Introduction

The Modigliani Miller (MM) third proposition described that the value of firm is not changed with respect of its financing decision (Debt, Equity) in the frictionless competitive market. They also took assumption for that there is no bankruptcy or financial distress cost, no tax and transaction cost. So the value of firm remains same whether it financed by equity or debt.

Since 1958, Modigliani and Miller's determining article, academics and researchers continuously tried to clarify how firms opt their capital structure. This general suspense exists if corporations are identifying an optimal capital structure then they could maximize their value by applying and sustaining that financial combination. A plenty of explanations had been presented to clarify why firms choose the capital structure they do. For instance, information between firm's mangers and financial markets is asymmetric. (Myers & Majluf, 1984), there is a tax shield between debt and non-debt expenses (DeAngelo & Masulis, 1980), and for maintaining discipline in management use debt (Grossman & Hart, 1982) have all been offered as explanations. This confusing mixture of answers lead Myers (1984), in his presidential address to the American Economic Association, to conclude that no clear solution exists as to why firms make certain choices concerning their debt/equity mix. Nobody provided the precise answer that is accepted generally of this puzzle (Norton, 1990). The entire subsequent development of corporate finance is the relaxing of MM assumptions that give us new way to think. If we take MM as a benchmark than we might understand when these decision may change the firm value.

The aim of this research is to explore, what the optimal level of capital structure that can maximize the firm value by using the existing research and different industries data (mixture of debt equity). I want to explore the firm might increase their value by using the optimal capital structure to remain competitive in turbulent business era. My study based on these assumptions, there is no corporate income tax, no transaction or bankruptcy cost.

We (instead of ‘I') are not completely disagreeing with the MM propositions. We want to explore various helpful insights for deciding capital structure, begging from the Modigliani Miller No magic in leverage theory or leverage is irrelevant with the firm value. But I try to find a financial mixture (debt equity level) which may increase the firm value by using the industry data and turn some insights about capital structure in new way. We will try to find a certain range of debt equity percentage which may increase the firm value. But our theories will not seem to explain the actual financing behaviour of investor and also far away from the finding a actual capital structure which increase the firm value. We take this opportunity to analysis the exiting theories about capital structure and try to push this research further.

Literature Review

Capital structure is irrelevant to determine the firm value and how it perform in future(Modigliani and Miller, 1958) who create the new sight for thinking on capital structure. Contrast many other studies and Lubathkin and Chatterjee (1994) argued that there is relationship exit between capital structure of the firm and its value. In another paper of Modigliani Miller (1963) argued that their model is not effective if we take tax into consideration. There is a tax shield on the debt interest payment that may rise the firm value if we add debt proportion in equity. In recent studies, researchers have showed that how optimal capital structure has effect on the firm vale they r not much interested in it. Rather than the emphasis more on capital structure influencing management to make strategic decisions (Hitt, Hoskisson and Harrison, 1991). The performance of the firm is dependent on all these decisions (Jensen, 1986). How to cope the conflict between the owners and manger on the capital structure decision which is the burning issue now a days (Jensen, 1989)?

Brigham and Gapenski (1996) argued that, in theory, the Modigliani Miller model is applicable. Although, in practice, bankruptcy costs or financial distress cost exist and these costs are directly proportional to the debt level of the firm. So if firm increase their debt level, financial distress cost also rise. So optimal capital structure only be achieved if tax shield exist that benefit the increase in debt level is equal to the financial distress cost. Warner (1977) argued that, the perspective financial distress costs a firm may faces and this cost reflected in the share price which considered by the investors by making the investment decisions.

If we use theoretical model, management of firms are capable to calculate the optimal capital structure but in reality many studies found that most of the firms don't have an optimal capital structure. (Simerly and Li, 2000). Although research still continue on the topic full understanding of capital structure not been achieved yet ( John & John, 1993; Bagwell & Zecher, 1993) there is a reason behind this limited understanding is required a integration of organisational theory into investigation (Frankfurter & Philippatos, 1992).

