Subject The article reviews static and dynamic trade-off theories of capital structure and empirical study results related to revealing the main determinants of optimal leverage. Special focus is on direct and indirect costs of bankruptcy. The reviewed theoretical models do not provide a complete idea of how to take into account the effect of tax shield and financial distress costs when making practical decisions related to capital structure. Objectives The aim of the study is to examine the adjusted present value (APV) approach to substantiate the optimal capital structure. Methods The analysis of the evolution of capital structure theories after the Modigliani-Miller theorem shows that there are difficulties in practical application of theoretical results. To review the possibility of practical use of conclusions on static and dynamic trade-off models, I test the APV approach on the case study of PAO Rostelecom. Conclusions and Relevance The findings demonstrate that the determination of debt capacity may be perceived as a powerful tool to manage corporate financial flexibility. Testing the APV approach at PAO Rostelecom shows that the current financial leverage is within tolerable limits. Despite the weaknesses of the APV model, such as difficulty to estimate probabilities of default and cost of financial distress, the obtained results allow financial managers to make more informed decisions on capital structure management.
Keywords: capital structure, trade-off theory, bankruptcy costs, APV approach
Modigliani F., Miller M. Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Review, 1963, vol. 53, no. 3, pp. 433-443.
Kraus A., Litzenberger R.H. A State-Preference Model of Optimal Financial Leverage. Journal of Finance, 1973, vol. 28, iss. 4, pp. 911-922.
Warner J.B. Bankruptcy Cost: Some Evidence. Journal of Finance, 1977, vol. 32, iss. 2, pp. 337-347.
LoPucki L.M., Doherty J.W. The Determinants of Professional Fees in Large Bankruptcy Reorganization Cases. Journal of Empirical Legal Studies, 2004, vol. 1, iss. 1, pp. 111-141.
Altman E.I. A Further Empirical Investigation of the Bankruptcy Cost Question. Journal of Finance, 1984, no. 39, pp. 1067-1089.
Bhabra G.S., Yao Y. Is Bankruptcy Costly? Recent Evidence on the Magnitude and Determinants of Indirect Bankruptcy Costs. Journal of Applied Finance & Banking, 2011, vol. 1, no. 2, pp. 39-68.
Ang J.S., Chua J.H., McConnell J.J. The Administrative Costs of Corporate Bankruptcy: A Note. Journal of Finance, 1982, vol. 37, no. 1, pp. 219-226.
Betker B.L. The Administrative Costs of Debt Restructurings: Some Recent Evidence. Financial Management, 1997, vol. 26, no. 4, pp. 56-68.
Bris A., Welch I., Zhu N. The Costs of Bankruptcy: Chapter 7 Liquidation versus Chapter 11 Reorganization. Journal of Finance, 2006, vol. 61, no. 3, pp. 1253-1303.
Gilson S.C., John K., Lang L. Troubled Debt Restructurings: An Empirical Study of Private Reorganization of Firms in Default. Journal of Financial Economics, 1990, no. 27, pp. 315-355.
Lawless R.M., Ferris S.P. Professional Fees and Other Direct Costs in Chapter 7 Business Liquidations. Washington University Law Quarterly, 1997, vol. 75, pp. 1207-1236.
Lubben S.J. The Direct Costs of Corporate Reorganization: An Empirical Examination of Professional Fees in Large Chapter 11 Cases. American Bankruptcy Law Journal, 2000, vol. 74, no. 4, pp. 508–552.
Tashjian E., Lease R.C., McConnell J.J. Prepacks: An Empirical Analysis of Prepackaged Bankruptcies. Journal of Financial Economics, 1996, vol. 40, pp. 135–162.
Thorburn K.S. Bankruptcy Auctions: Costs, Debt Recovery, and Firm Survival. Journal of Financial Economics, 2000, no. 58, pp. 337–368.
Weiss L.A. Bankruptcy Resolution: Direct Costs and Violation of Priority of Claims. Journal of Financial Economics, 1990, vol. 27, iss. 2, pp. 285-314.
Andrade G., Kaplan S.N. How Costly Is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed. Journal of Finance, 1998, vol. 53, no. 5, pp. 1443-1493.
Chow D., Pham T. Some estimates of direct and indirect bankruptcy costs in Australia: September 1978–May 1983. Australian Journal of Management, 1983, no. 14, pp. 75-95.
Kwansa F.A., Cho M. Bankruptcy Coast and Capital Structure: The Significance of Indirect Cost. International Journal of Hospitality Management, 1995, vol. 14, no. 3–4, pp. 339-350.
Fischer E.O., Heinkel R., Zechner J. Dynamic Capital Structure Choice: Theory and Tests. Journal of Finance, 1989, no. 44, pp. 19-40.
Ameer R. Financial Liberalization and Firms’ Capital Structure Adjustments Evidence from Southeast Asia and South America. Journal of Economics and Finance, 2013, vol. 37, no. 1, pp. 1–32.
Getzmann A., Lang S., Spremann K. Target Capital Structure and Adjustment Speed in Asia. Asia-Pacific Journal of Financial Studies, 2014, vol. 43, no. 1, pp. 1-30.
Yamada K. Inter-Firm Relationships and Leverage Adjustment. SSRN Electronic Journal, 2013, no. 5. doi: 10.2139/ssrn.2067775.
Bancel F., Mittoo U. Cross-country Determinants of Capital Structure Choice: A Survey of European Firms. Financial Management, 2004, no. 33, pp. 103-132.
Brounen D., De Jong A., Koedijk C.G. Capital Structure Policies in Europe: Survey Evidence. Journal of Banking & Finance, 2006, vol. 30, iss. 5, pp. 1409–1442.
Myers S. Interactions of Corporate Financing and Investment Decisions: Implications for Capital Budgeting. Journal of Finance, 1974, vol. 29(1), pp. 1-25.
Damodaran A. Applied Corporate Finance. 3rd Edition, Wiley, 2010, 752 p.
Teplova T.V., Getalova A.S. Rabota na zaemnom kapitale: optimum dolgovoi nagruzki kompanii: ot teoreticheskikh kontseptsii k prakticheskim model'nym obosnovaniyam (chast' 2) [Work on borrowed capital: company’s optimal leverage: from theoretical concepts to practical model grounding (part 2)]. Upravlenie korporativnymi finansami = Corporate Finance Management, 2013, no. 5, pp. 262–279.
Anyukhina I.M., Ivaninskii I.O., Kataeva E.V., Ozornina O.V., Serebryanskii D.V., Shmidt-Rost M. Otsenka optimal'noi struktury kapitala kompanii OAO “Uralkalii” i Kali&Salz AG [Assessing the optimal capital structure of OAO Uralkali and Kali&Salz AG]. Korporativnye finansy = Corporate Finance, 2008, no. 4, pp. 88–105.