Capital Structure Is an Important

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 expenses associated with advertising may be more significant.

Although advertising costs can be substantial, it is essential that companies place significant amounts of funding into advertising. Such funding is necessary because it provides companies with a competitive advantage. According to Doraszelski & Markovich, (2007)

"Practitioners know very well the value of advertising to achieving their long-term market share and profitability goals. A survey of senior executives in 1999 reveals that 82.9% somewhat or strongly agree that good advertising can provide their company with an edge over the competition in the marketplace. Furthermore, 86.8% somewhat or strongly agree that advertising is a long-term investment that contributes to the financial growth and stability of their company (American Advertising Federation, 1999; Doraszelski & Markovich, 2007)."

The authors also explain that firms believe that advertising has the capacity to give them a sustainable competitive advantage over other firms (Doraszelski & Markovich, 2007). Nevertheless, dynamic models of advertising competition, assert that the opposite is true. these models suggests there is a "globally stable symmetric steady state (Doraszelski & Markovich, 2007). " Accordingly, differences among firms are bound to fade away over the long-term (Doraszelski & Markovich, 2007). Additionally, little room exists for a lasting competitive advantage (Doraszelski & Markovich, 2007). Competitive advantage is not lasting even if firms were to come into the market individual and as such differ in their strategic positions from the very beginning (Doraszelski & Markovich, 2007).

Advertising is an important part of any firm because it makes the public aware of the products and services available to them. As such capital spent on advertising is a vital aspect of a company's overall business strategy. In addition, advertising expenses have an influence upon capital structure because it requires capital and without it marketing strategies will fail.

Brand Value

Lastly brand value is defined as "the amount that a brand is worth in terms of income, potential income, reputation, prestige, and market value. Brands with a high value are regarded as considerable assets to a company, so that when a company is sold a brand with a high value may be worth more than any other consideration ("Brand Value")." According to Madden et al. (2006), in recent years a great deal of attention has been given to the importance of branding. The authors explain that the work of Aaker (1991) concerning the power of branding has greatly increased interest in this particular facet of marketing (Madden et al., 2006). The article also asserts that even though many executives now have a greater understanding of brand value, marketing executive sill face challenges associate with defining brand value from a financial standpoint (Doyle 2000; Lehmann 2004; Madden et al., 2006). The authors assert that "The lack of financial accountability "has undermined marketing's credibility, threatened marketing's standing in the firm, and even threatened marketing's existence as a distinct capability within the firm" (Rust, Ambler, Carpenter, Kumar, and Srivastava 2004; Madden et al., 2006)."

The research also suggests that there is a substantial link between brand value and the financial performance of a company. For instance, in a study evaluating the most valued brands conducted in 1995 and 1996, researchers found a positive relationship between financial brand values and market to book ratios. Additional studies found that the "Interbrand values are significantly and positively related to stock prices and returns. Using their own metric for measuring brand equity, Simon and Sullivan (1993) demonstrated that brand equity comprises a large percentage (more than 151%) of the replacement value of many firms. As they noted, Conchar, Crask, and Zinkhan's (2005) comprehensive meta-analysis provides evidence of a significant positive relationship between a firm's advertising and promotion spending and the market value of the firm, thus supporting the linkage between a firm's brand-building activities and the financial performance of the firm (Madden et al., 2006)."

There are two extremely important levels associated with brand value; the micro level and the macro level. As it pertains to the macro level (also known as the enterprise level) brand value influences the perception of investors and financial analysts, and subsequently plays a role in determining the stock prices of firms (Chu & Keh, 2006). On the other hand, at the micro level (also known as the consumer level) brand value has a positive influence on behavioral outcomes, such as purchase intent (Chu & Keh, 2006).

Since this is the case, the development of a brand has garnered a great deal of attention within many companies. Brand development has also necessitated a significant amount of corporate resources (Keller, 2003; (Chu & Keh, 2006)). The article asserts that brand management strategies are vital and are usually inclusive of a firm placing some assets in advertising and different promotional activities. Investments are also made in the area of research and development (Chu & Keh, 2006). The authors explain, "In leveraging brand equity, it is critical to understand the determinants that contribute to its creation (Chu & Keh, 2006)."

Chu & Keh, (2006) also explains that the "individual contributions of advertising, other promotional (e.g., consumer and trade promotions, event marketing, and sponsorships) and R&D expenses to brand value remain unclear. If firms spend too little, the returns should be positive. In contrast, if they spend too much, the returns should be negative. As such, the link between these expenses and brand value should not be linear. Rather, any deviation (positive or negative) from optimal spending should affect performance (Chu & Keh, 2006)."

Obviously, capital structure, advertising expenses and brand value are critically important issues confronting firms throughout the world. This is particularly true of multinational corporations that operate in several different regions of the world. Whatever the case may be for a firm, the type of capital structure that is adopted is essential to the current and future success of a firm. The capital structure must be designed in a manner that is conducive to meeting the overall goals of a firm and to the development of capital flows that are consistent with other companies in the industry.

