Impact of Capital Structure on

Financial Performance of Firms:

Evidence from Engineering Industry
of Bangladesh
 A Project Paper
on
Impact of Capital Structure on Financial
Performance of Firms: Evidence from
Engineering Industry of Bangladesh

Submitted To
Department of Finance
University of Dhaka

Supervised By Submitted By
Mohammad Salahuddin Chowdhury Muktadir Billah
Assistant Professor Id No.: 20-286
Department of Finance Section: A, MBA 20th batch
University of Dhaka Department of Finance
University of Dhaka

Date of Submission: 17th September 2019

 Letter of Transmittal
17th September, 2019

Mohammad Salahuddin Chowdhury

Assistant Professor
Department of Finance
University of Dhaka

Subject: Submission of Project Paper on “Impact of Capital Structure on Financial

Performance of Firms: Evidence from Engineering Industry of Bangladesh”

Sir,
I have the honor to state that I am Muktadir Billah bearing ID No. 20-286, a student of MBA
20th Batch, Department of Finance, University of Dhaka. You have assigned me to prepare a
project paper on “Impact of Capital Structure on Financial Performance of Firms:
Evidence from Engineering Industry of Bangladesh” as a partial requirement of MBA
Program.

It was an opportunity of rediscovering my potentials and full of excitement. This project paper
gave me an occasion to apply my theoretical expertise, sharpen my views and ideas which will
be a good head start for my future professional career.

I would like to convey my special thanks and gratitude to you for patronizing my effort & for
giving me proper guidance and valuable advice. I have tried to give my best effort to complete
the report successfully. If I have any unintentional error that may have entered into the report
will be considered with sympathy.

I therefore, would like to request you to accept the project paper on the assigned topic. I
earnestly request you to call upon me if you think any further work should be done on the topic.

Sincerely Yours
Muktadir Billah
ID. No.: 20-286
Section: A, MBA 20th Batch
Department of Finance
University of Dhaka

Signature

i
 Declaration
I, Muktadir Billah, hereby declare that the project paper on “Impact of Capital Structure on
Financial Performance of Firms: Evidence from Engineering Industry of Bangladesh” is
uniquely prepared by me after the collection and analysis of all the required data from annual
reports, financial statements and websites of Dhaka Stock Exchange.

The presented project paper does not breach any existing copyright and no portion of this report
is directly copied from any work done before. The data for this work are collected from
financial reports of all engineering companies that are listed in Dhaka Stock Exchange, articles
and from my personal experience.

I also confirm that the project paper is prepared only for my academic requirement, not for any
other purpose.

Muktadir Billah
ID. No.: 20-286
Section: A, MBA 20th Batch
Department of Finance
University of Dhaka

Signature

ii
 Letter of Certification
This is to certify that the project paper on “Impact of Capital Structure on Financial
Performance of Firms: Evidence from Engineering Industry of Bangladesh” has been
successfully prepared by Muktadir Billah, ID No: 20-286, MBA 20th Batch as a partial
requirement of the MBA program under Department of Finance, University of Dhaka.

I have found him sincere, hardworking and devoted to his duty while he was preparing this
project paper under my supervision and guidance. I am glad and very much satisfied with his
performance.
I wish him every success in all respects.

Mohammad Salahuddin Chowdhury

Assistant Professor,
Department of Finance
University of Dhaka
Date: 17th September, 2019

iii
 Acknowledgement
At first, I would like to express my gratitude from my heart to Almighty Allah for giving me
the strength and patience to prepare the project paper properly within the scheduled time.

Then, I would like to thank my honorable teacher Mohammad Salahuddin Chowdhury,

Assistant Professor, Department of Finance, University of Dhaka. I am especially grateful to
my respected teacher and supervisor for his constant presence and valuable instruction during
the time of preparation of the project paper.

I would also like to thank all of my friends who have given me courage and valuable suggestion
for the preparation of the project paper.

