Which factor affecting the choice of capital structure influences the choice between debt and equity especially in companies in which the current holding of the management is on the lower side?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Control
Option (1) Control — Correct. Debt normally does not dilute control. A public issue of equity may reduce the management’s holding and make the company open to a takeover. So this factor weighs most where the management’s present holding is already low.
Option (2) Flexibility — Incorrect. Flexibility means not using the full debt capacity. The firm keeps some borrowing power to meet unforeseen situations.
Option (3) Risk consideration — Incorrect. Risk consideration looks at the business risk and the financial risk of the firm. If the business risk is lower, the firm can use more debt.
Option (4) Regulatory framework — Incorrect. Regulatory framework is about the rules of law a firm must follow, such as SEBI guidelines for a public issue of shares and debentures.
NCERT (2026-27 Edition): “10. Flexibility: If a firm uses its debt potential to the full, it loses flexibility to issue further debt. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances.” “11. Control: Debt normally does not cause a dilution of control. A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. This factor also influences the choice between debt and equity especially in companies in which the current holding of management is on a lower side.” |