set affect contracting costs. In turn, these costs impact on the choice between alternative forms of finance such as debt and equity, and between different classes of fixed-claim finance such as debt and leasing. The author will examine the relationship between the cost of capital and the structure of capital, and the effect of cost to raise finance in terms of making financial decision in the firms. Literature review 2.1 Theory of capital The origins of capital structure theory lie in the models of optimal capital structure that were developed in the wake of the famous Modigliani-Miller irrelevance theorem. These models later became to be known as the static trade-off theory (see e.g. Modigliani and Miller, 1958, 1963; Baxter, 1967; Gordon, 1971; Kraus and Litzenberger, 1973; Scott, 1976; Kim, 1978; Vinso, 1979). In this theory, the combination of leverage related costs (associated with e.g. bankruptcy and agency relations) and a tax advantage of debt produces an optimal capital structure at less than a 100% debt financing, as the tax advantage is traded off against the likelihood of incurring the costs. This theoretical result is now widely accepted in the profession. However, in seeking to model the wide diversity of capital structure practice, a number of additional factors have been proposed in the literature. 2.2 Factors that affect capital structure First, the use of debt finance can reduce agency costs between managers and shareholders by increasing the managers share of equity (Jensen and Meekling, 1976) and by reducing the free cash available for managers personal benefits (Jensen, 1986). Second, Myers and Majluf (1984) argue that, under asymmetric information, equity may be mispriced by the market. If firms finance new projects by issuing more equity, under pricing may cause les profit for existing shareholders in terms of the project NPV. Myers (1984) refers to this as pecking order theory of capital structure. The underinvestment can be reduced by financing the mispriced equity by the market. Internal funds involve no undervaluation and even debt that is not too risky will be preferred to equity. If external finance was required, firms tended first to issue the safest security, debt, and only issued equity as a last resort. Under this model, there is no well-define target mix of debt and equity finance. Each firms observed debt ratio reflects its cumulative requirements for external finance. Generally, profitable firms will borrow less because they can rely on internal resources and retain earnings. The preference for internal equity implies that firms will use less debt than suggested by the trade-off theory. Other factors that have been invoked to help explain the diversity of capital structures include: management behaviour (Williamson, 1988), firm-stakeholder interaction (Grinblatt and Titman, 1998), and corporate control issues (Harris and Raviv, 1988 and 1991). 2.3 How to finance The conventional discussion on a firms choice between long-term and short-term debt has generally focused on three aspects: matching debt maturity with asset life; extending the term-to-maturity of loans to stretch the firms debt capacity; and concentrating long-term debt issues in periods of relatively low interest rates. Recent development in the financial research literature has advanced several economics concepts such as transaction and agency costs, tax-timing option, and information asymmetry, to the debt maturity choice paradigm. Brick and Ravid (1985) show that taxes can also imply an optimal debt maturity structure. Depending on the term-structure of interest rates, long-term (short-term) is optimal, since it accelerates the tax benefit of debt given an increasing (decreasing) term structure. When firms cannot reveal the true quality of their cash flows, i.e. when information asymmetry exists, they can prevent or abate undervaluation by using a variety of signalling devices, such as debt (leverage), dividend payments or the maturity structure of debt. Thus, information asymmetry gives firms an incentive to signal their quality and credibility by taking on more debt and shortening their debt maturity. A higher leverage, especially more short-term debt, signals favourable inside information to the market because it offers the possibility to renegotiate terms in the future, when more information has become available. Long-term debt entails higher information costs than short-term debt, because the market expects a stronger deterioration of quality than insiders do. Firms with a low level of information asymmetry are therefore more likely to issue long-term debt (Flannery, 1986). In the study of international capital structures, Rajan and Zingales (1995) argue that it is important to test the robustness of US finds in different environments. They identify as potentially important the cross-country differences in tax and bankruptcy codes, in the market for corporate control and in the historical role played by banks and security markets. Methodology This survey focuses primarily on the determinants of the capital structure policy of firms but also includes some questions on topics that are closely related to the capital structure. For example, the questions address