Capital Structure in the Modern World Anton Miglo Capital Structure in the Modern World Anton Miglo Capital Structure in the Modern World Anton Miglo Nipissing University, Ontario, Canada ISBN 978-3-319-30712-1 ISBN 978-3-319-30713-8 DOI 10.1007/978-3-319-30713-8 (eBook) Library of Congress Control Number: 2016940577 © The Editor(s) (if applicable) and The Author(s) 2016 This work is subject to copyright All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made Cover illustration: Cover image © CVI Textures / Alamy Stock Photo Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Springer International Publishing AG Switzerland To my parents Alla and Viktor Preface Capital structure is a very interesting and probably one of the most controversial areas of finance It is an area of permanent battles between different managers defending their favorite approaches, between theorists and practitioners looking at the same problems under different angles, and between professors and students since the area is complicated and requires a superior knowledge of econometrics, microeconomics, accounting, mathematics, game theory etc Many of the results obtained in capital structure theory over the last 50–60 years have been very influential and led their authors to great international recognition Among the researchers who contributed significantly to capital structure theory, note Nobel Prize Award winners Franco Modigliani, Merton Miller, Joseph Stiglitz, and most recently Jean Tirole Although until recently capital structure theories did not have strong support from practitioners and were too complicated to teach at colleges and business schools, they are quickly gaining recognition at universities and in the real world This field has become extremely intriguing to potential employees and students The roles of investment banker and corporate treasurer, which require fundamental capital structure education, are very popular This book focuses on the microeconomic foundations of capital structure theory Some areas are based on traditional cost-benefit analyses, but most include analyses of different market imperfections, primarily asymmetric information, moral hazard problems and, more recently vii viii Preface developed, imperfections involving incomplete contracts Knowledge of game theory and contract theory prior to reading this book is beneficial but I aim to present the material in the most accessible way possible, with lots of examples for readers with different levels of knowledge For additional readings in the field of capital structure, I recommend Capital Structure and Corporate Financing Decisions (edited by Baker and Martin, 2011) and Financing Growth in Canada (edited by Halpern, 1997) Both of these editions have a more applied approach to capital structure, including empirical research and econometrics, and cover a lot of interesting topics relating to capital structure and financing decisions I would also recommend the journalofcapitalstructure.com website dedicated to capital structure discussions This book attempts to explain the basic concepts of capital structure as well as more advanced topics in a consistent fashion The first part is focused on providing an introduction to the major theories of capital structure: Modigliani and Miller’s irrelevance result, trade-off theory, pecking-order theory, asset substitution, credit rationing, and debt overhang I think that the majority of the basic ideas in capital structure compliment each other quite logically although significant disagreement between researchers still exists about which theory is more important in practice Part II discusses such topics as capital structure and a firm’s performance, capital structure and corporate governance, capital structure of small and start-up companies, corporate financing versus project financing and examples of optimal capital structure analyses for some companies Many advanced theories of capital structure discussed in Part II are still growing areas of research At the same time, the objective of the book is not to cover as many topics of capital structure as possible but rather to review the major theoretical concepts and provide basic tools to understand the complicated area of capital structure Many of the existing ideas of capital structure were created by “injecting” a new type of market imperfection into different capital structure analyses From my experience, the comprehension of this fact is crucial to understanding the theory of capital structure At the beginning of my PhD studies I was spending a lot of time explaining to my adviser why debt financing and equity financing create different degrees of risk for a company At the time, I was surprised not to see an extremely enthusiastic Preface ix reaction to my “discoveries” from my PhD adviser who was mostly pointing to the importance of market imperfections in my research When teaching capital structure in my classes, I am always primarily concerned with how well students understand the difference between perfect and imperfect markets The challenge for me has been to explain the importance of the marginal differences in models’ assumptions These differences are often responsible for large variations in models’ predictions and their capacities to explain existing empirical evidence It has been a fascinating experience for me to see how much progress students demonstrate in understanding different financial concepts This book was inspired by over 20 years of my experience in capital structure research I was also inspired by my experience with teaching finance courses at different universities in Europe and North America including courses directly related to capital structure such as Financing Strategies and Corporate Governance, Advanced Corporate Finance, Financial Management II, and Entrepreneurial Finance It was also inspired by my working experiences in areas of capital structure management including issuing stocks and bonds in commercial banks The financial crisis of 2008 and 2009 also provided extra motivation It seemed that many companies faced problems that stemmed from their financing policies Some discussions in this book are devoted to this topic Anton Miglo North Bay, Ontario, Canada References Baker, H., & Martin, G (Eds.) (2011) Capital structure and corporate financing decisions, Robert W. Kolb series in Finance John Wiley and Sons, Inc Halpern, P (Ed.) (1997) Financing growth in Canada University of Calgary Press .. .Capital Structure in the Modern World Anton Miglo Capital Structure in the Modern World Anton Miglo Nipissing University, Ontario, Canada ISBN 978-3-319-30712-1... microeconomics, accounting, mathematics, game theory etc Many of the results obtained in capital structure theory over the last 50–60 years have been very influential and led their authors to great international... the comprehension of this fact is crucial to understanding the theory of capital structure At the beginning of my PhD studies I was spending a lot of time explaining to my adviser why debt financing