This article throws light upon the top three factors of capital structure trend in the private sector. The factors are: 1. Debt-Equity Norms 2. Review of the Norms 3. Industry Practice.
Capital Structure Trend: Factor # 1. Debt-Equity Norms:
We know that the norm of debt-equity ratio is 2: 1. The same is also followed by various all-India Financial Institutions which granting credit in the private sector although there are certain relaxations which are:
(a) Capital intensive industries; (i.e… Paper, Cement, Aluminium, Fertilizer in the private sector maintain a debt-equity ratio of 3: 1 except Ship Building industry where the same ratio is around 6: 1 or even higher.)
(b) Very high cost project in the priority sector;
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(c) Projects in backwards area; and
(d) Project sponsored by technician entrepreneurs.
Capital Structure Trend: Factor # 2. Review of the Norms:
The normal Debt-Equity ratio 2:1 which has also been suggested by various all-Indian Financial institutions. The State Governments and the Association of Industry request the Central Government to relax the said debt-equity ratio norms.
Accordingly, the Government requested the Management Development Institute to carry out a survey about the debt equity ratio norms which are followed by the various all-Indian Financial Institutions, industries Government Agencies among others and to suggest a recommendation for the same.
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The study was carried out by Dr B. K. Madan, Chairman, Management Development Institute, New Delhi. He submitted the report in February 1977 which was published by the institute in January 1978.
The study has revealed that the debt-equity ratio norms of 2 : 1 which has been suggested by various financial institutions has been treated as a general guidelines or broad indicator rather than as a rigid one in order to assess the capital structure composition of firms either to increase of capital or financial assistance or for fresh issue.
But the large capital intensive industries are permitted to maintain the ratio of 3: 1 or even higher. At the same time, the small industrial projects are allowed some concessions, reliefs and aids which will help them to maintain very high level of debt in relation to equity for such purposes.
The following recommendations have been suggested by the study conducted by the Dr. B. K. Madan, Chairman, Management Development Institute, New Delhi:
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(i) The debt-equity norm of 2: 1 should be maintained for the purpose of good order in, and for facilitation of decision making, although the norm is considered at present a general indicator or a broad guideline relating to the matter for desiring long-term capital structure of a project, the same must be considered as much as practicable and not as a rigid one.
(ii) Whether the existing debt-equity ratio norm should be raised or not, the study suggested that there should hardly be a case for upward shift of the existing norm for such ratio.
(iii) The report also revealed that the application of multiple norms for various industries is neither desirable nor practicable i.e., one norm should be applied for all.
Capital Structure Trend: Factor # 3. Industry Practice:
The public sector enterprises (where the entire amount of equity is supplied by the Government and also major portion of the long-term debts) maintain usually a lower debt- equity ratio than the private sector enterprises as noticed by Dr. B. K. Madan.