In India, firms are found with different financing policies. The capital structure decision of
a firm is concerned with the determination of debt-equity composition. Proper planning of
debt- equity mix is required as it has an impact on shareholders' earnings and risk. Various theories
of capital structure have been propounded in explaining the relationship between market value
of the firm and its capital structure decision. In practice, planning an optimum capital structure
is the most difficult task as the decision is influenced by myriads of factors, which are
highly psychological, conflicting, complex and qualitative in nature, thus adding to the woes of
financial executives. The "right" capital structure supports strategic-financial goals, while also
optimizing flexibility and minimizing cost. This article intends to examine the capital structure planning
of Indian companies with different risks and its impacts and also discusses a model for building
an optimum capital structure which is more relevant and pragmatic.
Risk management is the process of
identification, assessment, and prioritization of risks to
minimize, monitor, and control the probability and impact
of unfortunate events. The firm's decision for use of debt
in the capital structure affects certain risks,
namely, Financial Risk (FR) and risks arising out of
"Non-Employment of Debt Capital", generally called NEDC Risks. The risk arises out of the use of
the debt capital while the latter is the outcome of the use of only equity or more of equity and less
of debt in the capital mix. To put it in another way, debt capital has both advantages
and disadvantages. These advantages and disadvantages are experienced when the firms make use
of debt in their capital structure. Use of equity form of financing only takes away the
advantages associated with the debt financing. In other words, equity holders would sacrifice some
benefits/returns and the benefits foregone would represent the opportunity cost of using equity
capital. The NEDC risks form the subject matter of
these foregone costs/benefits. |
