Capital Structure and Firm Value: Analysis of UK Firms, 1970-2018

This report investigates the relationship between capital structure and firm value among UK listed firms from 1970 to 2018, utilizing panel data and STATA software for analysis. The study examines how changes in capital structure, including debt and equity, influence firm valuation, considering factors like exchange offers and recapitalizations. The analysis employs various econometric models, including pooled regression, error component models, and Hausman tests, to address potential biases and capture heterogeneity. The findings suggest a positive relationship between firm value and leverage, supporting the debt tax shield effect, although empirical support for the capital structure-firm value link is limited. The report also discusses limitations in the data, such as the availability of market forecasts and data dynamics and the implications of these limitations on the analysis. The study references relevant literature, including works by Masulis, Baltagi, and others, to support its theoretical framework and empirical findings.

CAPITAL STRUCTURE & FIRM VALUE:
We examining the effects of marginal structure of capital and value of firm among listed firms
of U.K . Given data used accounting data at Firm-level for the period 1970to2018. the data
samples of various private companies upon market value assets profit debt etc are collected
from 1970 to 2018 & this sample period was selected to mitigate the investigation on
CAPITAL STUCTURE AND FIRM VALUE .Reports are focused on these certain industries and
period.
All given data are panel data by nature .Firms are heterogeneous and cross section , time
series data cannot able to control its heterogeneity and have a risk of obtaining bias
result .Whereas panel can capture unobserved heterogeneity and can control heterogeneity
problem . We are using STATA software to analyses our result. Here we used restricted model
or pooled regressing to know between group variations. Here we are using Error component
model to capture the essence of heterogeneous firm or within group variation and to solve the
endogenity problem which creates biasness in result . we are decomposing our error term
either one way or two way. We need to do decompose because the random disturbance is
suffers from non zero covariance .estimating by OLS is not be efficient so we have to transfer it
in such a manner so that random error has no autocorrelation .First difference model has
limited use .LSDV(least square dummy variable ) treats heterogeneous part as dummy variable
from this we got ISIN specific variation .
From the regression result shows all the dependent variables has positive relation with the
dependent variable. Here capital structure of a firm consist firm’s debt and equity which reflect
the value of a firm. Here we have stock price but don’t have equity related information to
estimate firms value or capital structure. Coefficient are same in almost all regression. if the
value of rho is zero or nearly equal to zero it indicates the sample is not very heterogeneous
and here In our regression result rho is 0 .20032247 so we can say our sample data is not
much heterogeneous .
Wald chi square statistics used to test the hypothesis of background theory that at least one
of the regression’s predictor coefficient is not equals to zero .prob >chi2 is the probability of
getting a wald statistics as extreme. The p -value compare at alpha level, by which we
accept a type I error up to 10% error is acceptable .If p value is lower than 0.05 then we can
say there is a statistically significant relation between independent variable and variable
dependent variable(Baltagi, B.H., 1981).
And finally by applying Hausman test we choose appropriate model for our data between fixed
effect model and random effect model .Our result suggest as p value is more than 0.05 so we
are rejecting the null hypothesis here and by this result we can say random effect model is
appropriate for our given data .
Adj. R square and R square are same , it reflect honest association between dependent and
independent variable and if Root,MSE is close to zero it will be considered as better fitted .

