Capital Structure of Industries in the UK - Dissertation Example

Download file to see previous pages Only in the case of the basic materials sector, the model is significant and we find a significant relationship between the leverage ratio with free cash flow and tax benefits. Again for the financial services sector tax benefits are significantly associated with leverage but other variables are not. Amongst the control variables (tax benefits and growth rate) only tax benefits are inversely related in the case of basic materials and directly related in the case of financial services.

Chapter 1 – Introduction
1.1. Background to the Context
At present all the major business organizations are uncertain regarding the fiscal decision which has to choose between the organizational debts and its equity capital (Kuhn, 2006). The capital structure of an organization has a direct influence either positive or negative (Bierman, 2003), on the output i.e., revenue and profits and the business. The basic target of researchers while investigating the capital structure, was mainly the developed countries, particularly the UK. Researchers have shown that firms in developing nations tend more to raise capital through equity while developed nations raise capital through leverage or external debt. Legal conditions and tax incentives play a significant role in a firm’s decision about capital structure. Hence a nation with underdeveloped capital market conditions and low protection of creditors will choose internal sources of funds (Baker and Martin, 2011). Decisions regarding capital structure are not an easy task (George, 1996).

There are many factors that affect the management’s perspective on decisions regarding capital structure, whether to raise funds from external sources or through equity. While deciding the capital structure of a firm, challenges and opportunities associated with different options shall be focused upon. Organizations that are in heavy debt follow a suitable plan which is set in accordance with their capital structure (Baker and Martin, 2011). However, with the change in the industrial environment and market, these plans are altered.

Moreover, organizations that are liable for heavy debts invest all their profit and earnings in the interest and the return to the shareholders, this automatically decreases the market value of shares. On the contrary, when an organization pays handsome taxes, more investors are attracted to it which increases its share value and thus its percentage is again balanced. Essentially two kinds of agency problems might arise. First, there might be conflicts between equity holders and creditors owing to which firms may decide to opt for lesser leverage (Parsons and Titman, 2009).

The greater the financial leverage, the greater will be the threats. These threats are of more significant consideration owing to the drastic alterations resulting from the financial crisis (Baker and Martin, 2011). Since the core focus of organizations is more risk = more profit, this is why they are willing to collect more funds from outside. ...Download file to see next pages Read More