Company Financing, Capital Structure, and Ownership: A by Sanjiva Prasad, Christopher J Green, Victor Murinde

By Sanjiva Prasad, Christopher J Green, Victor Murinde

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By Sanjiva Prasad, Christopher J Green, Victor Murinde

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Extra resources for Company Financing, Capital Structure, and Ownership: A Survey, and Implications for Developing Economies

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This is generally reckoned to have increased the cost of debt, but has also allowed firms to be freer to raise funds from equity. During the 1970s, equity issued increased from 6% to 10% of total external finance, while bond financing increased from 4% to 8% in the same period. Moreover, the internationalisation of Japanese business, together with the increasing flow of overseas investment, has given rise to a natural desire to raise funds from abroad. This has been in the form of eurocurrency, national markets, or foreign currency bonds.

Third, firms with high insider ownership have lower agency costs on the grounds that (i) standard debt provisions and covenants may be more effective when there is a close control of ownership; and (ii) if a large proportion of inside ownership indicates that the problem of sub-optimal investment is likely to occur thereby implying lower agency costs. Firth (1995) considers the impact of institutional shareholders and management interest on the firm’s capital structure. Firth’s study differentiates itself from those of Friend and Lang (1988) and Friend and Hasbrouck (1988) by using the whole of the sample data with managerial shareholder ownership expressed as a continuous variable instead of classifying firms into groups according to whether they had either above or below median managerial share holdings.

The issue of debt has two effects on the value of the firm: first, it increases the tax savings as long as the firm survives; but second, it reduces the probability of survival. Depending on which is the stronger of the two, the value of the firm might rise or fall as a result of a debt issue. The optimum value of debt is that at which the marginal tax benefits associated with one extra unit of debt is equal to the expected marginal cost of default (which rises as the firm’s gearing increases).

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