Determine Optimal Capital Structure in New Paradigm


The Modigliani Miller (MM) third proposition described that the value of firm is not changed with respect of its financing decision (Debt, Equity) in the frictionless competitive market. They also took assumption for that there is no bankruptcy or financial distress cost, no tax and transaction cost. So the value of firm remains same whether it financed by equity or debt.

Since 1958, Modigliani and Miller's determining article, academics and researchers continuously tried to clarify how firms opt their capital structure. This general suspense exists if corporations are identifying an optimal capital structure then they could maximize their value by applying and sustaining that financial combination. A plenty of explanations had been presented to clarify why firms choose the capital structure they do. For instance, information between firm's mangers and financial markets is asymmetric. (Myers & Majluf, 1984), there is a tax shield between debt and non-debt expenses (DeAngelo & Masulis, 1980), and for maintaining discipline in management use debt (Grossman & Hart, 1982) have all been offered as explanations. This confusing mixture of answers lead Myers (1984), in his presidential address to the American Economic Association, to conclude that no clear solution exists as to why firms make certain choices concerning their debt/equity mix. Nobody provided the precise answer that is accepted generally of this puzzle (Norton, 1990). The entire subsequent development of corporate finance is the relaxing of MM assumptions that give us new way to think. If we take MM as a benchmark than we might understand when these decision may change the firm value.

The aim of this research is to explore, what the optimal level of capital structure that can maximize the firm value by using the existing research and different industries data (mixture of debt equity). I want to explore the firm might increase their value by using the optimal capital structure to remain...