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Barclays PLC is the global financial services provider, providing a wide range of
financial services locally and internationally. Through its various subsidiary
companies, it provides financial services like retail banking, investment and
corporate banking, wealth management and credit cards (Barclay’s annual report,
2007). The Bank was established in the 17th Century as a partnership by goldsmiths.
During that period they acted as bankers by giving loans to merchants and
businessmen. Barclays PLC is the holding company of the Barclays PLC bank and
the ‘group’; Barclays PLC is listed on London Stock exchange, New York stock
exchange and Tokyo (

Banks and other financial institutions’ capital composition were distorted during
(2007-2009) due to the financial crisis; the effect of crisis brought special concern to
finance decisions; it was difficult for bank to lend each other due to liquidity problems
and tight economic conditions. Substantial amount of new capital from both private
investors and government had to be risen to rescue the situation (Acharya et al,
2011).The situation was real tough to even rise capital from markets due to down
turn and collapse of the market, governments had to intervene in some cases for
example U.K government became full owner of the Northern Rock after bank run
(Bank of England, 2007), also other banks like Lehman brothers failed due to

So what was the situation for Barclays PLC bank capital structure (2007-2010)?
This was the period when the world faced financial crisis. Did Barclay’s gearing level
decrease or increase? What happened to the share prices? Was there any capital
injection? Was it from government or elsewhere? This is what the authors are
interested to look at, and we will come back to this later.

On the other hand, the case study is intended to look at the applicability of capital
structure theories in the real world, does the optimal capital structure exists? It is all
about assessing the practical side of capital structure decisions. Try to see how
financial managers deal with capital structure decision to minimise the overall cost of
capital. Much attention and focus will be put in Barclays PLC Bank (2007-2010)
keeping in mind there was financial crisis within this period we are looking at.
Therefore we are concerned about Barclay’s bank PLC capital structure during the

Finance decisions are as important as investment decisions in maximizing

shareholders wealth. The financial decision has direct effect on Weighted Average
Cost of Capital (WACC) which is used in determining market value of the company
(Brealey,1995).The lower the WACC the better; It is very important for the
companies/firms to have good finance decision since poor finance decisions can
lead into business failure. When one speak of company finance decisions much
attention is focused on capital structure. The writers Keasey, Thompson & Wright
(2005), refer capital structure as being the way firms are financed. They imply that
funds may either be raised through others sources (i.e. Equity by issuing of shares or
Shot-term and long term debt) or by using profits earned by the company. We agree
with them as many other economists have similar definition to what capital structure
is. The firm can determine the value of the company by composition of equity finance
and debt finance. However, in order to find the value of each capital source one
must calculate the value of each source through determining the future flow of
benefits it brings. For example, equity capital will be valued by its future flow of
dividend while debt capital is through the summation of future flow of interest and
redemption payments (Lumby, 2011).

“Management who wish to maximize their company’s shareholders’

wealth should gear the company up to such an extent that its capital structure
would consist of almost entirely of debt capital, with very minimal equity
capital.” (Lumby, 2011)

However, Lumbys’ statement overlooks the fact that in real world there is bankruptcy
risk, agency costs and tax exhaustion. The question rise again what point mixture of
debts and equity will bring about optimal capital structure? Let’s turn back to
academic theories and see what it is said. There are several theories by different
economists who tried to analyse the concept of financing a company especially the
use of debt capital and equity capital. These theories will enlighten us on the matter.
Traditional Approach Theory

The traditional approach to capital structure depicts that there is an optimal capital
structure attained when financing a company. This is possible through the
application of debt finance to its capital structure; also the value of the company will
increase eventually (Watson, 2010). Whereas, the capital structure that involves the
deduction of the weighted average cost of capital and increasing the value of the
company is called optimal capital structure (Gregory, 2004). It has been
demonstrated that the cost of equity will increase as the company increases its level
of gearing (debt). At first the company will face a financial risk by shareholder’s and
as more gearing keeps increasing the company will face bankruptcy risk which will
eventually threaten the value of shareholders. Somewhere, between the increasing
in level of gearing and the cost of equity, the company will experience an optimal
capital structure and at that time the value of the company will increase. The
following diagram is going to assist with the explanation above.

