Financing decision is the second most important decision that companies and their financial managers make. Financing decision is concerned with the study of the financing mix or capital structure of a company. One thing is to find investment opportunities and another thing is to source for finance that will help the project sees the light of the day- this is more important now that the global economy is facing serious financial hard times.
Finance professionals in the past struggle to strike a balance in a company’s financing mix in order to influence the market price per share of the company. Then, they had little challenges to face as funds were relatively available. The case today is however different as the global economy is currently facing a crunch. Some people call it global financial crisis, while others call it global economic crisis. Whatever name it is called is not the issue, what matters is the effect it is having on financing and financing mix or structure of companies. Financing decision has never been this hard in the history of mankind as it is today.
Many financing options has been greatly abused in the past thereby creating the impression in the mind of people that most financial instruments are in fact toxic in nature. Take the misuse of (SPE) special purpose entities by Enron as a classic example. The effects of all these put together has heathen the financing decision atmosphere for financial managers to carryout his/ her financing decision function.
As share prices continue to plummet (as at the time of this writing), the pressure from shareholders on financial managers continue to increase. This situation has now made it difficult for companies to go to the capital market for additional funds. As if this is not enough, the banking sector crisis also almost removed the other option available to financial managers (credit). The implication of the above situation is that striking an optimum capital structure has moved from being practically impossible to being theoretically impossible. The reasons for this assertion are stated below:
- Absence of cheap debt/ loan. The traditional view of capital structure suggests that the increase in the required returns on equity by shareholders will be offset by the use of more cheap debts. What then happens now that cheap debts/ loans has almost disappeared as a result of global economic crisis?
- Increase in bankruptcy cost. Apart from the legal and administrative costs associated with bankruptcy, losses due to inefficiencies that characterizes the operation of companies at the verge of bankruptcy as well as selling of assets at a price below their economic value will severely affect the quest for the attainment of optimal financing mix as both cost of debt and cost of equity will be on the increase. Especially now that corporate bankruptcy is on the increase.
Faced with the above problems, there is only one alternative that companies can employ in order to achieve a near optimal financing mix. And that option is to uphold good corporate governance. By good corporate governance, I mean: the presence of a functional and operational internal control backed by good business ethics, the presence of good working capital management and the presence of a transparent reporting system.
What the above implies indirectly is that financial managers may no longer have to focus more attention and energy on the pursuit of optimum capital structure. Financing decision in the face of global economic/ financial crisis should be made as natural as possible if a company really wants to achieve financing equilibrium. This is evidenced by the fact that investors and lenders will voluntarily give cash to the company to finance her investment opportunities if and only if the company is doing well judging from other economic indicators.
To your financing decision success!