iv
 Executive Summary
The aim of the study is to examine the impact of capital structure on the performance of firms
in the Engineering Industry of Bangladesh. Capital structure is one of the major decisions that
a firm needs to take. It is mostly important to larger companies. As engineering industry is an
emerging one and one of the largest industries of Bangladesh, it is essential for the firms in that
industry to choose the better capital mix so as to increase their performance. The study is
conducted for the period 2000-2018 and companies in that industry that are listed with Dhaka
Stock Exchange have been selected for the study. Return on equity and return on asset have
been selected as the measure of performance and debt to asset ratio and debt to equity ratio
have been selected as the measure of capital structure. Some other variables including total
asset, liquidity and tangibility have been selected as earlier studies indicate that these variables
have some impact on firm performance. The main basis of the study is cross sectional
regression. For the purpose of getting correct results from the analysis various econometric
tests have been conducted. Unit Root Test is conducted for checking whether the variables
stationary and Variance Inflation Factor (VIF) test is performed to detect multicollinearity
problem. Then Fixed Effect and Random Effect Generalized Least Squares Regression is
performed and Hausman test is performed to identify the suitable regression model. Both the
measures of performance have come out with almost the same results. The results indicate that
the capital structure has major impact on firm performance. Both debt ratio and equity ratio are
seen to impact both the return measures negatively. But, coefficient of debt ratio is larger than
that of equity ratio. So, firms should try to avoid taking more debt in capital structure as debt
has fixed interest cost. It is also found that the size of a firm as measured by its total asset has
positive impact on the return on equity and return on asset. Total asset turnover positively
affects the firm performance as sales is directly related to profitability. The study also reveals
that when the firms are in tax burden they become cautious and divest their investment so as to
reduce cost. Tax to earnings before tax is only significant to return on equity because the impact
of tax on net income too little to be significant to return on asset. Liquidity affects the return
on equity positively. From the Granger Causality Test it is identified whether each pair of
variables has impact on one another. It has revealed that dependent variables has impact on
some independent variables. So, the performance of a firm is affected by multiple factors and
capital structure is a major factor to be considered.

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Table of Contents
Executive Summary ................................................................................................................... v
Chapter- 1 Introduction .............................................................................................................. 1
1.1 Overview of the Industry ................................................................................................. 2
1.2 Origin of the Study........................................................................................................... 3
1.3 Objective of the Study ..................................................................................................... 3
1.4 Rationale of the Study ...................................................................................................... 3
1.5 Scope of the Study ........................................................................................................... 4
1.6 Limitations of the Study................................................................................................... 4
Chapter- 2 Theoretical Aspects of Capital Structure ................................................................. 5
2.1 Capital Structure .............................................................................................................. 6
2.2 Types of Capital ............................................................................................................... 6
2.3 Determinants of Capital Structure ................................................................................... 7
2.4 Guiding Principles of Capital Structure ......................................................................... 10
2.5 Theories Related to Capital Structure ............................................................................ 11
Chapter- 3 Literature Review................................................................................................... 15
3.1 Literature Review........................................................................................................... 16
Chapter- 4 Methodology .......................................................................................................... 19
4.1 Techniques of Analysis .................................................................................................. 20
4.2 Model Specification ....................................................................................................... 20
4.3 Variables ........................................................................................................................ 22
4.4 Variable Definitions ....................................................................................................... 22
4.5 Sample and Sources of Data .......................................................................................... 24
Chapter- 5 Analysis and Findings ............................................................................................ 25
5.1 Descriptive Statistics ...................................................................................................... 26
5.2 Regression Analysis ....................................................................................................... 31
5.3 Interpretation of Selected Models .................................................................................. 37
5.4 Result of Granger Causality Test ................................................................................... 39
5.5 Findings.......................................................................................................................... 41
Chapter- 6 Conclusion ............................................................................................................. 43
References ................................................................................................................................ 46
Appendix .................................................................................................................................. 47

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 Chapter- 1
Introduction

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1.1 Overview of the Industry
Engineering industry of Bangladesh is one of the largest sectors and is working for meeting up
the requirements and demands of the customers. This sector is contributing toward poverty
alleviation of the country with its employment creation. The industry is also contributing to the
technological advancement and overall development of the country. The industry is also
assisting other industry as it provides machineries and equipment and also repairing services.

There are many engineering enterprises throughout Bangladesh. These are creating
employment opportunity for a large number of people. There are roughly fifty thousand
industrial units of this kind, most of which are small. Manufacturing sectors’ contribution to
the country’s GDP is increasing. Most of such industries depends largely on imported
machineries and parts for running their operation. If the products or machineries that these
industries import are produced within the country, the country can benefit a lot. For the
increment of small engineering enterprises, policy regarding environment and infrastructural
development is required.

Products of this sector include metal, electrical, electronic and electromechanical products. Part
of the manufacturing process maybe made of ceramics, rubber or plastic. So, small part of the
engineering sector supports other sector of the economy including industrial, agricultural, with
the production of spare parts, casting, moulds and dies, oil and gas pipeline fittings etc. Because
of such contribution to the economy, small engineering has received attention in government
policies.