Capital structure is also influenced by the source of the capital. According to Falukner & Peterson (2006) the tradeoff theory of capital structure assert that firms choose a leverage ratio by "calculating the tax advantages, costs of financial distress, mispricing, and incentive effects of debt vs. equity (Falukner & Peterson, 2006)." The literature has revealed that firms choose their capital structure using this theory predicts the structure by approximating firm leverage as a utility of a company's attributes. Additionally, companies "for whom the tax shields of debt are more significant, and the costs of financial distress is less significant, and the mispricing of debt relative to equity more favorable are expected to be more highly levered (Falukner & Peterson, 2006)."

When these companies understand that the end benefit of acquiring debt is constructive, they tend to embrace their favored capital structure by issuing further debt and/or decreasing their equity (Falukner & Peterson, 2006). The author further explains that the understood supposition has been that the leverage of a company is completely a function of the firm's demand for debt (Falukner & Peterson, 2006). That is, the provision of capital is considerably resilient when the price is correct and the cost of capital is dependent on the risk associated with the projects that the company takes on (Falukner & Peterson, 2006).

Even though the empirical literature concerning the aforementioned issue has been accurate, as it pertains to the proposed alternatives linked with firms' actual capital structure choices, other authors have posited that certain companies seem to be significantly under-levered (Falukner & Peterson, 2006). For instance,

"based on estimated tax benefits of debt, Graham (2000) argues that firms appear to be missing the opportunity to create significant value by increasing their leverage and thus reducing their tax payments, assuming that the other costs of debt have been measured correctly.1 This interpretation assumes that firms have the opportunity to increase their leverage and are choosing to leave money on the table. An alternative explanation is that firms may not be able to issue additional debt (Falukner & Peterson, 2006)."

The author further explains that the same type of market tensions that make capital structure choices pertinent such as, information asymmetry and investment distortions also mean that companies are controlled by their lenders (Falukner & Peterson, 2006). As such, when determining a firm's leverage, the variables that measure the constraints on a firm's ability to increase its leverage and the determinants of its preferred leverage it is important to must be taken into consideration (Falukner & Peterson, 2006).

Now that we have garnered a greater understanding of capital structure, advertising expenses and brand value, let us discuss in greater detail the influence of advertising expenses and brand value on Capital structure.

Influence of advertising expenses and brand value on Capital structure

The research already provided some evidence to suggest that both advertising expenses and brand value have an effect upon capital structure. The research suggests that advertising expenses can be substantial for a firm and as such capital must be raised to meet the obligations associated with these expenses. Additionally, brand value can great affect a firm's bottom line. The research asserts that there exists a positive correlation between brand value and the profitability of a firm. With these things understood, firms must choose a capital structure that understands the effect of advertising expenses and brand value on Capital structure.

Advertising, serves as a vital factor off marketing communications (Chu & Keh, 2006). Advertising is important because it has the capacity to improve brand name recognition and assist the firm in developing a reputation in a way that causes the brand to receive a higher price when compared to competing products that have identical physical features (Chu & Keh, 2006). From a strategic standpoint brand-based advertising can generates brand equity for companies because it has the capacity to make a distinction between the firm's product, and the products of its competitors (Chu & Keh, 2006). The authors also explain that "Advertising can also be viewed as an entry barrier, as the high amount of money needed to overcome the established brand loyalty of the incumbent may discourage some potential competitors from entering an advertising-intensive market (Ho et al., 2005; (Chu & Keh, 200))."

According to Singh et al., (2005) experts in the marketing field have long belived that advertising serves as a way of creating assets that are market based. These types of assets are important because they contribute greatly to shareholder wealth. The author explain that "Advertising promotes brand equity, which in turn generates financial value through enhanced cash flows attributable to customer loyalty, increased marketing efficiency, brand extensions, and higher margins (Keller 2002). The sources of such advertising-related cash flow augmentations are traced to price premiums (Farquhar 1989) and capturing greater market share (Singh et al., 2005)."

Singh et al., (2005) also asserts that a corporate branding strategy is different than a mixed branding strategy. This difference exists because the corporate branding strategy is positively correlated to corporate value (Singh et al., 2005). In addition, the existing literature posits that alterations in marketing spending are related to changes in stock prices (Singh et al., 2005). More specifically, there is a relationship between marketing strategies and the financial value of a firm (Singh et al., 2005). In addition, Joshi and Hanssens (2004) found that advertising has a positive, long-term influence on the market value of a firm.

These findings are quite important as it pertains to capital structure because capital spent on advertising has a positive impact on the market value of a company. That is there is a positive relationship between increases in advertising and other types of marketing and the financial strength of a company. This is significant because it means that equity instruments increase in value. This increase in value is beneficial to stockholders and it is also attractive to investors. In fact, Srivastava et al. (1998) points out that "advertising generates shareholder wealth by enhancing and stabilizing a firm's future cash flows. According to the authors, higher degrees of customer satisfaction, loyalty, and retention help reduce the variability of a firm's cash flows as its susceptibility to competitive or other market-based external shocks declines (Singh et al., 2005)." With this understood that capital structure of a company that has utilized equity instruments to finance operations will reap significant benefits from investing in advertising.