their approximate cost of equity to the managers, how they estimate their cost of equity (with CAPM or other methods), and whether the impact on the weighted average cost of capital is a consideration in their capital structure choice. The survey was developed after a careful review of the capital structure literature pertaining to the U.S. and European countries. For ease of comparability, the author tried to keep the format and design the survey similar to that of Graham and Harvey (2001), but modified or simplified some questions that are likely to be relevant in the UK context. For example, literature suggests that there are strong differences in corporate objectives between American and UK financial systems since the former system focuses on maximizing shareholder wealth while the later emphasizes the welfare of all stakeholder including employees, creditors and even he government. To examine this difference, the author ask the CFOs about the extent to which different stakeholders influence their firms financial decisions, the author also ask the firms the percentage of their free float share and whether they have preference or common share. 3.1 Sampling The initial samples for mailing the survey consist of a total of 57 firms from UK. The choice of initial sample was based on selecting firms that are representative of the UK firms, are widely traded, are comparable across country, and are public limited with available information. These criteria are important to justify the firms specific difference. From this sample, 9 firms were deleted because of non-availability of addresses and another 17 firms were deleted because they declined to participate in the survey, leaving a final sample of 31 firms. The survey was anonymous as this was an important criterion to obtain honest responses. In the mailing a letter was included that was addressed to the CFO or CEO explaining the objective of the study and promising to send a copy of the findings to those who wished to receive. A total of 12 responses were received by mail, which represents a response rate about 38 percent. 3.3 Summary of findings The respondent firms represent a wide variety of industries with a larger concentration in manufacturing; mining; energy and transportation sector; high technology; and financial sectors. About three forth of firms have a target debt to equity ratios, and about half of these firms maintain a target debt to equity ratios of one. Further, many respondents have a large percentage of their total debt in short term. About 80 percent of respondents report that they calculate their cost of equity, and over 77% of them employ the Capital Asset Pricing Model (CAPM) to calculate this cost. The estimated cost of equity reported by respondents ranges between 9%-15% only few firms report cost of capital greater than 15% The correlations among the demography variables of this survey are largely as predicted in the literature. These correlations will be discussed in detail in the next section. Analysis Three sets of factors in managers opinion that are likely to influence capital structure of firms are selected based on a review of literature. The first set is based on the implications of different capital structure theories such as the trade-off theory, the pecking order theory, and the agency cost theory. Generally the managers will make the financial decisions based on theories and through these decisions to affect their cost of capital. The second set relates to the managers timing of debt or equity issues since literature suggests that managers are concerned about financial flexibility. With evidence support in the findings, most of managers within all industries consider the financial flexibility as the most important issue when raise finance. Finance by short term may give the company advantage in changing their status to meet the changing world environment and provide less risks in investments. Finally, the last set of factors is based on common beliefs among managers about the impact of capital structure changes on financial statements such as the potential impact of equity issue on earnings. This factor shows the important of experience in managers mind and how it will be impact on the decisions. In summary, to analyse a companys capital structure, we assume that the company is only financed by two ways, either by shareholders equity or borrowings. It is just to consider how cost of capital affect the different proportion of debt in capital structure. Figure 8: Two advantages and two disadvantages of borrowing Advantages Disadvantages 1. Cheap direct cost because debt is less risky to the investor 1. Financial leverage causes shareholders to increase their cost of capital 2. Cheap direct cost because interest is a tax deductible expense. 