MADHAV LUTHRA 1520468 5BBA-D

Capital Structure Decisions: Research in Estonian Non-

The subjects related to companies capital structure have belonged to a range of the main
research topics among scholars and practitioners for a long time. The fundamental question is
whether the companies manage their capital structure knowingly (trade-off theory) or the
observed capital structure is a result of a random process resolute by historical profitability,
investment options, dividend policy and capital market conditions (pecking order and market
timing theories).
Till date there is no consensus. Many scholars argue that, neither traditional pecking order nor
trade-off theory provide satisfactory description of capital structure choices in practice. In the
past, there have been several studies which have concluded that companies do have a target
leverage ratio which they pursue in the long run, but pecking-order behaviour seems to
dominate over short-run capital structure decisions.
Purpose of this study is to inspect the relations between company-specific financial factors and
the capital structure decisions of Estonian non-financial companies and to scrutinize behavioral
differences between companies of dissimilar sizes.
A total of 260 Estonian non-financial companies divided into small, medium, and large
companies, each sample being analyzed by correlation-regression method in two aspects
Impact of financial factors on static capital structure and capital structure dynamics.
The main finding of research was capital structure decisions among Estonian non-financial
companies are driven by the pecking order theory, the evidences supporting optimal capital
structure choices in long run remain weak and the robustness of the pecking order behaviour
significantly differs between smaller and bigger companies.
Limited number of companies were surveyed due to hard manual work required to adjust
financial accounts. Implication of findings was somewhat limited as the study covered only a
single country.
The paper helps to identify financial drivers and to understand motivations behind capital
structure decisions of emerging market companies Capital structure was adjusted for operating
leases and quasi-equity debt to identify true amount put at risk and its mix between owners and
external lenders.

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MADHAV LUTHRA 1520468 5BBA-D

Stock Market Reaction to Strategic Investment Decisions

Investment managers in the olden times managed their firms funds and make decisions
which improve the long-run functioning of their business however we have now seen a reverse
in trend as fund managers these days are forced to manage the fund in order to meet the
demands of the market.
Historically, stock prices reflect all public information and respond rapidly to the release
of such information and in a informationally informed market, stock prices response to
corporate announcements represent the markets sentiment to those particular announcement.
This led to the formation of the Share-holder Value maximization hypothesis which predicts
that stock market will react positively to such corporate announcements. As opposed to this the
Institutional Investors hypothesis has the exact opposite prediction.. It believes that the large,
powerful investors focus on quarterly decisions rather than manager strategies aimed at long-
term advantage of the business. A third hypothesis called the Rational Expectations
hypothesis predict that the stock market will not react quickly or strongly to corporate strategic
announcements of investment decisions.
The Institutional investors hypothesis predicts the negative reaction of the stock market
because the larger and long term investments have a detrimental effect on short-term
profitability and profits from such investments will bear fruit in the longer-run.
To test the hypothesis, a sample of articles were taken from the Wall Street journal for a
period of 15 years. The sample included a total of 767 announcements by 248 companies in
102 industries.
The results from the study strongly supported the Shareholder Value Maximization i.e.
when corporations announced their strategic investment decisions, the stock market usually
reacted quickly and positively. In some cases, investors did react negatively as well which
proved that investors differentiated between good and bad investment decisions and did no
behave monolithically.
Hence the findings based on the study has several implications for further research. They
indicate a strong relationship between strategic investment decision announcements and stock
market valuation. The results of this study also have implications for practitioners. The
managers of successful companies need not worry about the stock market as they formulate te
business and corporate strategies. They can rest assured that long-run investment projects will
create substantial value for stock holders. Based on the results from this study, managers can
go ahead by making announcements of big investment strategies and then not fulfilling them
in order to shoot the prices and manipulate the market, but in the long run they too would suffer
from such unwise acts. In fact, based on the study managers who take long-term decisions
based on investment do not get penalised by the stock market and get rewarded in the long-
run. Also, it assures corporates that their managers do not have to think about constituents like
the stock market before making any such long-term investment/financial decision.

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MADHAV LUTHRA 1520468 5BBA-D

The Financing Preferences of Small Firm Owners

The article mainly focuses on the thought process of small firm owners and their financing
decision making. The author states that it is quite problematic for small owners and
entrepreneurs to raise funding from banks and other financial institutions and there would
always be a difference between the demand of for funding and funding support. Thus, owing
to the above mentioned factors, the owner has to carefully select between debt and equity for
his/her financing needs.
The gap discussed above is not due to the shortcomings of the capital market in the respective
economy but due to the inability of small firm owners to understand its functionality and
principles. They have unrealistic expectations of deals which involve the introduction of new
equity. Thus it was seen that small firm owners relied more on debt rather than equity, which
in turn burdened them with excessive levels of debt. In order to further test this theory,
Remmers and Schulman conducted comparative studies and reached different conclusions. The
first study discovered that debt/total asset ratio was independent of the firms size which the
other study indicated the debt/total asset ratio to first rise and then fall as firm grew in the
future. Holmes and Kent felt small owner-managed companies operate with higher levels of
debt as compared to larger firms and rely heavily on short-term debt.
The method adopted by the author involved directly investigating the financing preferences of
small firm-owners using a postal questionnaire. The author also sought to incorporate age and
size of the business, two related variables that are associated with the financial structure.
Initially 185 new businesses all less than four years old were included in the survey. All
business employed less than 100 employees. In the end more businesses such as manufacturing
industries were added to bring in more diversity. The survey reached a total of 555 firms
spanning the entire small scale industry. The overall response rate was 34 percent in line with
expectations.
The author from the above conducted research concluded that debt levels in small firms reflect
a demand side preference ordering and are not just a manifestation of supply side deficiencies.
The owners do appear to have a set of preferences over funding sources which are independent
of nature and size of business and do not rely on financial structures or balance sheet. Internal
funding sources are most preferred. Though the conclusion seems apt, the author could have
relied on data from other economies as well since he only relied on information provided by
industry sectors in New Zealand. Also this research was conducted in the 1990s and with the
advancement in the financial sector, the conclusion may not hold any present relevance.

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