The Cost Of Capital Structure Essay

903 Words Aug 28th, 2016 4 Pages
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). Debt Coverage: The debt coverage is usually measured by the ratio of operating income to interest expense and it shows the ability of a firm to make interest payment from its yearly operating income. 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…

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