Question

Firms with highly successful products and services often are met with a high regulatory burden, require significant levels of capital, rely on large-scale investments in technology, and benefit greatly from economies of scale that only the largest of firms possess on a sustainable basis. Beyond the basic market segmentation business strategy decision, firms must implement other strategies to remain competitive. Would you argue that targeting an optimal capital structure would be defined as one of these strategically competitive strategies, or are those critics aligned with Modigliani & Miller correct, who posit the capital structure irrelevance principle?

Thoughts?

Answer 1

For any production process to be profitable in the very long run and to have a good market share, capital in the form of machinery, infrastructure, buildings ,space plays a very important role. Ultimately, in the long run, growth comes from increase in ideas, technology and R&D. Without a hige investment in these areas, no firm can earn super normal profits as these huge investment and sunk costs would act as a deter to entry of new firms who would wipe out the super normal profits in the long run. In order to deter the entry, innovate the product, keep the demand high all the time , the firm needs to invest highly in capital, technology and R&D. In order to maintain monopoly and at the same time remain competitive, investment in capital is a pre-requisite.