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• W46584329 abstract "ABSTRACTThis study examines the impact of capital structure on the performance of listed firms in the European region by considering different systems of legal protection. Based on 5,050 listed firms in eight European countries, the results of the study reveal that owners in low level of legal investor protection countries are more likely to use the firm 's capital structure to serve their own interests. In the case of high level of legal protection the results indicate that debt is used as a disciplinary tool to constrain the expropriation of private benefits.JEL: K4, F23KEYWORDS: Capital Structure, Financial Performance, Legal Protection, Financial Behavior, Leverage(ProQuest: ... denotes formulae omitted.)INTRODUCTIONDuring the last half century we have witnessed the development of financial theories that emphasize the importance and impact of financial structure on firm performance. In their seminal work, Modigliani and Miller (1958) lay out the foundations of modem corporate finance by developing a theory that helps us understand factors that determine the firm's capital structure decisions. They demonstrate the value of a firm is independent of its capital structure and consequently there is no correlation between leverage and firm value in a world without taxes, agency conflicts, bankruptcy and transactions costs. Modigliani and Miller (1963) show that when taxes are introduced into their model the value of a leveraged firm is enhanced by the tax shield provided by the tax deductibility of interest payments on corporate debt. Under this condition, the value of the levered firm equals that of the unlevered firm plus the value of the debt tax shield.Following Modigliani and Miller, several other theories have set out to explain the capital structure choices of firms and their impact on firm value such as the pecking order theory, the free cash-flow theory, the trade-off theory and the agency cost theory. Jensen and Meckling (1976) propose in their agency cost theory the usage of debt as a disciplinary tool to ensure the performance of managerial staff. Doing so serves the best interests of shareholders specifically when control and ownership are separated. Thus, higher debt leads to reduce free cash-flow waste by managers (Jensen, 1986).Stulz (1990) confirms this effect by indicating that reduction of free cash-flow may decrease the cost of overinvestment and hence increase firm value. However this can also exacerbate the cost of underinvesting by leading managers to reject value enhancing projects. Accordingly, the trade-off theory (Myers, 1984) states that the benefits and costs of capital sources must be traded off until the benefits (e.g. tax advantages) of debt offset the costs (e.g. financial distress) of debt. In Myers (1977) model debt may cause underinvestment in future opportunities, specifically when debt-holders capture most of the investment return while shareholders bear most of the cost. A crucial assumption for this to happen is that the project is equity financed and outstanding debt matures after the return of the new investment is realized so that the increase in the value of bond-holders claims resulting from this project is an excess of its NPV. In this situation debt will have a negative impact on firm value by creating a conflict between shareholders and debt-holders. Therefore, Myers suggests the use of short-term debt may be a better option to avoid the distortionary effects on investment of such conflicts.The pecking order theory (Myers and Majluf, 1984) advances the underinvestment argument further by emphasizing the effects of informational asymmetries. For example, if managers' information about the value of the firm is superior to that of the market, firms should finance their investments in a hierarchal order giving priority to sources of capital that reveal the least information; i.e. using retained earnings followed by external financing. …" @default.
• W46584329 created "2016-06-24" @default.
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• W46584329 date "2015-03-01" @default.
• W46584329 modified "2023-09-24" @default.
• W46584329 title "The Impact of Financial and Legal Structures on the Performance of European Listed Firms" @default.
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