Section 1 Summary of the article

A good integration between strategy and finance dimensions can be tantamount to

a competitive weapon stated in the article Relation between Capital structure
and Corporate Strategy of The Australasian Accounting Business &
Finance Journal in June, 2008 Vol. 2, No.2 authored by M. La Rocca, T. La Rocca
and D. Gerace from the University of Calabria Italy and University of Wollongong
Australia.
With reference to the article mentioned above, it is evident throughout the article
that aligning finance decisions and investments strategy with the corporate strategy
is gaining more importance in the corporate sector within organizations. The overall
corporate strategy of the firm will need to integrate itself with finance dimensions in
order to remain competitive versus the competition in the industry. This leverage
will cause firms to behave more or less aggressively in the marketplace. Greater
integration will create value for the firm in the landscape that they operate in.
However, to understand the finance dimensions in firms decision making
understanding of the capital structure i.e. the fine balance of the financial
instruments of debt and equity too is equally important.
As quoted from the article, A firms capital structure refers, generally, to the mix of
its financial liabilities. In analyzing capital structure we focused on the type of funds,
debt or equity used in the firm for financing. There are various factors that forces
to have deviations in striking the right balance between equity and debt within
organizations and will be detailed as follows;
a) Conflicting of interests between managers and firms financial stakeholders
leading to the agency theory
i)
Causing overinvestment problems managers taking on unprofitable
ii)

investments and taking overly risky projects.

Causing underinvestment problems dealing with the relationships in
not fitting with shareholder interests and avoiding risk or not investing
in riskier projects

b) Relations between managers and non-financial stakeholders of the firm

leading to stakeholder theory.
c) The competitiveness of industry and market structures that operate
Firstly, the conflict of interests between the managers and the firms financial
stakeholders which gives rise to the agency theory. The interactions among the
managers and other financial stakeholders directly impacts on the capital structure,
corporate governance practices as well as the strategy plans put forward to go
towards the organizations vision.
The conflicting relationships between managers and other financial stakeholders
(shareholders and debtors) could make them to choose projects that do not bring
back the required return as per the needs of the shareholders. On the other hand,
there are instances shareholders put their efforts behind maximizing their share
values rather than maximizing the firms value. Undoubtedly this can bring in
overinvestment problems such as, managers investing on projects although having
negative Net Present Values (NPV) where their decision making power overrides the
interests of the shareholders. Some of the managers also tend to obtain overly high
risk projects which can be in line with the shareholder interests but NOT aligned
with debtor interests. This makes the managers to utilize the free cash flow within
the organization which can be distributed as dividends for the shareholders.
Underinvestment could also be varying from managers likely to reject positive NPV
projects which ultimately decrease the firms value. There are instances that
managers tend to avoid risky investment projects which would otherwise have
gained higher returns to the shareholders if estimated returns were shown.
Secondly, it is stated that firms financial policy if also affected by non-financial
stakeholders such as customers, suppliers, employees, etc although they have no
direct monitory stake in the firm, capital structure and financial policy can affect
them as stakeholder theory mentions. For example, a firms idea to liquidate the
business imposes added costs on other non financial stakeholders who may not be
able to obtain services, parts or products at the same time suppliers will have to
stop the business with the firm. Therefore customers and suppliers who can predict
the financial position of a firm may resist business activities with such firms with
financial distress.

On the other hand, Firms could by purpose use financial instruments to convey that
business is doing well in order build credibility within non financial stakeholders.
Hence, it is vital to ensure that non financial stakeholder interests are commonly
considered in making investment decisions and thereby, affecting the capital
structure.
Thirdly, the capital structure can be impacted from the market structures and
competitiveness in the industry. In the case of an industry downturn, highly
levered firms will experience lower operating profits within organizations which
would enable more conservatively financed competitors to aggressively drive their
products and be more competitive. As a result financially strong (Less levered)
forms can drive highly levered firms to a vulnerable state.
In particular it has mentioned that corporate strategies such as Diversification and
capital structure gain more interest due to their strategic implications and impact
con firms value.
Hence, it is evident that the decision making in line with the organization corporate
strategy needs to be done with the consideration of finance dimensions when
investments are done. This will enable organizations to be more competitive in the
market place rather than acting on different stakeholders own interests.

