Explain the following factors affecting the choice of capital structure of a company :
(i) Control
(ii) Regulatory framework
Explain the following factors affecting the choice of capital structure of a company :
(i) Control
(ii) Regulatory framework
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Solution and Explanation
Capital structure is the mix of owners funds (equity) and borrowed funds (debt) used by a company. The management chooses a mix that suits its needs.
Control and the regulatory framework both limit this choice.
Step 2: Factor (i): Control:
Equity shareholders have voting rights. If a company issues more equity shares, the control of existing owners gets spread over more people.
Debt holders have no voting right. So if the existing owners wish to keep control, they prefer to raise funds through debt.
Step 3: Example for control:
A family firm that fears losing its hold may take a bank loan rather than issue shares to the public.
A firm that does not mind sharing control may raise more equity.
Step 4: Factor (ii): Regulatory framework:
Every company works under laws and rules. These decide who can raise what kind of funds and how much. For example, banks and financial institutions must follow rules on the capital they hold.
Rules of the Companies Act and SEBI also guide issue of shares and debentures. The company must stay within them while setting its capital structure.
Step 5: Example for regulatory framework:
A company may not be able to issue preference shares or debentures beyond what the law allows, or it may have to meet norms on debt before borrowing.
So the rules narrow down the choices open to the management.
Final Answer:
The wish to keep control pushes a company towards debt, and the legal framework fixes the limits within which it can choose its capital structure.
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