Relationship Between Tangibility And Leverage

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Tangibility: Tangibility represents a firm’s investment in fixed asset as a component of total asset. Tangible assets are broadly accepted determinants of capital structure because fixed assets provide security to the capital provider by directing a claim against capital erosion. Information asymmetry between borrowers and firms increases the agency cost of debt which can be reduced by using adequate tangible assets that may serve as collateral to issue debt (Jensen & Meckling, 1976). This is obvious because firms with greater tangible assets are more capable to service their debt than their peers with fewer tangible assets. Thus, tangibility may be positively related with leverage. TOT also suggests a positive relationship between tangibility and leverage because collateralized debt reduces the cost of fund and thus induces firms to use more debt to get more tax shield benefit. We calculate tangibility as total fixed asset divided by total asset following previous studies (Rajan & Zingales, 1995; Jamal et al., 2011; Teker et al., 2009; and Lima, 2009). …show more content…
Therefore, debt coverage ability of a firm could be positively related with leverage. Hence, higher debt level increases bankruptcy cost and eventually the possibility of bankruptcy (Baral, 2004). Agency theory suggests that a firm can reduce agency cost by using more debt than equity. Thus, agency theory indicates that firm with greater debt service capacity use more debt and capitalize the opportunity to reduce agency cost of equity. Moreover, static trade-off theory suggests that optimal debt level is attained when present value of tax shield benefit completely offsets bankruptcy related cost of

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