Capital Structure and Corporate Strategy

This chapter responds to the general call for integration between finance and strategy by examining how financial decisions are related to corporate strategy. Finance allows organizations to quantitatively understand how a firm’s strategic initiative affects corporate value (Kochhar and Hitt 1998). With relatively few exceptions, strategic management and finance appear to be in a schizophrenic tension, if not in direct opposition (Ward and Grundy 1996). The polarity between finance and strategy, two areas of research that traditionally are studied separately, is apparent. These two areas present many connections. Thus, understanding the way in which these areas function individually and interrelate is relevant. In particular, the link between financial decisions and strategy is largely unexplored. An extremely relevant but controversial topic in the academic and business communities relates to capital structure decisions and their effects on the firm’s creation of value. A firm’s capital structure generally refers to the financing mix used to finance the firm. Based on the stylized facts about capital structure, many factors that result in benefits and costs influence the optimal mix between debt and equity. Firms that use debt as a source of finance can benefit from tax advantages as a result of the interest deductibility, reduction in asymmetric information, and managerial discipline. Some costs relate to the use of debt based on the presence of financial distress, agency problems, and loss of financial flexibility. The relationship between a firm’s management and its financial and nonfinancial stakeholders generates relevant information asymmetries and agency problems at the base of costs of financial distress and differences between “real” decisions and financing decisions. Therefore, the concept of value maximization is important to better understand the potential interrelation between capital structure and corporate strategy. In general, the literature on finance and strategy is concerned with the strategic actions of key players such as managers, shareholders, debt holders, competitors, workers, and suppliers that affect firm value and the allocation of value between claimholders.