Review of literature

Cash management is a broad term that refers to the collection, concentration, and disbursement of cash. It encompasses a company's level of liquidity, its management of cash balance, and its short-term investment strategies. In some ways, managing cash flow is the most important job of business managers. If at any time a company fails to pay an obligation when it is due because of the lack of cash, the company is insolvent. Insolvency is the primary reason firms go bankrupt. Obviously, the prospect of such a dire consequence should compel companies to manage their cash with care. Moreover, efficient cash management means more than just preventing bankruptcy. It improves the profitability and reduces the risk to which the firm is exposed. Cash management is particularly important for new and growing businesses. As Jeffrey P. Davidson and Charles W. Dean indicated in their book Cash Traps, cash flow can be a problem even when a small business has numerous clients, offers a superior product to its customers, and enjoys a sterling reputation in its industry. Companies suffering from cash flow problems have no margin of safety in case of unanticipated expenses. They also may experience trouble in finding the funds for innovation or expansion. Finally, poor cash flow makes it difficult to hire and retain good employees. It is only natural that major business expenses are incurred in the production of goods or the provision of services. In most cases, a business incurs such expenses before the corresponding payment is received from customers. In addition, employee salaries and other expenses drain considerable funds from most businesses. These factors make effective cash management an essential part of any business's financial planning. "Cash is the lifeblood of a [store]," wrote Richard Outcalt and Patricia Johnson in Playthings. "Without cash for inventory, payroll, and other expenses, an emergency is imminent." When cash is received in exchange for products or services rendered, many small business owners, intent on growing their company and tamping down debt, spend most or all of these funds. But while such priorities are laudable, they should leave room for businesses to absorb lean financial times down the line. The key to successful cash management, therefore, lies in tabulating realistic projections, monitoring collections and disbursements, establishing effective billing and collection measures, and adhering to budgetary restrictions.

Capital Structure is a mix of debt and equity capital maintained by a firm. Capital structure is also referred as financial structure of a firm. The capital structure of a firm is very important since it related to the ability of the firm to meet the needs of its stakeholders. Modiglianiand Miller (1958) were the first ones to landmarkthe topic of capital structure and they argued thatcapital structure was irrelevant in determining thefirm¶s value and its future performance. On theother hand, Lubatkin and Chatterjee (1994) aswell as many other studies have proved that thereexists a relationship between capital structure andfirm value. Modigliani and Miller (1963)showed that their model is no more effective iftax was taken into consideration since taxsubsidies on debt interest payments will cause arise in firm value when equity is traded for debt.

Pinegar and Wilbricht (1989) discovered that principal-agent problem can be dealt with to some extent through the capital structure by4 increasing the debt level and without causing any radical increase in agency costs. Lubatkin and Chatterjee (1994) argue that increasing the debt to equity ratio will help firms ensure that managers are running the business more efficiently. Hence, managers will return excess cash flow to the shareholders rather than investing in negative NPV projects since the managers will have to make sure that the debt obligations of the firm are repaid. Hence, with an increase on debt level, the lenders and shareholders become the main parties in the corporate governance structure. Thus, managers that are not able to meet the debt obligations can be replaced by more efficient managers who can better serve the shareholders.

Warner (1977) argues that the potential bankruptcy costs a firm might face are reflected in its share price and this is taken into consideration by investors when they make investment decisions. Bankruptcy costs refer to the costs associated with declining credit terms with customers and suppliers. It can be argued that suppliers would not be willing to give long term credit terms to the firm as the latter faces the risk of default and similarly, customers would avoid buying products and services from a firm facing a high risk of default since warranties and other after sales services will be void or at risk.

Lang, Stulz and Walking (1991) uses the Tobin¶s q as a proxy to determine the quality of investment. Firms with a high µq¶ showed that firms were using their free cash flows to invest in positive NPV projects whereas firms with low µq¶ showed that firms were investing in negative NPV projects and therefore, the free cash flows should instead be paid out dividends to the shareholders. As a whole, this study is in line with the free cash theory and was considered as very reliable among economists.

Jensen (1989) states that when free cash flows are available to top managers, they tend invest in negative NPV projects instead of paying out dividends to shareholders. He argues that the compensation of managers with an increase in the firm¶s turnover. Hence the objective of the company is to increase the size of the firm by investing in all sorts of projects even if these projects have a negative NPV. Dorff (2007) argued that compensation of managers tend to increase when there is an increase in the firm¶s turnover.

Therefore, linking the ownership structure to management can solve the principalagent problem. This is in line with Smith (1990) who carried a study on 58 Management Buyouts of public companies during the period of 1977 to 1986. His findings revealed that there exists a positive relationship between management ownership and the performance of the firm. This study also provide empirical evidence that increase in operating profits result from the decrease in operating costs and the proper management of working capital of the firms. This is in line with Lichtenberg and Siegel (1990).

This paper is a review of the literatures on capital structure and provides empirical evidence that here exists a relationship between the capital structure and ownership structure of the firm. Economists have not yet reached a consensus on how to determine the optimal capital structure (debt to equity ratio) that will enable firms to maximise performance by simultaneously dealing with the principal-agent problem. Taking into consideration the shortcomings of both equity 7 and debt financing, it can be argued that debt financing is better as it allows tax deductibility on interest payments and also provides a mechanism to control the activities of managers.

Therefore, the coefficient _2 is expected to be negative and in this case, it will support the idea that agency costs can be reduced by giving shares of the firm to its managers.

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