What is the capital structure theory?

Capital structure refers to the composition and proportional relationship of various capitals of enterprises. Capital structure is the core issue of enterprise financing decision. Enterprises should comprehensively consider the relevant influencing factors, adopt appropriate methods to determine the optimal capital structure, and continue to maintain it in the future additional financing. Capital structure theory includes net income theory, net operating income theory, MM theory, agency theory and hierarchical financing theory.

capital structure

Generally speaking, the problem of capital structure is the proportion of debt capital, that is, the proportion of debt in the total capital of an enterprise. Capital structure can be divided into broad sense and narrow sense. Capital structure in a broad sense refers to the composition and proportion of all funds (including long-term funds and short-term funds). Generally speaking, the generalized capital structure includes: the structure of debt capital and equity capital, the structure of long-term capital and short-term capital, and the internal structure of debt capital, long-term capital and equity capital. In a narrow sense, capital structure refers to the composition and proportion of various long-term capitals, especially the composition and proportion of long-term debt capital and (long-term) equity capital. The capital structure mentioned in this chapter refers to the capital structure in a narrow sense.

Influencing factors of editing this paragraph

The factors that affect the capital structure include: (1) the financial situation of the enterprise; (2) Enterprise asset structure; (3) sales of enterprise products; (4) the attitude of investors and managers; (5) The influence of lenders and credit rating agencies; (6) Industry factors; (7) Income tax rate level; (8) The changing trend of interest rate level.

Edit the main content of this paragraph.

Capital structure theory includes net income theory, net operating income theory, MM theory, agency theory and hierarchical financing theory. (1) net income theory holds that the comprehensive capital cost of enterprises can be reduced by using debt. Because the debt cost is generally low, the higher the debt level, the lower the comprehensive capital cost and the greater the enterprise value. When the debt ratio reaches 100%, the enterprise value reaches the maximum. (II) The theory of net operating income holds that the capital structure has nothing to do with the enterprise value, and the key factor that determines the enterprise value is the net operating income of the enterprise. Although the enterprise has increased the debt capital with lower cost, it has also increased the risk of the enterprise, resulting in an increase in the cost of equity capital and a constant comprehensive capital cost of the enterprise. Regardless of the degree of financial leverage of an enterprise, its overall capital cost remains unchanged, and its value is not affected by the capital structure, so there is no optimal capital structure. (III) MM theory MM theory holds that in the absence of enterprise and personal income tax, the value of any enterprise, whether it has liabilities or not, is equal to the operating profit divided by the rate of return applicable to its risk level. The enterprise value of the same risk is not affected by the existence and degree of liabilities; However, considering the income tax, due to the existence of tax avoidance interests, the value of the enterprise will increase with the improvement of the debt level, and shareholders will also get more benefits. Therefore, the more liabilities, the greater the enterprise value. (IV) Agency Theory Agency theory holds that the capital structure of an enterprise will affect the working level and other behavior choices of managers, thus affecting the future cash income and market value of the enterprise. The theory holds that debt financing has a strong incentive effect and regards debt as a guarantee mechanism. This mechanism can encourage managers to get more for less and make better investment decisions, thus reducing the agency cost caused by the separation of the two rights; However, debt financing may lead to another kind of agency cost, that is, the cost incurred by enterprises accepting the supervision of creditors. A balanced enterprise equity structure is determined by the balance of equity agency cost and creditor's rights agency cost. (V) Hierarchical financing theory: (1) The cost of external financing includes not only the cost of management and securities underwriting, but also the cost caused by the "insufficient investment effect" caused by information asymmetry. (2) Debt financing is superior to equity financing. Due to the tax saving benefit of enterprise income tax, debt financing can increase enterprise value, that is, the more debts, the more enterprise value increases, which is the first effect of debt; The expectation of financial crisis cost and the present value of agency cost will lead to the decline of enterprise value, that is, the more liabilities, the greater the decline of enterprise value, which is the second effect of liabilities. Because the above two effects cancel each other out, enterprises should be moderately indebted. (3) Due to the existence of information asymmetry, enterprises need to reserve a certain debt capacity, so that profitable investment opportunities can temporarily issue bonds and avoid issuing new shares at excessive cost. From the mature securities market, the priority mode of enterprise financing is internal financing first, followed by borrowing, issuing bonds and convertible bonds, and finally issuing new shares to raise funds. However, in the 1980s, emerging securities markets had obvious preference for equity financing.