Source: - Watson, D and Head A, (2010) “Cost of Capital and Capital Structure”;
Corporate Finance Theory and Practice, 5th Edition, FT Prentice Hall, pg.283.

Nevertheless this theory operates under the assumptions that; there are no taxes at
corporate or personal levels, company can be financed through debt and equity only,
and also a company can change their capital structure without the issue or
redemption costs. It also assumes the simultaneous increase and decrease of debt
capital and equity capital as one or the other changes.
Pecking Order Theory

This theory emphasises the use of internal financing rather than external source of
finance. A company should consider its internal source of finance or retained
earnings before outsourcing for external finance. In case its internal finances are
insufficient for its new project then it should use debt finance first before using equity
financing (Watson, 2010).

Watson (2010) further explains that, the reason for this is there is no issue cost, ease
of accessing the source of finance and there are no third party costs involved. He
says, with retained earnings there is no cost of attaining it and it is easy since the
funds are within the company. Also the second preference which is debt finance, the
issue cost is cheaper compared to equity financing which involves issuing of new
share and part ownership of the company. Based on Myers (1984), the pecking
theory preference of financing is due to the existence of asymmetry information
between the company and the capital market.

Miller and Modigliani’s Theories

The economists Miller and Modigliani (1958) theorem considered the irrelevance
proposition of capital structure. The theory viewed that in a business world where
capital markets are perfect, it is irrelevant of how the company’s capital structure is
composed or financed for its operations. They suggested that the market value of the
firm is determined by its performance or achievements and by the commercial risk
involving its activities. Also assumes that the value of the company in the market is
independent and cost of capital (i.e. the cost of equity and debt) is independent of
the way it chooses to finance its investments (Watson, 2010). The basis proposition
of M&M Theory was based on no taxes, no transaction costs, no bankruptcy costs,
equivalence in borrowing costs for both companies and investors, symmetry of
market information, meaning companies and investors have same information and
finally no effect on debt on company’s earnings before interest and taxes.
There are two basis of M&M Theory:-

1. Modigliani and Miller’s Capital Structure (Net Income Approach):

The theory assumes that there are no taxes and no bankruptcy costs to a
company because of perfect market. It was also commented that the
weighted average cost of capital (WACC) remains constant with changes
in company’s capital structure. There will be no changes or benefits to the
WACC, no matter how the firm borrows. Since, there are no changes
benefits from increase in debt (level of gearing), the capital structure does
not influence the company’s equity cost. It will be determined by the risk
free rate of return and business risk of the company. Using the arbitrage
theory Miller and Modigliani were able to illustrate how irrelevant capital
structure is in determining the market value and average cost of capital of
a company.
“Arbitrage theory states that, goods which are perfect substitutes
for each other should not sell at different prices in the same market.”
(Watson, 2010)
Therefore, Miller and Modigliani proposed that companies which are
similar in every way except their method of financing should have the
same value of average cost of capital and market value.

2. Modigliani and Miller’s Trade Off Theory of Leverage:

In 1963 Miller and Modigliani revised their theory where taxes were
involved at a corporate level. The theory assumes that there are benefits
in leverage within a capital structure and it is easy for a company to reach
an optimal capital structure. When a company finances through debt, the
interest paid on debt is tax deductible which in a way provides a shield to
the company’s profits.
Source: Jones,S (2009), ‘Paper on the potential impact of the financial
crisis on the UK companies’, Norwich Economic Papers, University of East
Anglia Norwich Economic Paper.

There are differences between the theories, as we saw in the first Miller and
Modigliani’s theory that there are no taxes in its capital structure composition
therefore it does not enjoy the benefits like the second theory by Miller and

Also with MM I theory suggested that it does not matter how the firm’s proportion of
debt and equity since there are no corporate taxes involved, while MM II theory
where there is corporate taxes the firm’s greater proportion in debt means more
benefit to the company because of the interest tax shield.