2. Bankruptcy risks if borrowings are too high. The main advantage of borrowing is that the debt has a cheaper direct cost than equity. Debt is less risky to the investor than equity (low risk result a low required return) Interest payments are tax deductable whereas dividends are not. However, borrowing has two distinct disadvantages. Firstly it causes shareholders to suffer increased volatility of earnings. This is known as financial leverage. The increased volatility to shareholders returns resulting from financial leverage causes shareholders to demand a higher rate of return in compensation. The second disadvantage of borrowing is that if the company borrows too much, it increases its bankruptcy risks. At reasonable levels of gearing this affect will be imperceptible, but it becomes significant for highly geared companies and results in a range of risks and costs which have the effect of increasing the companys cost of capital. Limitation and Ethical issue The research focus on the UK market and respondents are from different areas of industry. The limitation has been carried out. First will be the time of the research. As a three months research, the data was not examined as correct enough to support the authors point. The data collection should be carrying continually in a long period of time and often reviewed at some certain time. Second, the way of collecting these data is limited by mailing. The survey may not represent the whole market as the limited number of respondents. A research should conduct all the possible methods including quantitative and qualitative. Finally, as this is not a professional research, lots of objectives in the research declined to give feedback in judging their financial structure in the case some of this could be their classified information. The ethical issue has been raised in this research; this will be honesty in the feedbacks from the respondents. As this survey is anonymous research, the managers may not give the right information in case of rising threats in competition. The importance of financial structure in firms causes the mangers to think before they actually answer the questions. The privacy issue in their mind raised that they may not want to share all the information regarding to the financial statement. Conclusion The purpose of this article is to supplement the existing literature with an analysis of the factors determining the financial structure affecting the cost of capital. The analyses give rise to the following conclusions. The study presents a dynamic model to address the possibility of adjustment costs incurred in reaching an optimal capital structure. And examine the literature in the factors in capital structure in affecting the cost of financing a firm through the facts in reality. The conclusion can be drawn as the cost of capital is a key factor that firms taken into account when raise finance along with the financial flexibility. On the other hand, the capital structure of a firm will affect the firms cost in both short term and long term. The firms raise the finance to meet the required target, there is no such a way to limit firms financial structure. They may want to choose a short term loan to meet flexibility of cash flow, in the contrast; the long term finance may require more information and satisfaction of the firms. The cost of capital depends on how firms finance their capital structure. Reference and bibliography Barclay, M.J. and C.W. Smith (1995), The Priority Structure of Corporate Liabilities, Journal of Finance, Vol. 50, No. 3 (July) Baxter, N. D. (1967) Leverage, the Risk of Ruin and the Cost of Capital, Journal of Finance, 22 Brick, I. and Ravid, A. (1985) On the relevance of debt maturity structure, Journal of Finance, 40 Flannery, M. (1986) Asymmetric information and risky debt maturity choice, Journal of Finance, 41 Gordon, M. (1971) Towards a theory of financial distress, Journal of Finance, 26 Graham, J.R., M.L. Lemmon and J.S. Schallheim (1998), Debt, Leases, Taxes and The Endogeneity of Corporate Tax Status, Journal of Finance, Vol. 53, No. 1 (February) Graham, J.R. and C.R. Harvey (2001), The Theory and Practice of Corporate Finance: Evidence from the Field, Journal of Financial Economics, Vol. 60, Nos. 2/3 (May) Grinblatt, M. and S. Titman (1998), Financial Markets and Corporate Strategy (Irwin/McGraw- Hill, USA) Harris, M. and A. Raviv (1988), Corporate Control Contests and Capital Structure, Journal of Financial Economics, Vol. 20 Harris, M. and A. Raviv (1991), The Theory of Capital Structure, Journal of Finance, Vol. 46, No. 1 (March) Jensen, M.C. (1986), Agency Costs of Free Cash Flow, Corporate Finance and Takeovers, American Economic Review, Vol. 76, No. 2, Jensen, M.C. and W. Meckling (1976), Theory of the Firm: Managerial Behaviour, Agency Costs, and Capital Structure, Journal of Financial Economics, Vol. 3, No. 4 Kim, E. (1978) A mean-variance theory of optimal capital structure and corporate debt capacity, Journal of Finance, 23 Kraus, A. and Litzenberger, R. (1973) State preference model of optimal leverage, Journal of Finance, 28 Mehran, H., R.A. Taggart and D. Yermack (1999), CEO Ownership, Leasing and Debt Financing, Financial Management, Vol. 28, No. 2 Modigliani, F.F. and M.H. Miller (1958), The Cost of Capital, Corporation Finance, and the Theory of Investment, American Economic Review, Vol. 48, No. 3 (June) Myers, S.C. (1977), Determinants of Corporate Borrowing, Journal of Financial Economics, Vol. 5, No. 2 (November) Myers, S.C. (1984), The Capital Structure Puzzle, Journal of Finance, Vol. 39, No. 3 (July) Myers, S. and Majluf, N. (1984) Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics, 13, Rajan, R.G. and L. Zingales (1995), What Do We Know About Capital Structure Choice? Some Evidence from International Data, Journal of Finance, Vol. 50, No. 5 Scott, J. (1976) A theory of optimal capital structure, Bell Journal of Economics, 7 Vinso, J. (1979) A determination of the risk of ruin, Journal of Financial and Quantitative Analysis, 14 Williamson, O.E. (1988), Corporate Finance and Corporate Governance, Journal of Finance, Vol. 43, No. 3 (July) Advantage and disadvantage of borrowing, available on website www.accaglobal.com, access on 28.04.2010

