New age firms are

For these kind of Firms, more Debt means, low WACC, more EPS, low ICR and high leverage. For these guys clean Debt or Mezzanine Debt is always a good option. As they always look for an acquirer to buy them. So, the acquirer will be attracted by low WACC, high EPS etc.

However for traditional and age old or long term companies BEP is the key. Because whether they make profit or loss they have to service their Debt promptly. For them a balanced mix of equity is preferred over a large Debt based capital structure.

I hope this explains.

Warm Regards

This is a very loaded question! Not easy to get a simple answer. 

Here is a recent analysis by SNL https://www.snl.com/InteractiveX/article.aspx?CDID=A-34762317-12844&KPLT=4

And checkout the work by professors Atif Mian and Amir Sufi and their excellent book HOUSE OF DEBT with active link here http://houseofdebt.org/

Modigliani and Miller approach states capital structure as irrelevant in perfect market situation. What matters is the assets company hold. But, later on researchers found the benefits and cost of debt in real life situation. Interest tax shield as well as Lower agency cost due to management's discipline are considered as benefits whereas bankruptcy cost is a cost.Again, people started using different parameters. Following papers may be helpful...

http://siteresources.worldbank.org/INTEXPCOMNET/Resources/Rajan_and_Zingales_1995.pdf

http://ro.uow.edu.au/cgi/viewcontent.cgi?article=1018&context=aabfj

In most cases of established firms, the impact of capital structure on firm performance is a secondary effect compared with the impact of changing market conditions and Modigliani-Miller applies. If survival under market uncertainty is viewed as essential, then a capital structure that  mitigates bankruptcy risk under market  swings would be preferred (less leverage).

It can be one of measures of macro prudential policy actions, under "lending standards" - whether tightening or loosening - generally product or financial conduct regulations that applies to measure "the product" - in your case "the product" of your firm - whether your firm is foreign or domestic. Just another perspective. Best wishes   

Dear Nabila Nisha

Greetings,

I think the capital structure is very important decision, the firms must  know the mixed and the percentage of debt and equity that give the good picture for the investors and bankers . But this is depend on the conditions of firm , environment and competitors . Debt item is very sensitive for any firm , some firms using the debt  to meet the liabilities and to make some of investments to compensate with the interest .This method in my opinion is very good to keep the success. 

Best Regards

Yes, however that would depend on the efficiency of  capital markets where these firms in question operate. For instance high transaction cost will certainly do not good on the performance of the firm as that compromise cash flow bank which could have been utilized to generate more funds in operations. Further, the magnitude impact of different levels of debt-to-equity ratios to  firm performance or the value of a firm  is more likely to be dependent  on the value of intangible assets in place also referred to by a few as firm growth prospects.

Further,the question about  wether different levels of debt or equity yields various levels of performance would also partly depends on the nature of tax code such companies operate.For instance, in the U.S a classical tax system exists  where else in New Zealand we learn about Dividend imputation tax system where dividend taxes are wiped out by transferability of dividends tax credits in future years so that dividend tax cancels off partly or complete.

Where else in the Classical tax regime dividends are taxed once in the hands of shareholders and again at company level .Again, the impact of debt with not be the same on market performance in different context. With that in mind,the appetite for equity would not be the same as in the other tax regime .

Of course debt is more is likely preferable  when it generate a lucrative tax shield which often results in greater value than an otherwise manager who will prefer expensive equity when debt generate some value in better tax treatment of debt along with its disciplining role on free cash flow reduction used on perk projects.Of course we know dividends play a significant role on the perceived value of a stock or firm if i can put it that way.

Higher levels of equity relative to debt  is an important requirement for dividend payment, when firms pay dividend its stock suggest that the firm has confidence with future profitability and stability of profits in the next 3 or 5 years ,thus it becomes more attractive to the eyes of investors thus lifting up it share price or its market cap.

On the other hand firm may prefer to reinvest such dividends thus increasing the existing value of shares which is often not as much as it could be increased by market forces. Therefore debt to equity ratio impact on performance will also depend on what the firm does with its distributable profits.

Of course. Contrary to the celebrated Modigliani-Miller theorem debt/ equity ratio is one of the basic covenants in corporate loan agreements determining interest rates and thus profits. To the extend that stock returns follow the "incremental rate of profit" that is the ratio of the change in profits normalized by investment  the debt/ equity ratio can play significant part in stock performance especially in crisis periods. Of course this is a quite different explanation than the cost of capital approach which in line with the Modigliani -Miller theorem suggests that the debt/ equity ratio determines the cost of capital in the presence of taxes.      

