Capital Structure

The capital structure of a company can have a huge effect on the perceived success of that company by impacting on risk and return. While debt finance is cheaper than equity, it carries more risk due to constant nature of interest payments. If more debt is to be taken on by Shareholders then they are going to require a better rate of return to offset the risk.
Over the past three years Murray International Holdings (MIH), former owner of Rangers Football Club, has restructured twice. Both times has been to reduce the level of debt it holds. The company has been struggling in recent years and has been making a loss. With the amount of debt that it has (£370m down from £637m the previous year) the risk to the returns of the shareholders is still very high, and as such they require a high rate of return. Additionally, this high level of debt increases the amount of interest payments required, which reduces the profits (or increases the losses in this case) that can be used to pay out dividends to shareholders.
The second restructuring involved a deal with Lloyds Banking Group to reduce £118m of debt with them in return for a similar amount of share capital and premiums.
MIH has to reduce the debt to a point where the risk is low enough to encourage shareholders and reassure the market about their position which will increase the market value of the shares.
There is a traditional view that there is a balancing point between the amount of Equity and debt capital required (gearing level) that is considered to be the optimal capital structure. A little debt helps to increase the share value and dividend payouts to investors but too much debt will increase the risk beyond a point that investors are happy to accept and as a result will require a higher rate of return.
However, Modigliani and Miller (1958, 1963), disagreed that there was an optimal capital structure. They believed that a company's value depends entirely on business risk and that the total market value of any company is independent of its capital structure. The volatility of the MIH's earnings is what increases the risk under their theory.
These two theories both agreed that extreme positions, i.e. all debt or highly geared, were to be avoided as the benefits provided by the other form of finance would be lost to the company. Therefore a compromise between the two extremes was to be sought regardless of whether there was an opitmal capital structure or not.
In the case of MIH, the amount of restructuring and the type (reduction of debt in the first instance and exchange of debt for equity in the second) leads to the conclusion that MIH has not decided what the level of gearing it requires is. The changing conditions and health of the company give rise to fears regarding its ability to pay interest and the lack of dividends poor market value of the company is a cause for concern for shareholders.