Leadership :: essays research papers

Webster's Dictionary defines leadership as the position or guidance of a person or thing that leads, directing, commanding, or guiding head, as of a group or activity. However Leadership has not one single definition, but many. Leadership is often an intangible factor that makes one group more effective than another. It exists at different levels within organizations and should be woven throughout the entire organization. Different organizations use different ways in effectively teaching or molding their employees how to be an effective leader. One such company is the R.E. Brown Company and Associates, who have developed a yearlong program that is strictly used as a program to teach their employees how to become a more effective leader. They use what they believe as the Nine Behaviors of leaders. This program doesn't directly start off with the introduction of the nine behaviors, but of little tasks given to the participants. They are broken into small groups where they interact with each other, summarize common threads, and then present their findings to the larger group. Then once this has taken place they develop specific action plans to take back to their groups and from there on they work coherently together as a team. This develops a bond, and creates a model of team leadership, sharing, and reflection. Once this has happened then the teams are introduced to the nine behaviors of leadership where they discuss each one and try to use the information that they have gathered to take back to their own jobs were they can become even more successful then they have ever been before. The Nine Behaviors that develop exception leaders are: 1.  Ã‚  Ã‚  Ã‚  Ã‚  Motivating others through adaptive leadership, who knows when to direct, coach, facilitate, or delegate, depending on the task and person. 2.  Ã‚  Ã‚  Ã‚  Ã‚  Empowering others, which is a sort of delegation that will help you as a leader to control the situation with the help of others. 3.  Ã‚  Ã‚  Ã‚  Ã‚  Encouraging teamwork, which is balancing results, process, and relationships. 4.  Ã‚  Ã‚  Ã‚  Ã‚  Preparing people for change allowing you to understand their psychological responses and helping them to create a positive change with force-field analysis. 5.  Ã‚  Ã‚  Ã‚  Ã‚  Vision/Mission, which establishes guidelines for accomplishing a specific goal. 6.  Ã‚  Ã‚  Ã‚  Ã‚  Using multiple options by allowing you to see different strategic possibilities and being open to more day-to-day options. 7.  Ã‚  Ã‚  Ã‚  Ã‚  Taking intelligent risks, relating decision-making to risks and getting consensus. 8.  Ã‚  Ã‚  Ã‚  Ã‚  Stretching personal creativity that renews personal resources. 9.  Ã‚  Ã‚  Ã‚  Ã‚  Showing passion for work by demonstrating presence, inspiration, and energy.   Ã‚  Ã‚  Ã‚  Ã‚  Each company has their own way of developing programs that center on ones ability to become an effective leader; this was just one aspect that I was able to find.

How does a government budget deficit affect the economy Essay

Identify two periods in recent history in which the United States has run budget deficits. What were the reasons for the deficits during those time periods? A government budget deficit occurs when the governments expenses exceeds its revenues. Because of this spending the government has to find alternatives to finance this added expense through borrowing. A government deficit in the long-run can reduce savings, growth, and income. In the short-run if the economy is performing below its output potential deficits are good because it increases expenditures moving output closer to potential. Two periods in recent history when the U. S. was running on a deficit were 2000-2008 and 2008-present. Within the two time periods the country went to war adding roughly $1. 1 trillion to the national debt we also had a significant tax cut that also added to the debt by $2 trillion. There also was a recession that caused the unemployment rates to go up increasing the government spending to cover unemployment insurance. The financial crisis of 2007-2008 was also played an important part in deficits. During this time there was a threat of collapse of large financial institutions and decline in the stock market Dow Jones lost 33. 8% of its value in 2008. The housing and auto industries suffered many companies that relied heavily on credit also suffered. Banks simply stopped trusting people to pay them back so they stopped making loans that most businesses needed to regulate their cash flows. Unfortunately this recession was not only felt in the U. S. but it also had a damaging affect too many foreign countries.

