Profitability for a Business within the Saudi Arabian - Dissertation Example

The capital structure has been one of the most important issues in the business literature since Modigliani and Miller established their capital structure irrelevance assumptions in their seminal theory of 1958. Since then, a number of theories have been posited, suggesting several elements that may determine a company's capital structure decision. The capital structure consists of a mixture of equity and debt. The study of capital structure tries to elucidate the mix of securities and financing sources used by firms to finance the investment. The majority of the study on the capital structure has focused on the percentages of debt vs equity observed on the right-hand side of firms' balance sheets. However, there are several differences between the financial structure and capital structure. Also, 'Capital structure is defined as the relative amount of debt and equity used to finance enterprise' (Al-Sakran, 2001). This issue is a significant issue in finance.

However, Myers (2001) mentions that there is no general theory of equity and debt choice, with no reason to expect one, but there are a number of helpful conditional theories. He stated, "there is another possibility: perhaps financing doesn't matter" (Myers, 2001, p. 2). Modigliani and Miller (1958) proved that the company's value, cost, or availability of capital is not affected by how funding, whether debt or equity. Myers mentions that M&M assumed perfect capital markets, where financial innovation would stop any change in the trend of their expected equilibrium.

Titman and Wessels (1988) mentioned that different theories of capital structure might affect the debt-equity choice of the company by denoted asset structure, non-debt tax shields, growth, uniqueness, industry classification, size, earnings volatility, and profitability. 

Most capital structure theories argue that a capital structure choice of the company somehow is affected by owned assets. Scott (1977) suggested that companies can increase the value of their equity by selling secured debt. Also, Myers and Majluf (1984) argued that the sale of secured debt might be useful for the company. Their model shows that there might be costs related to issuing securities about which the decision-makers of the company have good information.