Abstract This research explores the relationship between earnings volatility and capital structure decisions made by companies. It examines two prominent theories - the pecking order theory and the trade-off theory - which propose that companies may choose debt or equity financing based on fluctuations in earnings volatility. The aim is to understand how human decision-making in the corporate world responds to changing financial circumstances. The research also provides an example using Reliance Industries and Adani Enterprises to illustrate how a company should make funding decisions.

Introduction Capital structure decisions are crucial for companies as they determine how funds are secured for daily operations and future expansion. These decisions involve weighing the use of debt and equity financing. The choices made by management in this area are significant, as they shape overall company performance and align with shareholder interests to optimize wealth. Earnings volatility, which measures the fluctuation of a company’s earnings over time, also plays a role in capital structure decisions. Companies with higher earnings volatility face increased uncertainty and risk, affecting their engagement with capital markets and ability to maintain a stable capital structure.

Literature Reviews Various studies have examined the relationship between earnings volatility and capital structure decisions. Franks et al. (2012) found no discernible relationship between earnings volatility and leverage in European companies, suggesting other factors may be more influential. Demirgüç-Kunt and Maksimovic (1999) suggested that the relationship between earnings volatility and debt is stronger for firms with greater development potential. De Jong et al. (2004) found that less profitable firms have a stronger correlation between earnings volatility and debt. Barclay and Smith (1995) found that firms with higher earnings volatility tend to have higher leverage ratios. Rajan and Zingales (1995) found a negative correlation between earnings volatility and leverage in large U.S. companies. Titman and Wessels (1988) also found that firms with more volatile earnings have lower leverage ratios.

Objectives The objectives of this research are to explore how earnings volatility influences capital structure decisions, examine the trade-off theory and pecking order theory in the context of capital structure decisions, and analyze the impact of factors like growth opportunities and profitability on the relationship between earnings volatility and capital structure decisions.

Methodology The research utilizes pre-existing data from two companies, Reliance and Adani Enterprises Limited, to analyze their debt and equity structures and determine which one is more profitable based on their chosen capital structure.

Data Analysis The analysis of the provided statistics reveals that Reliance has a substantial debt and equity structure, while Adani Enterprises has a smaller debt and equity structure. However, Reliance has a significantly higher market capitalization compared to Adani Enterprises. This highlights the importance of maintaining a balanced mix of debt and equity, taking on debts that can be feasibly met to ensure sustainable growth and continuity.

Conclusion In conclusion, there is a correlation between earnings volatility and capital structure decisions, but this relationship is influenced by various factors. The trade-off theory suggests that companies with high earnings volatility may prefer equity funding, while the pecking order theory proposes that companies may opt for debt financing in the face of drastic changes in earnings volatility. The literature reviews present mixed results, emphasizing the complex nature of this relationship. A comprehensive understanding of the factors influencing capital structure decisions is necessary in the business realm.