Corporate Finance, 6th Edition

Chapter 35WORKING OUT DETAILS: THE DESIGN OF THE CAPITAL STRUCTURE

Steering a course between Scylla and Charybdis

By way of conclusion to the part on capital structure policy, we would like to reflect once again on the thread that runs throughout this set of chapters: the choice of a source of financing.

We begin by restating for the reader an obvious truth that is too often forgotten: If the objective is value creation, then the choice of investments is much more important than the choice of capital structure. Because financial markets are liquid, situations of disequilibrium do not last. Arbitrage inevitably takes place to erase them. For this reason, it is very difficult to create value by issuing securities at a price higher than their value. In contrast, industrial markets are much more viscous. Regulatory, technological and other barriers make arbitrage – building a new plant, launching a rival product, and so on – far slower and harder to implement than on a financial market, where all it takes is a telephone call or an online order.

In other words, a company that has made investments at least as profitable as its providers of funds require will never have insurmountable financing problems. If need be, it can always restructure the liability side of its balance sheet and find new sources of funds. Inversely, a company whose assets are not sufficiently profitable will, sooner or later, have financing problems, even if it initially obtained financing on very favourable ...