The Costs of Unemployment - Free Essay Example

Sample details Pages: 3 Words: 817 Downloads: 10 Date added: 2019/05/30 Category Society Essay Level High school Tags: Unemployment Essay Did you like this example? When workers become involuntarily unemployed, there are several costs associated which they will unquestionably have to bear. These could come from the fact that there are certain firm-specific skills that an individual has, thus leading to scarce opportunities for individuals searching for jobs matching their specific skills (Lazear, 2003). Moreover, the costs could be associated with the model proposed by Harris and Holmstrom (1982), in which they stated that the workers have to be assumed to be risk averse and of unknown productivity or capability, meaning, only through experience the employers can really know about an employee’s productivity, and so, in an unemployment context, there is a lack of information regarding this. Don’t waste time! Our writers will create an original "The Costs of Unemployment" essay for you Create order Furthermore, the costs could also come from large expenses in the process of searching for a new job (Mortensen, 1986). Several other labor market frictions can also be associated with the costs borne by the workers. Owing to the high costs of unemployment present when a worker is involuntarily let go, both the worker and the firm will suffer substantial changes in their behavior. Previous literature found that, for the worker to be willing to bear the risks of unemployment, he or she will require an extra compensation which could take the form of higher wages, better working conditions or several extra benefits. This extra compensation is generally specified as compensating wage differential. Firms must, therefore, compensate the workers ex ante to bear the nontrivial costs of unemployment. More precisely, Abowd and Ashenfelter (1981) presented a model in which they proved that there is a competitive equilibrium wage rate which will vary according to the unemployment risk, concluding that the compensating wage differential varies across industries and is larger the higher the risk. Similarly, Topel (1984) found strong evidence that unemployment insurance (UI) benefits have a significant impact o n both wage differences and unemployment. More authors, such as Hamermesh and Wolfe (1990), while approaching it differently, have focused on this same idea that the workers must gain a premium to bear the risk of unemployment. The two authors also found strong evidence that a large percentage of differences in wage differentials (from 14% to 41%) can be attributed to the divergences existing in unemployment risk between industries. Several authors have studied this subject looking at it in different ways, although all of them have reached similar conclusions. The size of the premium mentioned above will be higher, the higher the risk. One can say that an increase in risk can be associated not only with a higher probability of unemployment in a given firm, but also, with an increase in the costs incurred by workers during an unemployment spell, as well as the higher the worker’s degree of risk aversion. A crucial matter for this paper is whether or not these compensating wage differentials, associated to the unemployment risk, affect the firm’s financing decisions. Though, one could look at this in another perspective, i.e., what if an increase in the leverage of the firm has an impact in the unemployment risk? An increase in the financial leverage of a company will have an impact on the company’s probability of entering into financial distress. As previously studied by several authors, Ofek (1993) found that a firm’s response to financial distress has several dimensions, one of which being employee layoffs. Since a company in financial distress usually has to lay off workers so as to be able to meet its debt obligations, this will lead to an increase in the workers’ exposure to lay off risk. Given this, it is reasonable to assume that if a firm raises its levels of leverage, the costs associated with the compensating wage differentials will also increase , owing to the increase in the risk the workers will have to bear. Despite this conclusion, this paper goes the other direction. The aim is therefore to understand what is the impact, if any, the unemployment risk has on the firm’s financing decisions. The trade-off theory, which is the traditional theory of capital structure and the one in which this paper will be focused on, stresses the existence of an optimal level of equity capital and debt. This ideal level between equity and debt can only be achieved by a balance between tax benefits and the costs of financial distress (Kraus and Litzenberger, 1973). In accordance with Myers (1984), a firm following this strategy will have to set an ideal debt-to-value ratio and then continuously move towards the goal. As stated in this theory, the total value of a levered firm will be equal to the total value of an unlevered firm plus the present value of the tax shields the firm will get from debt, less the present value of the costs of financial distress. In other words, the net present value of a debt issue will equal the net present value of the tax shields plus the net present value of the costs of financial distress.