Research Proposal on "Influence of Advertising Expenses and Brand Value on Capital Structure"

Research Proposal 15 pages (4478 words) Sources: 15 Style: Harvard

[EXCERPT] . . . .

Capital Structure is an important aspect of a company's overall business strategy and dynamics. In addition, marketing is an essential aspect of an organizations overall health. The purpose of this literature review is to examine the influence of advertising expenses and brand value on Capital structure. Let use begin this discussion by defining capital structure, advertising expenses and brand value.

Capital structure, advertising expenses and brand value

Capital Structure is defined as "The makeup of the liabilities and stockholders' equity side of the balance sheet, especially the ratio of debt to equity and the mixture of short and long maturities ("Capital Structure")." According to Kochhar (1996) capital is a significant resource for any company and the supply of capital is often uncertain. The author explains that this ambiguity makes it possible for financiers to exercise control over the company. The author further insists that "the two major classes of financial liabilities-debt and equity-are associated with different levels of benefits and control (Kochhar, 1996)."

Additionally, Michaelas et al. (1999) asserts that various studies have concluded that "the combination of leverage related costs and the tax advantage of debt, produces an optimal capital structure below 100% debt financing, as the tax advantage is traded against the likelihood of incurring bankruptcy costs (Michaelas et al. 1999)." Even though, this theoretical assertion is commonly accepted, the question that it poses is whether or not the different gearing related costs and benefits are considerable enough to have a substantial influence on optimal capital structure (Michaelas et al. 1999).

The capital structure that a company chooses is dependent upon different factors including, the industry membership, and the capital structure strategies of competitors and the extent of capital needed. As it pertains to industry membership, some industries require a company to raise higher amounts of capital than others. For instance the automobile industry requires a great deal of capital. As such the capital structure for an automobile company may be quite different than the capital structure of a company in another industry.

The capital structure of a company is also determined by the capital structure adopted by the capital structure of competitors. That is, companies within the same industry often have a similar capital structure. These similarities are usually present so that companies can remain competitive. For instance if one company has a capital structure that is dominated by debt but the other companies have a capital structure that is dominated by equity, an imbalance is present.

The capital structure is also determined by the amount of capital needed. Companies need to raise capital for any number of things including research and development, marketing, and improvement of customer service. All of these factors are essential to ensuring that a company has the tools that are needed to be successful and realize the goals of the enterprise.

The research further explains that there are two characteristics of the relationship between the level f a company's debt and the company's dealings as it pertains to input and output markets (Kale & Shahru, 2006). Kale & Shahru, (2006) base their research on the hypothesis. The first of which asserts that a company has the capacity to utilize a lower level of debt in its capital structure to persuade both suppliers and customers to accept relationship-specific investments (Kale & Shahru, 2006).

The researchers explain that the premise of this hypothesis can be found in studies conducted by Titman (1984) and Maksimovic and Titman (1991). In the work conducted by Titman (1984) it is asserted that a company that presents a unique product may necessitate that customers undertake investments that decrease in value if the company is forced to liquidate (Kale & Shahru, 2006). In this type of environment, lower leverage ensures that the company will have a liquidation policy that considers the outcome on its customers. Additioally, customers may not be enthusiastic about having a relationship with a company that is highly levered, which is also less likely to be concerned about its status (Maksimovic and Titman, 1991; Kale & Shahru, 2006). The researchers "apply this intuition to R -- S investments by suppliers and customers and hypothesize that firms that expect their suppliers/customers to undertake R-S investments will carry lower levels of debt (Kale & Shahru, 2006)."

The second hypothesis presented by the researchers considers the connection between a company's decisions concerning of debt level and bargaining position when compared to its suppliers and customers (Kale & Shahru, 2006). The researchers hypothesized that the findings of the research would be consistent with previous studies concerning the role of debt in management -- labor union bargaining (Kale & Shahru, 2006). Previous research in this area asserts that increasing the debt level also "increases the management's bargaining power vis-a' -vis a labor union by reducing the amount of firm surplus available for sharing with labor. Specifically, the researchers hypothesize that a firm may choose a higher debt level when it faces suppliers/customers who have relatively higher bargaining power. The empirical implication of this hypothesis is a positive relation between a firm's debt level and measures of supplier/customer negotiation power (Kale & Shahru, 2006)." Overall the study found that

"the firm's leverage is negatively related to the R&D intensities of its suppliers and customers. There were also lower debt levels for firms operating in industries in which strategic alliances and joint ventures with firms in supplier and customer industries are more prevalent. Consistent with a bargaining role for debt, there a positive relation between firm debt level and the degree of concentration in supplier/customer industries (Kale & Shahru, 2006)."

The literature review thus far has demonstrated the importance of capital structure as it pertains to the overall strategy of a firm. As it pertains to the management and development of a capital structure, there are several factors that must be taken into consideration. The first consideration is the type and quantity of capital that the firm necessitates to carryout business activities. Once this is understood, the type of financial instruments that will be used must be determined. That is a company must decide whether to finance operations with debt or equity. Debt financing usually involves the acquiring of loans. On the other hand, equity financing involves the issuing of stocks and bonds. The type of structure that is utilized will determined the company's capital structure.

In addition, companies must take into consideration the types of capital structures that other firms in the industry have adopted. That is, companies must develop and management a structure that is not too expensive or to inexpensive when compared to other firms in the industry. This is one of the ways in which a firm can remain competitive.

Capital structure is also important for those that desire to invest in a company. That is potential investors examine the type of capital structure that a company utilizes through the examination of certain ratios. These ratios include the debt ratio, the equity ratio and/or the debt to equity ratio. In many instances potential investors simply examine the debt/equity ratio. This particular ratio reflects the amount of capital that is financed through debt. The higher the debt/equity ratio, the more debt instruments that the company utilizes to finance operations. The average debt to equity ratio differs depending on the industry. In some instances a high debt to equity ratio is not alarming because of the industry that the company is a member of. In other instances, a high debt/equity ratio symbolizes that the company is highly leveraged in debt that is not justifiable based on the industry that the company is a member of. Investors who are weary of the capital structure that that has been adopted by a company will be less likely to invest in the company.

Advertising Expenses

Advertising is an extremely important aspect of marketing within any company. Depending on the industry of a company, advertising capital is at the forefront of a business strategy. Advertising is so important because it introduces consumers to a particular product or services. In many instances advertisements allow companies to introduce their brands to the public. According to Bagwell (2008)

"By its very nature, advertising is a prominent feature of economic life. Advertising reaches consumers through their TV sets, radios, newspapers, magazines, mailboxes, computers and more. Not surprisingly, the associated advertising expenditures can be huge. For example, Advertising Age (2005) reports that, in 2003 in the U.S., General Motors spent $3.43 billion to advertise its cars and trucks; Procter and Gamble devoted $3.32 billion to the advertisement of its detergents and cosmetics; and Pfizer incurred a $2.84 billion dollar advertising expense for its drugs. Advertising is big business indeed (Bagwell, 2008) ."

Advertising expenses may be inclusive of both television and print media. It is also inclusive of other types of advertising that requires resources. In most instances companies take advertising expenses into consideration when choosing the type of capital structure that will be adapted. Companies within certain industries may be a bit more dependent upon advertising than others. As such… READ MORE

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