Is debt a substitute of equity? Relevancy of financial policy in current economic scenarios

Muhammad Ayub Mehar

Applied Financial Economics, 2005, vol. 15, issue 5, 337-366

Abstract: It is concluded in this study that debt and equity are not alternative sources of finance, they have been proved as complementary sources of finance. The study is based on a theorem. According to the theorem, leverage ratio of a company depends on its operational and financial activities including sales, profits, inventories and working capital. The validity of the theorem has been tested through Global 500 companies. The combination of debt and equity may vary from industry to industry. However, debt cannot be applied as a substitute of equity. The results suggest that financial structures of companies need an overhauling and entire system of financial regulations should be changed. A standardized combination of debt and equity will be helpful in optimal allocation of financial resources.

Date: 2005
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DOI: 10.1080/0960310042000314188

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