Capital stracture

Key factors that affect structure choice 5. 1. 1 Profitability and variation of profitability Profitability is one of the close to well-tried bon ton characteristics In confirmable research regarding companies choice of capital structure. The tradeoff speculation predicts that higher profitability is associated with developmentd debt levels and the reason for this Is twofold.First, companies achieving high profitability apply less(prenominal) risk of monetary distress and bankruptcy, so the comprise of debt Is lower. Second, higher profitability means that companies fecal matter achieve higher economic consumption of the Interest tax shield by Increasing the amount supplement and hence the promised Interest payments each period. Similarly, Increased debt get out serve as a adolescently factor for managers when free cash flow likely Increase with Increased profitability.However, as dynamic trade- off theory predicts adjustment be will prevent companies from adjusting th e capital structure immediately and the unlikelihood of companies macrocosm at their refinancing points at the time of measurement ca use of goods and servicess the prediction of the found allegations amongst leverage and profitability to be negative due to the static character of the clincher analysis. Retained earnings are the favored financing gibe to the pecking order theory which contradicts the predictions made by trade-off theory.Higher profitability should change the company to retain more earnings which is the prefer able source of funding, and as such, the amount of leverage needed by the company should decrease. Empirically, profitability is systematically found to be negatively related to leverage, as predicted by both theories. Therefore the interest hypothesis is made 5. 1. Asset Tangibility (Asset in place) The thought bed asset tangibility as a determinant is that tangible assets provide more security for potential investors as assets can serve as collateral. This will master the risk for debt holders and ultimately reduce the cost of debt for the companies and they will be able to operate with higher leverage ratios without Incurring higher financial distress costs. Accordingly, the trade-off theory predicts that companies In which tangible assets accounts for a large part of the asset structure should let in larger debt levels than companies with a relatively larger amount of Intangible assets. Furthermore, collateralized debt makes It touchy for Investors to conduct asset substitution as the debt holders have collateral In specific assets.Therefore agency costs should be lower amidst shareholders and debt holders, and companies should use more debt relative to the amount of tangible assets they own. The pecking order theory makes the setback prediction as It suggest that tangibility will generate less information asymmetries between potential Investors and shareholders, and hence the cost of issuing legality will fall, resulting in lower levels of utilise to predict that the cost of debt will fall as they will now be able to have alliterated debt.So unless the cost of equity falls below the cost of debt, the pecking order theory implies that companies will use the cheapest sources of funding, debt would still be the preferred funding to equity, at to the lowest degree for moderate amounts of debt. Therefore the prediction of the pecking order theory top executive non be as unambiguous as some researchers argue. base on predictions of these theories and the consistent findings in previous empirical research the following relationship between asset tangibility and leverage is expected. 5. 1. Growth probability Growth opportunities calls for a similar reasoning as previously used to explain the predictions of asset tangibility effect on leverage, although with opposing conclusions. The number one notion of the relationship between addition opportunities and leverage is made by Myers, who states that th e problem of shareholders making sub optimal investment decisions is more severe when a company has more ripening opportunities as potential investors cannot value or square up which growth opportunities the company should follow.The value of a companys growth opportunities are most likely only valuable to the individual company, or at least less liable to other companies, in which case the costs of financial distress and bankruptcy will be higher for companies with many growth opportunities. With this consideration the trade-off theory suggests a negative relationship between growth opportunities and leverage.Similarly, with many investment opportunities the earnings before taxes is assumed to be lower in which case companies will not be able to fully utilize the interest tax shields associated with high amounts of leverage. Furthermore, companies having more investment opportunities likely value financial legibility highly, which also reduce the optimal leverage ratio. Contrast ing this prediction is once again the pecking order theory, as it predicts a positive relationship between debt and growth opportunities.The argumentation behind is that growth opportunities involves higher information asymmetries as shareholder are not willing to reveal much information about their investment opportunities, and apt(p) that investment opportunities requires investment outlays and thus increasing a companys financing deficit, companies will issue debt financing and preferable worth-term financing when they experience finance deficits. The empirical results show consistent behavior of the relationship between leverage and growth opportunities and it is expected that this behavior is also present for Danish companies.