When dealing with MM I theory a proportion increase in the debt capital in a

company’s capital structure causes an increase in the return on equity to
shareholders. This is because the higher the debt level results to more risk for
investors in that company therefore, shareholders have to be paid a higher risk
premium by the company on the stocks. However it is said that the company’s
changes in the debt- equity ratio does not have an effect on the weighted average
cost of capital. On the other hand the MM II shows how a company may use the debt
capital more compared to equity capital due to the benefits enjoyed from the
corporate tax. This also means the greater the proportion of debt will lower the
weighted average cost of capital of the company.
Market Timing Theory

It’s not very common theory but it does have relevance. The theory suggests that the
prior attempts made to the equity market are the overall outcome of the present
capital structure. Market timing theory implies that, firms issue new shares when they
perceive they are overvalued and that firms repurchase own shares when they
consider these to be undervalued. Also it prefers external equity when the value of
equity is low. The company do not experience optimal capital structure so there
decisions accumulate over time. (Baker & Wurgler, 2002)

Authors are more convinced with traditional theory. Which agrees that gearing can
bring about optimal capital structure, at a certain point, although too much gearing
can increase financial risk and bankruptcy risk; Proper finance decision could be to
gear a company up to certain level keeping in mind risks. However, the theory did
not take into consideration tax and did not suggest what exactly proportion of debts
could bring about optimal capital structure. This remain the job of finance manager to
find out what level of gearing could minimise Weighted Average Cost of Capital of
their company taking into consideration business activities, regulation environment,
cost of raising fund and risk profile of the company. Large companies like Barclays
PLC are in better position to have more of gearing because of its creditworthiness
and advantages of cheap debts. Let’s come back to our main focus of Barclays
capital structure (2007-2010), keep in mind the financial crisis



(The Guardian, 2009)As the impact of financial crisis, there was drastically falls of
shares price towards 2008 and 2009; they fell from 32p to 98p which is said to be
lowest level since 1993.Fall in share prices affect market value of company since
market value of equity is obtained as a product of share price with outstanding
number of shares at that particular time. Although Barclays did not want to admit its
financial problems faced during this time, it could be seen clearly from market trend
how bad shares performed in this period of time. “Barclays had suffered a severe
loss of confidence following speculation that it faces further losses on hundreds of
billions of pounds worth of toxic investments” (The Guardian,2009).
Graph showing changes in share prices for Barclays for the period 2007-2010

Source: - Barclays PLC (BARC.L) viewed at 29th December 2012

As from the above graph, financial crisis impacted the Barclays PLC share prices
especially towards end of 2008 and in the beginning of 2009.The estimation is that
volatility in prices of shares moved from 25% to 45% between financial years 2007 t0
2009 (Barclays PLC annual report 2009).

The decrease in shares prices can be explained as result of the recession caused by
the financial crisis. In general, recessions associated with decreases in stock prices,
not only in Barclays but the situation was worse for the market as whole (source),
especially the companies with higher market risk. The situation began to improve
towards 2010 whereby the share prices began to rise given the starting of recovery
of the world’s economy and financial position. Moreover(Barclays bank PLC annual
report 2009,pg 18), “Ordinary share capital of Barclays Bank PLC was increased by
the issue to Barclays PLC of 4,388,000 ordinary shares during the 2009 financial
year this was credited as fully paid with £25m as cash consideration. Barclays PLC
owns 100% of the ordinary issued”. Furthermore there were capital injections from
Barclays PLC to Barclays PLC bank on year to year basis to strengthen the capital

Graph showing Long Term Debt levels For Barclays PLC from 2004-2012

Long Term Debt

Period (June 2003 to June 2012)

Source: Barclays viewed at 05/01/2013

As it can be seen from the graph, Barclays long term debt increased from 2006 to
2008 but there was drastically drop in amount of long term debt in 2009, but again it
rose towards 2010.The decreased of long-term debt capital could (probably) be as a
result of severe hit of financial crisis; As it was difficult to raise capital by issuing long
term debt securities in the capital markets. Barclays had also decrease the debt in
2009 level gradually by increasing the amount of equity (Barclays Bank PLC annual
report 2009).
3. Leverage ratio

