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Determinants of Capital Structure

Nayyar & Muzammil

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I ntroduction

~ Attaullah Shah & Safiullah Khan~ Capital Structure

DebtEquity

~ Lower cost of capital~ Maximizing shareholder wealth~ Optimal capital structure

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VARIABLES AND HYPOTHESES

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Dependent and I ndependent Variables

LEVERAGE

Tangibility of Assets(TG)

Non Debt Tax Shields

Size (SZ)

Growth (GT)

Profitability (PF)Earning Volatility

(EV)

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Measure of Leverage (Dependent)

~ Three methods to measure leverageMarket based

Book value basedTotal debt/total asset based measure

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Tangibility of Assets (TG) I ndependent

~ Large amount of fixed assets, borrow atlower rate of interest.

~

Assets provide security to creditors.~ Positive relation between tangibility of assetsand Leverage.

H1:A firm with higher percentage of fixed assets will have higher debt ratio.

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Size (SZ)

~ Two conflicting view pointsDont considered direct bankruptcy cost as anactive variable.There is less asymmetrical information aboutlarger firms.

~ This means, there is negative relationshipbetween size and leverage.

H2: There is negative relationshipbetween size and leverage of the firm.

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Growth (GT)

~ Bond holders fear of risk~ Might invest in risky projects~ High lending rates~ Firm will prefer internal funding

H3: Firm with higher growth rate will have lower leverage

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Profitability (PF)

~ High profitability high the internal funding,followed by low leverage

~ So negative inverse relation betweenprofitability and leverage

H4: firms with higher profitability will

have lesser leverage

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Earning Volatility (EV)

~ Business risk due to inefficient managementpractices

~ Firm should have to pay risk premium toexternal fund providers

~ So firm will prefer internal funding just toreduce cost of capital

H5: Earning Volatility is negatively related to leverage

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Non Debt Tax Shields

~ Firms use more debt for tax savings~ Because interest is paid on debt that will

decrease firms EBT so there would be lesstaxable amount

H6: NDTS are negatively related toleverage.

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Descriptive Statistics

And Models

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Leverage Ratios of firms

oTextile industry has average of 0.723 leverage againstthe mean leverage of all industries i.e 0.666

oProfitability of power sector is 0.055

oCement industry tangibility 0.655

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Model Specifications

~ Panel data is used~ I t combines the features of time series and

cross section.~ Panel data usually provides the researchers

a large number of data points, increasing thedegree of freedom and ambiguity among

explanatory variables.~ I mprove the efficiency of econometric

estimates.

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Constant Coefficient Model

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The Fixed Effects Model

~ I ndividual firm effects, time, or to controllomitted variables, that differ among firms

but are constant over time.

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Discussion of the results

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