The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Theory and Practice of Optimal Capital Structure
Foreword
Introduction
Theory and Practice of Corporate Risk Management
Theory and Practice of Optimal Capital Structure
Introduction to Funding and Capital Structure
How to Obtain a Credit Rating
Refinancing Risk and Optimal Debt Maturity
Optimal Cash Position
Optimal Leverage
Introduction to Interest Rate and Inflation Risks
How to Develop an Interest Rate Risk Management Policy
How to Improve Your Fixed-Floating Mix and Duration
Interest Rates: The Most Efficient Hedging Product
Do You Need Inflation-linked Debt?
Prehedging Interest Rate Risk
Pension Fund Asset and Liability Management
Introduction to Currency Risk
How to Develop Currency Risk Management Policy
Translation or Transaction: Netting Currency Risks
Early Warning Signals
How to Hedge High Carry Currencies
Currency Risk on Covenants
Optimal Currency Composition of Debt 1: Protect Book Value
Optimal Currency Composition of Debt 2: Protect Leverage
Cyclicality of Currencies and Use of Options to Manage Credit Utilisation
Managing the Depegging Risk
Currency Risk in Luxury Goods
Introduction to Credit Risk
Counterparty Risk Methodology
Counterparty Risk Protection
Optimal Deposit Composition
Prehedging Credit Risk
xVA Optimisation
Introduction to M&A-related Risks
Risk Management for M&A
Deal-contingent Hedging
Introduction to Commodity Risk
Managing Commodity-linked Revenues and Currency Risk
Managing Commodity-linked Costs and Currency Risk
Commodity Input and Resulting Currency Risk
Offsetting Carbon Emissions
Introduction to Equity Risk
Hedging Dilution Risk
Hedging Deferred Compensation
Stake-building
In this chapter we will give a brief overview of the theory of optimal capital structure of the enterprise, and how companies apply it in practice. As in Chapter 1, there is a significant gap between theory and practice. In the broadest sense, finding the optimal capital structure means determining what proportion of the firm’s capital should come from various sources. For instance:
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what is the optimal split of equity versus debt (ie, optimal leverage)?
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what is the optimal split of debt between bank loans and bonds?
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what is the optimal split of debt between secured and unsecured? and
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should the company have any convertible bonds or other hybrid sources of capital?
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Various forms of capital have different expected cashflows, different treatment upon default of the company, different tax and accounting treatment and different implications in terms of the relationship with the stakeholders of the company. The vast majority of academic research is devoted to the first question (optimal leverage), and we shall now focus our attention on this issue.
PLAN OF THE CHAPTER
We start by summarising the main steps we take
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