1.1 Background
An optimal capital structure, defined as the ideal mix of debt, equity, and other financing sources that maximize a company's value while minimizing its cost of capital, is beneficial to firms in several ways. It offers a lower cost of capital, bolsters financial flexibility, curtails the risk of ownership dilution, and enhances the credit rating (Forbes & Hodgkinson 2014). However, despite the many advantages of having an optimal capital structure, the major issue is how to establish a relatively perfect capital structure. Given different theories, such as Resource-Based View (RBV), Information Processing Theory, Pecking Order Theory and Trade-off Theory, have been proposed for the financial structure of firms, it is essential for us to explore whether an optimal capital structure actually exists or the factors that influence this financial structure.
The representative information resources management theories that can be applied to the capital structure of banks in the United Kingdom (UK) are Resource-Based View (RBV) (Varadarajan, (2023) and Information Processing Theory (Wickens & Carswell, 2021). The former suggests that a firm’s resources, including information resources, contribute to its competitive advantage. In the case of banks, effective management of information resources can help optimize the capital structure by enabling better risk assessment, improved decision-making, and efficient allocation of financial resources. The latter examines how organizations acquire, process, and use information to make decisions. Within the context of capital structure, it can be applied to analyze how banks gather, analyze, and utilize information to assess risk, determine optimal capital levels, and make financial decisions. Efficient information processing can lead to better capital structure decisions and risk management practices. In addition to these two theories, the trade-off theory emphasizes the existence of an optimal capital structure. Specifically, an optimal debt ratio that is decided by the contrasting benefits of debt1 and the cost of debt2. Existing studies have analyzed the effect of transaction costs and the speed of adjustment in achieving the optimal capital structure (Miguel and Pindado, 2001; Guad et al., 2005; Flannery and Rangan, 2006; Gonzalez and Gonzalez, 2008; Qiao and Lin, 2023). Moreover, the pecking order theory indicates the existence of informative asymmetry between the company and the market, as well as the disciplinary effect brought by the market on firms, representing that companies tend to get funding internally rather than receive financing externally. However, the pecking order theory does not support the existence of an optimal debt ratio. In terms of its framework regarding information asymmetry, it can also be considered from tax, agency, or behavior (Frank and Goyal, 2009).
Previous studies have found that the capital structure of firms is determined by more than just firm- or country-specific factors (Booth et al., 2001; Bancel and Mittoo, 2004). Moreover, country-specific factors can also affect firm leverage through their effect on the impact of firm-specific variables (De Jong et al., 2008). In this paper, we focus on our analysis of the United Kingdom since the UK has the advantage of effective management of information resources, a unique institutional and legal framework, and a dynamic and diverse economy. Firstly, the effective management of information resources can optimize the capital structure of banks operating within the UK financial system. By leveraging advanced technologies infrastructure, robust data analytics capacities, and a well-established regulatory framework, banks in the UK are well-positioned to harness the power of information resources in shaping their capital structure decisions. Through efficient risk assessment, enhanced decision-making processes, and the utilization of timely and accurate financial information, banks can strive for an optimal mix of debt and equity financing that aligns with their risk appetite, business objectives, and regulatory requirements (Gimber and Rajan, 2019). Furthermore, the effective management of information resources enables banks to adapt to dynamic market conditions, anticipate emerging risks, and make proactive adjustments to their capital structure to maintain financial stability and competitiveness in the UK banking sector. More importantly, the UK is one of the leading global financial centers, making it an important market for companies looking to raise capital. As a result, the UK capital markets have a diverse range of financial instruments, making it an ideal market for studying capital structure decisions and their impact on a firm’s financial performance. Second, the UK has a unique institutional and legal framework that shapes corporate finance decisions. The UK’s legal system, for example, is based on the common law system, which provides a stable and predictable legal environment for firms (Caenegem, 1988). Additionally, the UK has a well-developed institutional infrastructure, such as stock exchanges, regulatory bodies, and financial intermediaries, which provides a robust framework for firms to access capital markets. Finally, the UK has a dynamic and diverse economy, with firms across various sectors, including finance, technology, and manufacturing. The diversity of firms and sectors makes it possible to study the impact of capital structure decisions on firm performance across different industries and business models. We provide the possibility of analyzing how country-specific factors affect capital structure indirectly through firm-specific variables.
The UK belongs to a market-oriented economy, offering greater investor protection and transparency than the bank-oriented economies like Spain, Italy, Germany, and France. For this reason, it further supports why we analyze banks in the UK instead of the bank-oriented economies. In this paper, we adopt the multiplicative model to estimate the unique factors influencing a firm's capital structure in the UK. This paper makes two pivotal contributions to the realm of capital structure research, particularly in the context of banks within the UK. Specifically, our research uniquely integrates multiple theories - the Resource-Based View, Information Processing Theory, trade-off theory, and the pecking order theory - to offer a comprehensive understanding of capital structure dynamics.