The change in structure of capital and the value of firm relation has little support empirically.
Firm value and leverage should be positively related which attributes a debt tax shield effect.
The change in capital structure is inspect through exchange offers, and recapitalizations. In
initial days of a month most of the exchange offers are open which typically comes with a pack
of brand new securities with larger value of market in terms of previously – announced prices
of exchange offers than these exchange tender .
Most of the exchange offers maximize securities in numbers and maximize the offer duration
than can be exchanged, which can be accepted by a min number of security holders.
exchange offer totally are different from recapitalizations because all the effected security
generally opted recapitalization. It happened at isolated time point. Most are directly effected
security holder approved recapitalization. Firm’s asset structure is uncorrelated with capital
structure change because capital structure change, exchange offers and recapitalization
involves no cash inflow / outflow.
In a firm the Exchange Offers has an effect of the value of Common Stock of the firm .
Recapitalization and exchange offers exist because of
i) the margins in debt tax shields,
ii) margins in the costs of leverage &
iii) implicit information , expectations on revised earnings of firms (Masulis, R. W.,1983)
change of the common stock's value are measured by old riskless securities & the debt level
directly .marginal value of common stock is not equal to the marginal value of the firm .
Change in preferred stock has convert into protective & incomplete contract for old securities.
Change in firm’s market value , disbursements of cash making security holders use tender
and alter firms' old securities price which changes in the exchange offers and recapitalization
and certainly affect the stock price.
Adjustment in any structure of capital alteration of the level of debt along with corporate and
liabilities of tax , security holders for payments of interest of marginal debt and premium
creation(Masulis ,R.,1978) .
The value of marginal interest of shield of tax of a firm almost identical the marginal benefit of
tax / dollar of debt and its multiple by the marginal present value of interest as future
payments .Debt issued by the firm aggregately expected marginal tax of debt is zero for each
firm.
tax , leverage cost effect and Information is the reason for any change in capital structure due
to change in debt for change in market value of firm . No debt tax shields exist where , the
change in debt level is equivalent to the summation of the recent payment value of debt
interest and discounted tax on premium subtraction is multiplied by the change in value of
the firm ( dollar) of subtraction of tax .

at optimum level of debt of a firm , the expected value of marginal tax effect is . a * is exactly
same as the expected value of marginal cost of leverage is b so here this is the strong reason
that a * will be is always positive .As b is monotonically decreasing function of debt now If a*
greater than b a firm could expand its value through increasing its debt and if a* less then b firm
could expand its value by diminishing its debt (Masulis, R. W.,1983).
Now assuming that investor are rational and able to predict max valuation of the firm and also
able to do must marginal debt level , except abrupt change happened in our the environment or
in the firm. Before-tax earnings new information could changes the expectation of the firm ,
leverage costs or shield of tax of non debt. Preceding changes in debt cannot involve
immediate change in bankruptcy law but alter the tax shield of the firm .this can be considered
as sudden changes before-tax earnings promise.
A debt level adjust by the tax +leverage cost effect when marginal earnings converted to
corporate tax. Generally this adjustment made a positive function of marginal level of debt .
Thus marginal debt influence the marginal market value of firm because to both tax &leverage
cost effects and information . But a debt change doesn’t reflect a decline in earnings of after-
tax and the earnings that decline due to tax + leverage cost effect reflect existence of a
costly shield of tax system. As different old securities faces different wealth transfer on seniority
basis, basis on convertibility and on contract protection price elasticity of them varies .
therefore market value of old securities are divided into classes like short term debt, debt that
are not convertible along with the protection of contract against the debt that are issued newly
without compensation and the debt that are not convertible without protection for the contracts
, debt that are convertible , and the stock that are preferred.
Limitations and source data :
Initial capital structure of a firm are traced through stock that are common, convertible , not
convertible and preferred , debt with short span of time, debt with long span of time anr
divided in to not convertible ,convertible, and unprotected & protected sectors.
To describe the margins of the structure of capital of a firm force margins in nominal values
of the debt with long term , premium problem and margins in involuntary liquid value of stock
that are preferred . Our data has numerous of limitations though the advantages of the
corporate tax for managing debt is over ratted , thus by biasing downward marginal debt
estimation could affect the nominal value of debt and liquid stock that are preferred when
market price are unavailable associating price elasticity because value of market are smaller
than their nominal value
Lacking market forecast means future market prediction is possible in a limited manner which
prevent the change in capital structure and force us to assume probability of market access is
zero . with limited prediction capabilities of market the time period of stock announcement
captures only abrupt changes of the structure of capital and value in absolute sense of the
dependent variable and the estimates of regression lowering bias along with this.

We have to face data limitation problem because all data we need for this analysis are not
easily available . The given data are Panel data it has dynamics but tremendous difficult to
calculate and as well as to mange .Data that strengthen our theoretical point of view and to
support our analysis .

Reference
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STATA RESULTS: