Capital Structure In Chemical Industry Of Pakistan Essay Example Pdf

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In the opening chapter, the background, problem discussion and purpose of the study were presented. The chapter ended with the targeted group and limitation of study. Capital structure was one of the most prolific domains of research in corporate finance.

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Research was spinning around a few theoretical models of capital structure since over than forty years but could not be able to provide the conclusive assistance to managers and practitioners for choosing between debt and equity in financial decisions. An important question that companies face in need of new finance was whether to raised debt or equity. A number of theories had been proposed to explain the variation in debt ratios across firms. The theories suggested that firms select capital structures depending on attributes that determined the various costs and benefits associated with debt and equity financing. In spite of the continuing theoretical debate on capital structure, there was relatively little empirical evidence on how companies actually select between financing instruments at a given point in time. The problem of capital structure choice had been heavily discussed by international researchers for the last few decades that: What were the determinants of capital structure choice? How did firms choose their capital structures? “Given the level of total capital necessary to support a company’s activities, was there a way of dividing up that capital into debt and equity that maximize current firm’s value? And, if so, what were the critical factors in setting the leverage ratios for a given company?” Modigliani and Miller (1958) theory was considered as fundamental corporate structure model in the modern corporate finance. The theory ascertained the irrelevance of capital structure to firm’s value in perfect markets, without taxes and transaction costs. Following on the perfect classification of market, most subsequent research focused to demonstrate that a firm’s capital structure decision was considered corporate and personal taxes, agency costs, bankruptcy cost, and other frictions. Those aspects of corporate environment were referred as “determinants of capital structure”. Main research in corporate structure was focused on following two competitive theories: The first one was the traditional “static trade-off” theory, which derived form the Modigliani and Miller (1963) hypothesis of capital structure irrelevance and suggested that firms choose their optimal capital structures by trading off the benefits and costs of debt and equity. The main benefit of debt was tax deductibility of interest, which was balanced against bankruptcy costs Kim (1978) and agency costs (Jensen & Meckling, 1976; Myers, 1977). It suggested the existence of a target optimal capital structure, which companies tried to reached. Contrary to the above was the “pecking order” theory, developed by Myers and Majluf (1984) which emphasized that there was no target level of leverage and companies used debt only when their internal funds were insufficient,

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