DYNAMICS OF FIRM’S MARKET VALUE, CAPITAL STRUCTURE AND RISK

ABSTRACT Since the literature started to relax the Modigliani and Miller (1958) assumptions, the existence and significant effects of factors of market imperfections (i.e., agency costs, asymmetrical information, corporate taxes, bankruptcy costs, transaction costs, and firm characteristics) have become a reality in today’s capital markets. This paper examines the dynamic relationships between changes in firm’s capital structure and their effects on firm’s market value under the prevalence of three different levels of systematic risk; high, medium, and low. The underlying assumption is that when a firm changes its capital structure, it actually changes the relative position and the market values of its capital suppliers ’ securities holdings resulting in changes in the degree of systematic risk the firm is exposed to. As for the effects of the risk factor, other studies in the literature included the risk factor as one of the factors/determinants of firm’s capital structure. This means that the other studies (1) could not show but the static effects of risk, (2) mix up the effects of low risk securities and high risk ones. As for the determinants of capital structure, the paper examines a comprehensive number of factors that have been examined or pointed out i