Capital Structure in the Cement Industry - Dissertation Example

? Programme of Study, Number, Centre & Intake. Rene Baldauf MSc in Finance Number: 10110336AAEF322 Centre of Enrolment: RDI/Germany Date of Enrolment: October 2006 Please identify any University of Leicester Tutors with whom you have discussed your proposal and the forum you used (e.g. workshops/Blackboard) Dr Chin Bun Tse On Blackboard Title (max. 15 words) Note on Content: A title should summarise the main idea of the proposal simply and, if possible, with style. You may want to use a title and a subtitle, separated by a colon (e.g. ‘Brown Eggs: What they are Made of and How to Eat Them’) Capital Structure in the Cement Industry: Which industry characteristics determine how the companies are financed? Abstract (max. 200 words) Note on Content: A brief and comprehensive summary of your proposal: The question about the right capital structure has been discussed since many years in the academic world. In the real world, one can find different capital structures between the companies. However, one can also observe differences between industries and not only companies. There must be some characteristics of different industries, which do have an impact on how companies choose their capital structure. Thus, the capital structure of cement companies, although there are differences between the companies, seems to have a common ground on its structure. The industry character of the cement has its specialities (very capital intensive, long pay back time of investments). In my paper, I would like to explore different industries and compare the average capital structure between those industries. I would put efforts to show how and why differences between industries might be seen. Several scholars have already analyzed the impact of the industry in which a company operates on the capital structure. Out of this work, several hypotheses can be formulated on which specific industry characters may lead to different kinds of financing strategies. Lastly, I would endeavour to test if this hypothesis applies for the cement industry and if therefore they help to explain the capital structure of the cement industry. Introduction (approx. 200 words) Note on Content: • A statement of your research question, possibly including a central question and three or four aspects or sub-questions (approx. 30–100 words depending on number of research questions). • Explain why this question is interesting (approx. 100 words). The aim of this thesis is to understand the capital structure of the cement companies in a comprehensive manner. Since there are different capital structures between different industries, the specific market environment can help to explain the general tendency on how the cement companies are financed. To answer the main question: Capital Structure in the Cement Industry: Which industry characteristics determine the finance strategy? I will be putting efforts to answer the following sub-question: a) How do capital structure in different industries look like, are there significant differences between industries? b) What is the nature of the industries, can we see interrelation between the nature of the industry and how the companies are financed within? c) What is the characteristic of the cement industries and can we use the hypotheses to explain the financing strategies of cement companies? The question of the right capital structure has been and is still discussed intensively in the finance literature. In practice, companies try to choose the right balance between debt and equity to achieve an (theoretical) optimal balance for the gearing. There are different concepts, which try to explain why companies have different financing strategies. With this paper, I want to provide some finding to explain by the means of the character of the cement industries as why companies within this sector tend for a certain capital structure. If the industry character is a relevant cause for the capital structure, then it is important to know the different requirements of attributes that go with different financing strategies. Relation to previous research (approx. 400 words) Note on Content: • Discussion of the relation between your proposed research and previous research. When Expanded in the dissertation this will be referred to as a Literature Review (approx. 400 words). The paper of Modigliani & Miller (M&M) with its irrelevance theory of capital structure was an important initiator for further research about capital structure. However, in practice, one can find many different capital structures and different concepts that have discussed the fact that there might be an optimal capital structure. Taxation is one important issue that explains the relevance of the capital structure and the reasons of interest payments that are deductible from tax, as well as debt that creates a tax shield, and that accordingly suggests that the gearing should be maximised. The Agency cost Theory (Jensen, 1986) deals with the agent-principle problem. It specifies that managers might act in their own interest instead of the owner. High debt requires interest payment and reduces the available cash flow for the manger (discipline effect). However, this would imply very high gearing, which is not often the case in practice. On the other hand, the trade-off Theory (A. Kraus and R.H. Litzenberger, 1973) argues that by increasing debt, the cost of financial distress also increases and at one point, it off-sets the benefit of the tax shield. Thus, capital