Changes in Firm's Capital Structure add Shareholder Value Research Paper

Changes in Firm's Capital Structure add Shareholder Value - Research Paper Example The higher the level of debt the higher the level of risk. But nevertheless the higher the level of risk the higher the possible returns on a given level of investment. Shareholder value comes from the demand for and supply of company shares. If the management of the company were to decide in favor of more equity issues, then depending on the demand for the company shares the company value would rise or fall. With that, the shareholder value also would rise or fall. A risk is inevitably associated with the value of the firm viz. managers or agents always prefer a higher level of debt because it increases the value of the firm or its assets. Indeed the risk also increases though from the viewpoint of the manager it’s irrelevant because equity issues would glut the market with company shares and bring down the value of the company. As a result, the existing shareholders cannot be happier. They would get a windfall if they sold their shares now. Similarly when more debt is issued the company becomes entitled to more tax benefits. That, in turn, increases the value of the firm and thereby the shareholder value. The capital market structure of the firm can be examined with reference to a number of theories. The Modigliani-Miller Theorem is the earliest of such theories to consider the relevance of capital structure to determine the value of a firm. In recent times these theoretical constructs have been developed in line with an ever increasing tendency to consider the leverage issue of the company. Leveraging by managers to achieve exclusive personal goals is nothing new. In fact, it’s the conflict of interests between the principals or owners (or shareholders) and the agents (or managers) that have thrust the issue of leverage to the fore. In other words, the complex issues revolving around the capital structure of the firm are basically influenced by this conflict in which managers tend to have more information about the probable outcomes of future investments.