(BQ) Part 2 book "Principles of corporate finance" has contents: Financing and valuation, understanding options, real options, valuing options, the many different kinds of debt, financial analysis, financial planning, working capital management, corporate restructuring,.and other contents. | pages 18 Part 5 Payout Policy and Capital Structure CHAPTER ● ● ● ● ● How Much Should a Corporation Borrow? I n Chapter 17 we found that debt policy rarely matters in wellfunctioning capital markets with no frictions or imperfections. Few financial managers would accept that conclusion as a practical guideline. If debt policy doesn’t matter, then they shouldn’t worry about it—financing decisions could be routine or erratic—it wouldn’t matter. Yet financial managers do worry about debt policy. This chapter explains why. If debt policy were completely irrelevant, then actual debt ratios should vary randomly from firm to firm and industry to industry. Yet in some industries, companies borrow much more heavily than in others. Look, for example, at Table . You can see that hotels and airlines are huge issuers of debt. On the other hand, high-tech businesses—such as biotech, software, and Internet companies—finance almost entirely with equity. Glamorous growth companies rarely use much debt despite rapid expansion and often heavy requirements for capital. The explanation of these patterns lies partly in the things we left out of the last chapter. We mostly ignored taxes. We assumed bankruptcy was cheap, quick, and painless. It isn’t, and there are costs associated with financial distress even if legal bankruptcy is ultimately avoided. We ignored potential conflicts of interest between the firm’s security holders. For example, we did not consider what happens to the firm’s “old” creditors when new debt is issued or when a shift in investment strategy takes the firm into a riskier business. We ignored the information problems that favor debt over equity when cash must be raised from new security issues. We ignored the incentive effects of financial leverage on management’s investment and payout decisions. Now we will put all these things back in: taxes first, then the costs of bankruptcy and financial distress. This will lead us to conflicts of .