structure is decided on company level with no general valid norm. However, looking at the balance sheet of companies in the cement industry, one can find noticeable higher debt than in other industries. Hence, there are most likely some industry specific characters that motivate companies to have a certain capital structure. Bradley, Jarrell and Kim (1984) found in their study that 54% of variation in firm leverage ratios can be explained by industry influences. By comparing different industries and their aggregated leverage ratio, the proposed research will identify the industry character that has the same tendency in terms of capital structure. In addition, the research will also consider further researches, which have been undertaken regarding cross-industry comparison. Long and Malitz (1985), Bowen, et al. (1982) and Kester (1986) have also recorded leverage ratios of industries with similar outcomes. Other researcher (e.g. Titman and Wessels, 1988) have also focused on the characteristics of the firm itself. Lastly, the inter industry comparison in proposed research will be based on the Swiss Performance Index and its industry sectors. The findings will be compared with literature findings, which have acquired industry data from the United States. Consequently, the proposed research will include formulation of industry depended characteristics, which determine capital structure. The findings shall be tested within the cement industry. Proposed methods (approx. 400 words) Note on Content: • A precise statement of the methods you propose to use. • Justify the choices you make. Explain why this method is being used in preference to others. • Discuss the specifics of the method(s) you will use. Be clear about data sources and what will count as data in your research project. • (In your methods section you may need to make some reference to other exemplary studies and will certainly need to refer to the literature on research methods.) The basic objective of the research is to explain capital structure within the cement industry with the help of characteristics of the industry. Therefore, the researcher will put efforts to analyse the main industry cluster listed at the Stock Exchange in Switzerland (SPI) and will analyse the capital structure (Debt/Equity Ratio) of those industries. The industries clusters in the research are: Industrials (including Cement) / Basic Materials / Oil&Gas / Consumer Goods / Health Care / Basic Material. In addition, the research will include testing of correlation of different variables of the industry and the gearing. In specific, the variables are specifications of the industry environments. This would be capital-intensity, profitability, free cash flow, fix-asset/total asset ratio and average firm size (sales). In the second phase, the findings will be tested with the nature of the cement industry. The cement industry will be represented by a sample of the top global companies of cement industry since cement industry is in the SPI part of the cluster “Industrials” and only one cement company is listed in the SPI. Reflections (approx. 500 words) Note on Content: Include reflections on: • Potential practical and empirical obstacles (e.g. access). • Conceptual and theoretical problems and difficulties. • Ethics (both in the narrow and the broader senses). • Your position as a researcher in a political field, and reflection on how this will impact on your study. Conclusion (max. 200 words) Note on Content: • Very brief wrap-up, including discussion of immediate next steps you need to take. Do not restate everything you have already said. In conclusion, analysis of the literature has indicated that the capital structure is the way a company finances all of its functions and growth by means of various sources of funds. It is a mix of a company's ‘long-term debt, particular short-term debt, common equity and preferred equity’ (Swanson & Srindhi, p. 48). Different internal as well as external factors decide the capital structure of cement industry. The macro variables of the financial system of a nation like tax strategy of government, inflation speed and capital market situation are the key external factors that have an effect on the capital structure of a firm. The micro factors as well have an effect on the capital structure of industries. In this regard, the proposed research will include efforts to fulfil the major objective of identifying industry characteristics that determine the financing strategy of companies in the cement industry. Timetable (approx. 100 words, or a one page diagram) Note on Content: • Provide dates and major steps or milestones. • This should be presented in bullet points or as a pictorial diagram. • Make sure that you include other commitments such as holidays, and allowing time for tutors to approve your research proposal. # Task Name Date Date Date Date Date Date Date Date Date Date 1 Literature Review 1st week 2 Submission of Research Proposal 2nd week 3 Secondary Research 3-4th week 4 Analysis of Data 5-7th week 5 Primary Research 8-10th week 8 Analysis 11-14th week 9 Rough Draft of Dissertation 15-17th week 10 Final Submission 18th week References Note on Content: • A full list of works referred to in the text referenced correctly. • Quality is more important than quantity, demonstrating engagement with relevant literature. • The Internet should not be the only source of references. Swanson, Z. and Srindhi, B. The Capital Structure Paradigm: Evolution of Debt/Equity Choices. Praeger, 2003. Read More