A company can form its capital structure in such a way
in order to be able to fund its operations in the most efficient way. Some
firms select to fund their operations via debt (loans or bonds), while others
prefer to issue equity in form of common, preferred or restricted stocks.
Furthermore, a lot of companies use their internal funds, before they decide to
use external financing. I shall try to investigate the determinants of capital
structure in big European listed firms in Europe from 2002-2017. It is
important to detect what are the main determinants of the capital structure of companies
in every macroeconomic case (before crisis, during crisis, after crisis). Is
the pecking order or the static-trade off theory the theory that determines the
capital structure decision in different macroeconomic conditions? Additionally,
I shall examine the impact of macroeconomic variables, such as inflation and
the impact on interest rate and age on firm’s capital structure. I want to examine
which theory (pecking order, static tradeoff, market timing) is more
appropriate in different macroeconomic periods in big (by market
capitalization) firms in Europe area, because big firms can more easily issue
equity or debt due to their size. Also, information asymmetry is more intense on
big listed firms. Financial leverage determinants are important for the
investors, because by knowing them they can interpret more thoroughly firms
financial statements. In addition, managers want to know the impact of every
financial variable to the firm’s leverage, because they will be able to
influence more efficiently the total debt to total equity ratio.
In this part I will explain how I will try to answer
my research questions. I will use Datastream and Compustat to extract the
required annual report data, while I will download each country inflation data
from the world bank database. I shall investigate the period between 2002-2017
and I will divide the whole 15 years period into 3 sub- periods (2002-2007,
2007-2010,2010-2017). By this split I want to find out what are the basic
capital structure determinants in each period and if they change from each
period. The first period is characterized as a period with stable macroeconomic
indicators. The second period was determined by the biggest financial crisis
till the Great Depression of 1929 and it is called Great recession, while 2010-2017
is a period when many firms decided to change their corporate structure and
governance. I intent to select non-financial firms, because these firms are
closely regulated and they must keep an amount of capital according to Basel
and other international regulations. In the next stage I intend to separate
firms according to their industry and country.
Litzenberger (1973) stated that the actual tradeoff
between the tax shields and the cost for financial distress is a determinant
factor for the amount of debt that each firm should use to finance each
operation. Other important capital structure theory is the pecking order theory
from Myers and Majluf (1984), where
there is a hierarchy between internal funds, debt and equity that each firm can
use to fund its operations due to the information asymmetry between managers
and investors. Many academics have tried to point out the most important
determinants of the capital structure. Market timing is another capital
structure theory that states that firms capital structure decision is affected
by the stock market. Specifically, market timing theory states that firms issue
equity when managers think that the company is overvalued and repurchase equity
when they think that company is undervalued. This theory is supported by Baker and Wurgler(2002), whose findings
propose that “market timing has large, persistent effects on capital
structure”. Frank and Goyal (2009)
point out that profits, log of assets, expected inflation, tangibility, market-to-book
assets ratio and median industry leverage are the key determinants of firm’s
leverage. Profitability is another key determinant according to Fama and French (2002), while Hackbarth, Miao and Morellec (2006) add
macroeconomic dimension as the determinant for the financial leverage. Kieschnick and Moussawi (2017) stated
that firm age has a negative correlation with the financial leverage of a firm.
Non-debt tax shields are
another determinant of capital structure by many academics. Specifically, DeAngelo and Masulis (1980) point
out that the introduction of non-tax shields change the optimum percentage of
debt in a firm. Furthermore, Šarlija and
Harc(2012) state that there is negative
correlation between liquidity and financial leverage.
Writing my thesis I will try to understand what are
the most important factors in determining the capital structure of the firms in
Europe. Do the capital structure determinants change after the Great Recession?
Are there differences between industries in the same time
span? Are the macroeconomic variables a decisive factor for the capital
structure? What capital structure theory
is supported the most by the thesis findings? Some hypotheses that I shall investigate
are the following:
: There is a negative correlation between
liquidity ratio and financial leverage.
: There is a positive correlation between inflation
rate and financial leverage.
: After the Great Recession capital structure determinants
are closer to pecking order theory principles.
: There is negative
correlation between profitability and financial leverage.