Corporate Debt Policy—Pre- and Post-financial Market Reforms: The Case of the Textile Industry of Pakistan

S. M. Amir Shah

Abstract


The literature provides evidence that the capital structure of
a firm is often a combination of several securities; it can arrange (1)
Bank loan (2) issue debentures/bonds, (3) issue shares (4) lease
financing, or (5) utilise its retained earnings. Eventually number of
ideas and theories has been developed to discuss the optimal capital
structure. Optimum is the trade-off between the benefit of tax and costs
of financial distress; a firm faces due to the borrowed money. Although
extensive research work has been done on the capital structure but still
it remains one of the unsettled topics in finance. Optimal capital
structure has an impact on corporate profits. Debt is considered as the
cheapest source of financing due to tax shield, higher the firm’s tax
bracket more the debt is advantageous to a firm. The trade off theory
states that higher debt is associated with higher profitability. Three
reasons support this theory; one debt allow tax shield. Second, more
trust is built on profitable companies considering more sustainable and
less prone to bankruptcy; hence high profitable companies are able to
seek more debt. Third, agency cost, for the profitable firms,
lenders/creditors give relaxation in monitoring charges, which reduces
the debt cost. This motivates profitable firms to go for more
debt.

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DOI: https://doi.org/10.30541/v46i4IIpp.465-478

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