The Determinants of Debt Ownership Structure - Some Empirical Evidence

Abstract

To open its doors. a new business requires capital, and still more capital is needed, if. The firm is to expand. Every business transaction involves funds directly or indirectly. With the increasing financial requirements, firms tend to have higher index of capital. A firm requires both equity forms of finance as well as debt to cater to its requirement. At the same time, there is always a need for critical exa111ination by the finance manager to decide on the optimum mix of equity and debt. The financing decision of the firm i.e. the deciding of the proportions of debt and equity is one of the basic decisions oriented to the achievement or the maximizatirn1 or the shareholders wealth. And therefore. the corporate, are forced to have clear vision on whether to go for equity or debt. Even if the firm decides to choose debt form of financing, they need to have a clear vision on the factors that contribute to the choice of debt and how to go about the forms of debt. Hence, determination of optimum debt level and its impact on the firms overall capital structure is regarded as an integral part of the firms financial decisions. The financial decision is not only confined to fund raising operations but extends beyond it. to cover utilization of funds and monitoring its uses. ·1 has the crux of financial decision l ies in decision making in the areas of optimum level of debt, method of raising those funds and various sources from which the debt can be raised. In determining the level of debt, the main consideration lies in, as to how much funds the firm should raise in the form of debt capital to fund its operations. In analyzing the method of raising debt capital. emphasis is laid on whether the organization can go for short-term debt capital or long-term debt capital. Anal) sets prefer long-ter111 capital rather than going for sho11-term debt capital, as in case of short-term debt capital, sometimes. the debt matures before the profit is earned out of the proposed projects. Hence. the emphasis is on the long term debt capital. Next comes the decision on the sources of funds, whether they are from individuals, lending organizations, especially banks etc. The above decisions are intimate I, related. Since the decisions on the amount of debt capital are intimately connected with other business functions, the managers should call upon the advice of other functional execute Ives of the firm while making decisions. pa11icularly. in regard to sources from which the required funds can be generated.