Factors Affecting Capital Structure

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Factors affecting capital structure

a.    Constitution of the company

While deciding the capital structures, constitution of the company plays a very important role. If the company is a private limited company or a closely held company, control factor may play dominant role. If the company is public limited company or a widely held company, cost factor may play a dominant role.

b.    Characteristics of the company

Characteristics of the company in terms of its size, age and credit standing play very important role in the capital structure decisions. Very small companies and the companies in their early state of life have to depend more upon the equity capital, as they have limited bargaining capacity and they do not enjoy the confidence of the investors. As such, it is better for these companies to go for equity shares capital in the early years of life, increase the capital base, increase the bargaining capacity and then go for borrowed capital in the later years of their life. Similarly, the companies having good credit standing in the market may be in the position to tap the source of their own choice, whereas the choice may not be available to the companies having poor credit standing in the market.

c.    Stability of earnings

If sales and earnings of the company are stable and predictable in future, the company does not mind taking the risk and it can borrow the funds, as cost factor and control factor will play more important role. However, if the sales and earnings are not likely to be stable and predictable over a period of time and are likely to be subject to wide fluctuations, the risk factor plays an important role and the company will not like to have more borrowed capital in its capital structure.

d.    Attitude of the management

If the management attitude is conservative, the control factor and risk factor may play important role in the capital structure decisions. If the management attitude is aggressive, cost factor may play an important role.