Market Structure and Financial Leverage: Does Market Power Affect Debt and Equity Decisions?

By Kare, Dilip D.; Price, Donald I. | Akron Business and Economic Review, Summer 1990 | Go to article overview
Save to active project

Market Structure and Financial Leverage: Does Market Power Affect Debt and Equity Decisions?

Kare, Dilip D., Price, Donald I., Akron Business and Economic Review

Market Structure and Financial Leverage: Does Market Power Affect Debt and Equity Decisions?

The issue of capital structure has been a subject of intense debate among researchers for the last quarter of a century. Various theories have been developed to explain the way a firm chooses its capital structure. These theories make predictions that range from the Modigliani-Miller [10] assertion that, in the absence of corporate taxes, capital structure has no effect on the value of a firm, to the proposition that, in the presence of taxes, the optimal capital structure is 100% debt (Modigliani and Miller [11]). But neither of the theories explains the "real world" behavior of firms. It has been observed that firms choose a capital structure that lies somewhere between the two extremes mentioned above. This has led to the belief that there may exist such a thing as an "optimal" capital structure that includes both debt and equity.

A large body of empirical research provides evidence that supports the view that firms do choose a capital structure that includes debt and equity and that there is a significant amount of commonality in capital structures (regarding the choice of financial leverage) of firms operating in the same industry. This finding implies that while different industries may exhibit widely differing capital structures, firms in the same industry choose capital structures that are similar. In an earlier study by Scott [12], inter-industry differences in financial leverage were shown to be far more significant than intra-industry differences.

Researchers have used a number of factors - both firm specific and industry-wide - to explain a firm's choice of a particular level of financial leverage. DeAngelo and Masulis [5] presented a hypothesis regarding the relationship between a firm's non-debt tax-shields and its capital structure. Boquist and Moore [1] investigated this relationship at the firm level and concluded that such relationship between these two variables is exactly opposite of the one hypothesized by DeAngelo and Masulis.

A more recent study by Bradley, Jarrel, and Kim [2] provided empirical evidence that, in addition to the firm's non-debt tax-shields, its expenditure on advertising and R&D will influence the firm's choice of financial leverage. Their findings also confirmed the results of the Chaplinsky [3] investigation that showed a link between the variability of firm value and its choice of leverage. It should be noted, however, that the Bradley, Jarrel, and Kim study [2] was based on firms classified according to the two-digit SIC code. In contrast, the analysis we present in this paper is based on firms grouped according to the four-digit SIC code.



Weston and Copeland [14], among others, mention sales stability and variability in earnings as two major influences affecting a firm's choice of capital structure. The conclusions of microeconomic theory strongly suggest that firms in highly concentrated industries, where significant entry barriers exist, enjoy more stable sales and earnings than do firms in less concentrated industries, where lower entry barriers are dominant. This suggests that a firm's market power in its industry may have a significant effect on the firm's choice of financial leverage. The purpose of this study is to test the hypothesis that the choice of financial leverage by a firm is influenced by the market structure of its industry.

Empirical research on this issue has produced contradictory results. Sullivan [13] and Hurdle [7] each found an inverse relationship between the level of concentration and a leverage ratio, debt to total invested capital. Melicher, Rush, and Winn [9], however, were unable to find any relationship between financial structure and levels of industry concentration. Sullivan [13] and Melicher, Rush, and Winn [9] examine mean leverage ratios for firms in various industry concentration intervals.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Cite this article

Cited article

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

Market Structure and Financial Leverage: Does Market Power Affect Debt and Equity Decisions?


Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?