The determinants of capital structure from a managerial perspective.

Abstract

This study ascertains financing behavior and Capital Structure determinants of a leading Jamaican corporation, Grace Kennedy Limited (GKL) in order to establish the extent to which the company follows the Static Trade-off theory (STOT), in which an optimal capital structure of the firm exists and can be derived by balancing the benefits of debt against costs associated with debt i.e. Bankruptcy costs and Agency costs and costs of underinvestment. STOT is compared with The Pecking Order theory (POT) which firm has no specific target debt ratio and capital structure is driven by the need of funds. The existence of Information Asymmetry, Signaling and relative costs associated with alternative methods and sources of funding lead the firm to have a preferred hierarchy for financing decision with the Internal Retained Earnings being preferred, followed by Debt and then Equity. GKL's financing behavior arguably follows the STOT, but more clear evidence supports the POT. The Firm has given preference toward the following funding sources and Corporate Principles, Financial Flexibility, Transactions Costs, Bankruptcy Costs, Credit Rating, Market Considerations and Timing are all seen as important fundamental factors (Determinants) in deciding about Capital Structure. Some concern is also given to Information about Asymmetry problems at international level. However, Agency Costs, i.e. Asset Substitutions, Wealth Transfers, and Over-investment are not found to be issues of major concern, as the Firm has good governance. Tax Shield benefits have no effect on the financial manager's decisions. Also an Industry Norm is not found to be important for GKL's Capital Structure decisions. The amount of debt in the Firm's capital structure is maintained at a low level according to a conservative policy. It is also driven by corporate strategic planning, and by the availability of profitable investments taking advantage of each funding source.