Graph showing debt to equity levels for Barclays PLC from 2004-2010

Debt to Equity
Source: - Barclays viewed at 29/12/2012

As it can be seen from graph Barclays was highly geared before the 2007 crisis. In
another words Barclays took advantage of cheap debt finance to minimise its
Weighted Average Cost of Capital (WACC) with debt/equity ratio which reflect high
gearing although it was not 100% leverage as suggested by MM II theory .Debt is
said to be cheaper than equity due to ‘tax shield’ advantage as discussed by Miller
and Modigliani (1963).Again the administrative cost of issuing debt is low than equity
and pre-tax interest rate is low than shareholders required rate of return (Pike and
Neale,2009).However, in 2007 as from the graph the debt/equity ratio dropped as
the effect of crisis, meaning Barclays minimised its WACC with low gearing ratio and
it rose again in 2008.There is no peak point the leverage/gearing level keeps on
changing depending on circumstances like economic conditions, regulations and risk
profile of business. Basing on the above graph, authors suggest there is no statist
debt/equity ratio point to minimise cost of capital instead its dynamic depending on
circumstances. Moreover, it remains work of financial managers to find out how
much mixture of debts and equity would minimise the WACC.
Table showing Debt/ Equity Ratios: -

Ratios 2007 2008 2009 2010

Debt Securities in issue + subordinated 74395 114067 107034 133261
Shareholders’ Equity 22917 33879 47831 50045
Debt / Equity 3.25 3.37 2.24 2.66

Table 1:- Data extracted from Barclays Bank PLC annual report. Balance Sheet
2007, 2008, 2009 and 2010.

4. Capital Injection in 2008

(House of Commons, Treasury Committe, 2009)Barclays PLC was one of the banks
which did not raise fund from government package to support the banking sector in
October 2008, with this decision it avoided government partial ownership and
conditions subjected to it as it was the case for RBS and Lloyds banking group which
rose money from government. Barclays PLC raised its capital requirement from
sovereign wealth funds.

In 13th October 2008, the UK Financial Services Authority announced all UK banks
should raise additional new capital to reach the stronger capital targets set. In 31 st
October Board of Directors of Barclays announced the proposal for raising an
additional capital of £7.3 billion on which £4.3 billion could be raised by an issue of
Mandatory Convertible Notes (MCN) and £ 3 billion by issuing the Reserve Capital
Instruments (Barclays Capital Raising (2008)). The table below shows capital
injection and investors.
Source: - Barclays announces Capital Raising (2008) pg.6

However, there was critics as to why Barclays did not raise the fund from existing
shareholders rather it raised from sovereign wealth funds. Mr.Varley, for Barclays
defended that the situation was out of normal situation (2007 crisis), so to speed up
and increase the size of capital, they had to raise capital from elsewhere, but indeed
the opportunity to subscribe could be given to the existing shareholders if the
situation could be normal (House of commons, Treasury committee, 2009).

In summary, we have looked at how different theories explained about optimal

capital structure and we (authors) prefer traditional theory which suggested that
optimal capital structure could be obtained by gearing company to a certain level
taking into consideration financial and bankruptcy risks. Moreover we have looked at
Barclays capital structure (2007-2010) found that the bank is highly geared (from
data and graphs) meaning it minimise its WACC with high gearing although the
gearing level dropped to some extent during the crisis, meaning Barclays minimised
its WACC with low gearing during the crisis. We can conclude that it’s a work of
financial managers to look on how much to gear the bank taking into consideration
economic conditions, regulations environment and risks. In real world practise there
is no single static point for optimal capital structure (Barclays being our example)
contradicting with Traditional theory but again bank cannot be 100% geared because
market are not perfect (this contradict with MM II theory).Theories gives the direction
but when come into practise it’s not necessarily it should be applied 100% because
some assumptions don’t work in real world, so it remains the work to financial
managers to find out how to minimise WACC.