Section 2 Background to the selected company

ODEL is a well known clothing retailer in the Sri Lankan market which has lasted
over the last two decades tagging on the theme on the inspiration of mind, body
and soul. Over the decades it has proved itself to be a leading brand that has been
loved, followed and enjoyed by many in the industry. This company was inspired to
be started up by the famous woman entrepreneur and fashion icon Ms. Otara
Gunewardene and thus has proven itself in the marketplace. They also have
developed brands such as, Odel Luv SL, Embark, Backstage type of revolutionary
brands to take the fashion retailing business to reach even greater heights. Odel
provides experience to its customers in providing a range of clothing for ladies,
gents and kids. As per the recent articles published in Daily Mirror - Daily FT on
September 12, 2014 an even more greater buzz was created around Odel with the
buy over of Odel by Softlogic . This made the strategy of ODEL which is, expansion

to key locations with a greater network of stores being a more eye catching news in
the corporate landscape and media (DailyFT, 2014) 1

Section 3 Analysis of findings in the case

Further reference has been made to the ODEL Annual reports published for
2011/2012 in order to provide justifications for the link between capital structure
and corporate strategy. This mentioned financial year of 2011/2012 was yet another
year of expansion for ODEL in having the strategy as to go into a diversified set of
stores in key locations. As per the comments made by the ODEL Chief Executive
Office (CEO) Ms. Otara Gunewardene; the company has recorded a profit increase of
Rs. 0.5 million versus the previous financial year (Rs. 3.3 to 3.8 million in
2011/2012). This increase in profits mainly came through the expansion of stores in
enabling the Odel experience to its customers. Industry dynamics has changed and
competitiveness has widened for the clothing retail market in Sri Lanka.
After a thorough analysis of the financials presented in the 2011/2012 Annual report
of ODEL, it can be shown that investment decisions have been made in line with
their corporate strategy of expansion in to a range of outlets. Having a look at the
figures illustrated in the financial statements of Balance Sheets and the Statement
of equity drawing a comparison between the years of 2011 and 2012, the levels of
debt has considerably increased and evident that they have been put behind the
expansion of outlets into key locations. As per the financial review given, total debt
for the company has increased up to Rs. 1252 million from Rs. 930 million that was
in the previous year.
At the meantime, a dividend to ODEL shareholders has been declared at Rs. 0.25
cents per share per year and has promised an increase of a further Rs. 0.25 cents
from year 2012. By the comparison made between the years, a portion of the
retained earnings out of the revaluations surplus transfers of the organization has
also been given as dividends for the shareholders who enable them to obtain

1 Source: Daily Mirror, Daily FT on September 12,2014

greater returns for the investments made. However, the share capital has remained
the same for the two financial years mentioned.
Further analyzing the scenario, it can be concluded that the management within the
organization are working towards and making investment decisions in line with the
corporate strategy of expansion. However, it is important to understand the correct
computations of investment appraisal methods such as, Net Present Value (NPV)
prior to going ahead with the investments decided in order to ensure that the
investment is financially feasible and gives the highest returns to its shareholders
and acts in the best interests of them. Thus, it is important to note not only to
consider the expansion of ODEL through the firm size but as well as the value of it
which generates more bottom line for the organization.
So it is evident that it is very important to have the fine balance between the
relations with managers and financial stakeholders of the organization. When real
time decisions to be made by the organization can be financially sound then it
creates a situation in which high or low debt can compromise a firms ability to get
the optimal advantage of the strategic investment options acting to satisfy common
interests

covering

all

the

stakeholders

(both

financial

and

non-financial

stakeholders) enabling the right strike of the capital structure. The biggest trigger is
that all investment decisions need to enable to add to the value creation process of
the firm.