Introduction to Finance

Control of the Firm
Common shareholders receive dividends and have voting control 
of the fi rm. Additional equity issues will likely reduce per-share dividends and dilute control. 
If shareholders worry about control, they may force a fi rm to use more debt fi nancing and less 
external equity fi nancing.
Profi tability
Firms with above-average profi tability can reduce fl otation costs and 
restrictive debt covenants by relying on internal equity to fi nance capital budgeting projects. 
More-profi table fi rms tend to use less debt fi nancing.
Financial Market Conditions
A fi rm can minimize its fi nancing costs by issuing debt when 
interest rates are near cyclical lows, especially if economists forecast rising rates in the future. 
Likewise, it is advantageous to issue stock when stock prices are high rather than depressed.
Management’s Attitude toward Debt and Risk
When push comes to shove, it is people, 
meaning the management team, who decide about fi nancing policy. Some management teams 
may be more conservative and hesitant to issue debt; others may be more aggressive and will-
ing to increase the fi rm’s fi nancial leverage. Their judgment and expectations for the fi rm’s 
fi nancial future will aff ect the fi rm’s capital structure.
DISCUSSION QUESTION 3
Since its founding, Facebook has had very little long-term debt on its balance sheet. 
You’ve been hired as a consultant to Facebook’s board. Explain if you would recommend 
a change in Facebook’s capital structure policy—and why.
LEARNING ACTIVITY
1. Professor Edward Altman’s website contains links to research on bond default rates 
and fi nancial distress: http://www.stern.nyu.edu/~ealtman.
2. Cutting-edge research on capital structure issues and many other fi nance topics can 
be found from the links on http://www.ssrn.com/update/fen/, the home page of the