Finance Essay Example | Topics and Well Written Essays - 3000 words

Finance - Essay Example The capital structures of the companies were affected strongly since the availability of debt capital financing as well as equity capital financing declined considerably. Under influence of the financial crunch firms reduced security issuance and financial institutions reduced issuance of loans by a large extent (Fosberg, 2012). Among many consequences, the major consequence faced by the firms was in their capital structure. The defaults of mortgage loans led to significant increase in debt amount of the firm’s capital structure. Results of recent research show that between the years 2006 and 2008 the market debt ratio (MDR) of the firms increased on average by 5.5 percent (Fosberg, 2012). The financial crisis was supplemented by severe recession in the US economy which boosted the soaring market debt ratios of the firms. If the effect of recession is removed then debt accumulation of the firms solely due to the financial crisis has been found to be approximately 5.1 percent ( Fosberg, 2012). This affirms the severity of the effect of the financial crisis on debt accumulation by the corporations and their capital structure. ... n capital structure made by the financial crisis, different factors were adjusted, such as, reduced profitability of the firm that resulted from recession. Although the effects cast by the financial crisis were major, the effects of recession were also huge and put significant effects on the debt capital financing by the firms. This paper evaluates the effects of the crisis critically from the points of view of three most recognized theories of capital structure and provides explanation with the help of real examples of companies that have suffered the impacts of the crisis. Literature Review Brigham and Ehrhardt (2002) explain in their book, Financial Management, that capital structure is one of the important instruments that allow firms to maintain control of its administration. Improper capital structure might be fatal for any organization. Capital structure relates to the various components of the financial policies made by the firms regarding investment activities (Jones, 2011). It is related to bankruptcy risk that high leverage firms might face during financially instable times. While the use of more leverage magnifies returns for equity holders, the downside threat of holding a large amount debt is very high. Therefore, firms should carefully consider their capital structure in their financial policies (Gunay, 2002). Debt financing The proportion of debt financing in the capital structure of a firm differ between firms and also depend on the existing capital structure. The type of debt incurred and the extent up to which the debt is extended are decided by the factors such as the cost of the debt and its availability to the firm. Without taking bonds into consideration, debt financing can be categorized in to two types, namely, financial credits and trade