What kind of debt (financial ou not, priority, linked with options) ?

What kind of equity ?

What kind of  financial performance indicator ?

First, you should indicate what indicators of financial performance are you referring. In general, however, the decisions of capital structure are important. M&M (1958), argue the irrelevance of the financial structure regarding the impact on the firm value, in an "ideal world".

Harris and Raviv (1991) believe that the leverage decreases due to profitability. The pecking-order theory (Myers and Majluf, 1984) maintains that firms with greater profitability require a lower amount of debt since they generate more internal resources to finance investments. By contrast, the trade-off theory suggests a positive relationship between profitability and debt, because the most profitable businesses have a lower probability of financial distress (Fama and French, 2002).

With regard to growth opportunities (as measured by market-to-book ratio or Tobin’s Q), there are divergent arguments regarding the sign of the relationship with leverage. While the arguments of the agency theory imply a negative relationship between growth and leverage (Jensen, 1986), the pecking order theory suggests both a positive and negative relationship. Myers (1977), for example, argues that the relationship is negative, as firms with high growth opportunities are more risky, since they have more volatile earnings and therefore have difficulty accessing low-cost credit. Even Fama and French (2002) maintain that high-growth businesses use less debt. By contrast, Myers (1984) argues that firms with high growth opportunities may use more debt to reduce costs arising from informational asymmetries and to send out a signal to the market with regard to the quality of investments. In empirical terms, while Michaley et al, (2015) found a positive relationship between leverage and growth opportunities, other studies found a negative relationship (e.g. Rajan and Zingales, 1995).

I also suggest to read Strebulaev, I.A., and Yang, B. (2013) The mystery of zero-leverage firms. Journal of Financial Economics, Volume 109, Issue 1, pp. 1–23.

Dear Scholar,

Firstly, I agree with Prof Fabrizio Rossi with regard to: What are the indicators of financial performance? Professor has mentioned various indicators used by great researchers for capital structure decisions.

You can also refer to the following link to get a basic idea about financial performance indicators.

http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Financial%20Performance%20Indicators%20(FPIs).aspx

please just read the academic litterature, in particulart Rajan and Zingales What do we know about capital structure.

And have a glance to http://papers.ssrn.com/sol3/papers.cfm?abstract_id=242288 and to http://papers.ssrn.com/sol3/papers.cfm?abstract_id=190245

To make effective capital structure decisions, the financial management should deal with financial market imperfections, such as taxes and transactions costs. As the Modigliani & Miller capital structure irrelevance theorem is valid in perfect markets, the firm target leverage should be driven by three factors related to the market imperfections: minimization of tax impact, costs of the financial distress and agency costs.

From a corporate income tax standpoint, the difference between debt and equity financing is that interests on debt are deductible, whilst dividends are not. As a consequence, adding debt to the capital structure increases the after-tax cash flow, under the condition that the firm has taxable earnings, as it receives tax benefits when it is in an income position. It means that there is a positive correlation between the interest tax shield and the value of the company. It has to be noted that the condition that the firm needs to have taxable earnings is an important constraint to the use of the debt, as the  interests on debt could trigger to a loss position.

The costs of financial distress are associated to the fact that excessive debt risen by the company to finance its activity could trigger to default, which raises direct and indirect bankruptcy costs. This is one of the factors which explains why the firms are generally under-leveraged with respect to their optimal level of leverage from a tax saving perspective: the probability of bankruptcy is positively correlated to the level of debt. The present value of the financial distress costs reduces the value of the firm, nevertheless it is not easy to determine it because the calculation of the financial distress probability, of the magnitude of the costs and of the discount rate to be used is complex.

The agency costs, that arise when there are conflicts of interest between stakeholders, affect the capital structure as far as the managers tend to make decisions that increase the value of the equity. This is due to the fact that they are appointed by the BOD, which is elected by the shareholders. Also, often the top management itself hold shares or stock options. The agency costs should be minimized to attempt to have an optimal capital structure.

In conclusion, the capital structure can contribute to the financial efficiency through the maximization of the tax benefits together with the minimization of financial distress costs and agency costs.

HI,

You may have a look to this paper:

Performance Measures in Earnings-Based Financial Covenants in Debt Contracts Journal of Accountingresearch september 2016, vol 54, issue 4 (pages 1149–1186

NINGZHONG  LI

Best regards