The impact of financial flexibility on capital structure decisions

Dissertation for Master's Degree

Major: Accounting

Research Abstract:

The purpose of this research is to examine the final value of cash for investors and to examine the relationship between financial flexibility and capital structure, as well as the impact of flexibility on capital structure decisions. In this research, the information of 94 companies during 6 years from 1983 to 1988 was tested for manufacturing companies. The hypothesis test is based on the panel method, the research method is correlational, and it is applied in terms of purpose. According to the first hypothesis, it was tested whether the final value of cash has a positive value in the Tehran Stock Exchange and whether investors value the financial flexibility of companies. The results showed that the final value of cash was positive according to Farkland's method and the final value of cash was not significant according to Clark's method. The results of the second hypothesis indicate that there is an inverse and significant relationship between financial flexibility and debt ratio. Also, the results of the third hypothesis also state that the final value of cash has the greatest impact on capital structure decisions. And the third hypothesis of the research is confirmed.

Key words: final value of cash, financial flexibility, panel, capital structure

1 Introduction:

The company needs capital in order to be established and it will need a larger amount of capital for development. The required funds are provided from various sources and in different forms, but all capital can be contracted into two main groups: loans and stocks

one One of the most complicated issues that concern current financial managers is the relationship between the components of the capital structure, which is a mixture of bonds and stocks to finance the company's stock price.

Deciding on the capital structure means how to finance the company, like other financial managers' decisions, affects the company's value. The company's value, like any capital asset, is based on the current value of its future returns based on a certain discount rate. is This discount rate to obtain the value of the company is the same as the cost of capital. Managers, as representatives of shareholders, should try to adjust the company's capital structure in such a way that the cost of the company's capital is minimal and, as a result, the value of the company and the shareholders' wealth are maximized. The funds that make up the capital structure are of two types. The second group inherits the rest of these flows, which are called ownership rights. The funds of the first group are cheaper than the second group due to the provision of a fixed yield for the creditors, but the more the company's debt increases, the risk of bankruptcy increases, and the shareholders, who provide the second group of funds and bear the costs in case of bankruptcy, demand higher returns. 

In the first chapter, the problem and the importance and necessity of the research are discussed, and also a short reference is made to the theoretical framework of the research and the purpose of the research is stated. The hypotheses and research questions along with the research model are explained in the following, and finally, in the first chapter, the definitions of concepts and specialized words are stated. 2-1 Statement of the problem Capital structure has been proposed as the most important parameter affecting the valuation of companies and for their orientation in the capital markets. The current changing environment has made the rating of companies in terms of credit somewhat dependent on their capital structure. This has brought their strategic planning closer to the selection of effective sources for the goal of "maximizing shareholders' wealth". (Douglas, 2001)[1]. Therefore, fluid factors and variables affecting the capital structure can affect the profitability and efficiency of companies in covering the aforementioned goal in the form of agency theory and compliance with hierarchy theory. (Warand, 1977) [2]. It is clear that the decision-making wave of financial managers in the context of compliance with the principle of matching when providing financial resources is considered a certain approach in adjusting the aforementioned decisions according to the requirements of the economic environment and is considered a suitable model for the prosperity and increasing effectiveness of the thinking governing the performance of companies (Sinai, Rezaian, 2016, p. 124).

Regarding the sources of financing, companies have different returns and risks in the field of capital markets. Therefore, the decisions related to the capital structure will have an effective role in the efficiency and credit of the companies with the capital providing institutions.But the importance of companies in terms of scope of performance, profitability, growth possibilities, size and type of activity will determine their diverse financial needs. In the meantime, sources from debt will increase their leverage and, as a result, their systematic risk, while increasing fixed costs. In addition, paying attention to the capital cost of different financing methods and paying attention to it will cause the emergence of suitable opportunities for profitability or the occurrence of a financial crisis for the company (Ravali and Seidner, 2001) [3]. Therefore, according to the characteristics governing the financial thinking of managers, it will register the main position of companies in the financial markets and their correct accreditation by the creditors of the capital markets.

Deciding on the capital structure is one of the most challenging and difficult issues facing companies, but at the same time it is the most vital decision regarding their continued survival.

Determining the optimal capital structure is one of the basic issues of financing companies. This matter has an important application in the field of decision-making regarding the financing of current operations and investment plans of companies. In the meantime, managers should pay attention to financial flexibility as one of the factors affecting the capital structure, companies in which management issues debt and increase debt without considering maintaining flexibility will lose potential investment opportunities in the future, and the result of this can cause serious threats to the growth and expansion of the company. Now this question is raised whether flexibility has an effect on capital structure decisions? And is the relationship between flexibility and leverage ratio reversed? And finally, the question can be raised whether flexibility is valuable from the point of view of investors? This research is trying to get a scientific answer to the above questions. 3-1 The importance and necessity of conducting research: The decision regarding the determination of the capital structure of each company not only forms the personality of the company, but also has a significant impact on the results of the performance of company managers.

Making a decision regarding the capital structure and its analysis and empirical analysis and choosing between debt and equity depends on the specific characteristics of the institution and it is very difficult that understanding the theory of capital structure can give managers the opportunity to achieve the optimal capital structure in order to maximize the wealth of shareholders.

The capital structure policy balances risk and profit. On the other hand, higher interest rate leads to higher expected rate of return. The risk associated with the use of more debt causes a decrease in the stock price, and on the other hand, a higher expected rate of return causes an increase in the stock price.

As a result, the optimal capital structure is the capital structure that maximizes the company's stock price, and this always occurs when the debt ratio is lower when it maximizes the expected profit per share and creates an optimal balance between risk and profit to maximize the stock price.

Managers should consider many criteria to make decisions about the capital structure of companies so that they can maximize the wealth of shareholders. Flexibility is a criterion that if company managers ignore it, it can cause liquidity problems and loss of investment opportunities, and finally, in very acute conditions, it can cause companies to fail to grow. Therefore, for the growth of companies, managers should look at flexibility as an output and all capital structure decisions should be to maintain or improve the company's flexibility. 4-1 Research Objectives: The most important goal of capital structure determination policies is to determine the composition of financial resources in order to maximize the wealth of shareholders, although this depends on several factors, of which capital structure is one of them. For example, if a company issues more bonds, it will break even. Its capital and financial leverage will increase. If the rate of return is higher than the interest rate, the profit per share will increase greatly (the effect of financial leverage). Capital structure determination policies help financial managers to determine the amount of profit before interest and taxes necessary to prevent the reduction of profit per share.