Bradley et al (1984) support the optimal capital structure which was summarizing in early evidence. By using factor analytical approach Titman and Wessels (1988) found the diminutive Evidence such as factors like tax shield and volatility of earnings forcasted by trade off theory have much influence on the firm capital structure. Baker and Wurgler (2002) showed that, by contrast to the trade-off theory movement in firms' market valuations have long relatively than transitory impacts on their capital structure. Harris and Raviv (1988) developed a model that create resistance strategy to corporate takeover to take a management capital structure decision. They also support the signalling theory which stated the certain level of leverage help investor to control and monitor the management and collect the information about the prospect of the firm.

Ross (1977) stated that management of firm has the inside information so they can target the debt level in firm capital structure. Myers and Majluf (1984) forecasted that, it is a negative relationship between the stock issue and its prices. That's the reason firm give preference to debt to equity by external financing.

Some firms are force to finance new project by more debt to defend youself by hostile takeover so we may see the more debt equity ratio in those firm capital structure mix (Muscarella and Vetsuypens, 1990). There are only two fundamental sources of firms financing that are debt and equity (Fama and Jensen 1982).

In 1963 Modigliani and Miller made a correction in his pervious model, so they change the capital structure model now they considered the corporate income tax assumption and said if firm has a more leverage so the value of firm in market will be maximised if other things remain constant. In 1994 Shyam-Sunder and Myers reassess empirical issues concerning capital structure and wrap up that firm pecking order hypothesis may imitate corporate action. If firm have a target capital structure then they might not achieved the opima.

“Most research on capital structure has focused on public, nonfinancial corporationswith access to U.S. or international capital markets. This is the right placeto start. These companies have the broadest menu of financing choices and canadjust their capital structures at relatively low cost. Yet even 40 years after theModigliani and Miller research, our understanding of these firms' financingchoices is limited. We know much more about financing tactics-for example thetax-efficient design or timing of a specific security issue-than about financingstrategy, for example the firm's choice of a target overall debt level.”(Myer, 2001)

Research Methodology

This research may reveal the range of certain percentage of debt in firm capital structure that can increase the firm value, for this we are going to use secondary data or content analysis In broad terms, secondary data research involves an analysis of existing data that were collected during the conduct of a primary research study. Secondary data research should have the following characteristics no manipulation of human subjects, no new data collection no identification of research participants.

Many studies published in context of firm capital structure but still a controversy on the firm optimal capital structure. I want to use those studies to and try to find the optimal level. For this i will collected the qualitative and quantitative data from the different data base, using library source, news papers, and internet sources. I will collect the article about capital structure from Modigliani and miller 1958 paper to 2010. Content analysis is a research tool used to determine the presence of certain words or concepts within texts or sets of texts. Researchers quantify and analyze the presence, meanings and relationships of such words and concepts, then make inferences about the messages within the texts, the writer(s), the audience, and even the culture and time of which these are a part. Texts can be defined broadly as books, book chapters, essays, interviews, discussions, newspaper headlines and articles, historical documents, speeches, conversations, advertising, theater, informal conversation, or really any occurrence of communicative language. Texts in a single study may also represent a variety of different types of occurrences, such as Palmquist's 1990 study of two composition classes, in which he analyzed student and teacher interviews, writing journals, classroom discussions and lectures, and out-of-class interaction sheets. To conduct a content analysis on any such text, the text is coded, or broken down, into manageable categories on a variety of levels word, word sense, phrase, sentence, or theme--and then examined using one of content analysis' basic methods: conceptual analysis or relational analysis. For content analysis I will select five industries and within those five industries I will select five companies in each industry and see the capital structure impact on the value of those companies. For analysing of data I will use the linter model taking two variable debt and equity ratio and firm value.

A clear benefit of using secondary data is that much of the background work needed has been already been carried out, for example: literature reviews, case studies might have been carried out, published texts and statistic could have been already used elsewhere, media promotion and personal contacts have also been utilized.

This wealth of background work means that secondary data generally have a pre-established degree of validity and reliability which need not be re-examined by the researcher who is re-using such data.

Furthermore, secondary data can also be helpful in the research design of subsequent primary research and can provide a baseline with which the collected primary data results can be compared to. Therefore, it is always wise to begin any research activity with a review of the secondary data.

Source: Essay UK - http://ntechno.pro/free-essays/finance/capital-structure-in-new-paradigm.php


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