Although, engineering products of this industry are mainly produced for the local market, the
industry has huge potential for export earnings and such earnings is increasing over time as
these products are exported to EU and USA. Exporters are provided 10% cash incentive from
the government. Besides this, the light engineering products of Bangladesh enjoy zero duty
under GSP facility.

The firms of this industry require to import some chemicals, which they import directly without
the help of other importers. Most firms require 2 to 3 lac Taka to start their business. Financing
is a major constraint for the development of this sector. Some of these problems are lengthy
procedure of bank loan financing, non-availability of sufficient fund, difficulty in getting
financial assistance for technological innovation and for risky investment, high interest rate on
loan etc. Load-shading is another major problem for such firms, which requires them to
maintain generator for uninterrupted supply of electricity. Other problems include fluctuation

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of price, lack of designing capability, unavailability of research and development facilities,
lack of knowledge of workers etc.

This sectors has huge opportunity to grow as it has sufficient demand from other sectors. It also
has potential for producing import substituting goods if it gets proper support. The export
potential is also increasing due to the lower cost of production.

1.2 Origin of the Study

This report is prepared for the partial requirement of the MBA program of Department of
Finance, University of Dhaka under the academic supervision of Mohammad Salahuddin
Chowdhury, Assistant Professor, Department of Finance, University of Dhaka. The topic of
the report is “Impact of Capital Structure on Financial Performance of Firms: Evidence
from Engineering Industry of Bangladesh”

1.3 Objective of the Study

The main objectives of the study are given below:
a) To get an understanding on capital structure of companies operating in engineering
industry
b) To examine the relationship between capital structure and financial performance by
companies listed with DSE in engineering industry
c) To analyze the impact of capital structure on firm performance by companies listed
with DSE in engineering industry

1.4 Rationale of the Study

The performance of a firm is measured as to how much return it generates from its investment.
The more return a firm generates the better the performance of that firm. There is evident
relationship between capital structure and the performance of a firm measured as return on
equity. The higher the return, the more value of the firm to equity holders. The study aims to
see how the capital structure affects the profitability of a firm.

A firm should always try to maximize the value to its equity holders. So, it should try to
generate higher return from its investments. Regulators of the firm also need to know the firms
performance to regulate properly. Again, investors should also know how the firm is
performing to decide whether to invest in that firm. Security analysts and policy holders also

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need such information for their analysis and decision making purposes. So, it is necessary for a
firm to examine how its choice of capital structure affects its performance.

Engineering industry is one of the largest and fastest growing industries of Bangladesh. So, its
impact on our economy is significant. It is the source of employment for a large number of
people. The demand for the products of engineering industry of Bangladesh is increasing. Huge
amount of foreign currency is generated from the export of engineering industry products. So,
the industry is contributing much in the economy. The analysis of the impact of capital structure
on the performance of firms of such a broad industry is thus important.

1.5 Scope of the Study

This study contains an analysis of the capital structure and its impact on financial performance
of firms over the period of 2000-2018. Here, various techniques to analyze capital structure
and firm performance are used along with regression analysis. This report also contains
literature review about capital structure and firm performance. As engineering industry of
Bangladesh is a broad one, there is a vast scope of analysis and determining the performance
of the companies with respect to capital structure.

1.6 Limitations of the Study

When preparing the project paper I have faced some limitations. As I am new in this field of
study, I have faced lack of experience. I have faced lack of in depth knowledge about writing
such report. I have also faced time constraint, as I am new in this field of practical scenario
analysis.

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 Chapter- 2
Theoretical Aspects
of Capital Structure

5|Page
2.1 Capital Structure
Firms require financing to start and continue the business. Firms perform business activities to
generate profit and maximize wealth, which is the goal of finance. As firms have to maintain
various types of tasks, they require huge amount of money. Capital is the source of firms’
financing. Firms need long term financing to purchase fixed assets and start the business and
short term financing to continue day to day operations.

In terms of economics, capital is the factor of production that is used to produce goods and
services and are not consumed significantly in the process of production. On the other hand, in
terms of finance, capital is a type of financial wealth that is used to initiate and maintain a
business.

Capital structure is mainly the mix of two types of capital namely equity and debt. Firms try to
obtain such a mix of equity and debt that has low cost and helps in maximizing wealth. This is
known as optimal capital structure. Before going to determinants of capital structure it is
necessary to know about the types of capital.

2.2 Types of Capital

There are mainly two types of capital from the perspective of ownership. These are equity and
debt capital. There are various types of equity capital and debt capital. These are discussed
below.

2.2.1 Types of Equity Capital

Equity capital gives the capital provider the ownership of firm. Equity capital can be divided
into two types based on the ownership structure and rights in getting dividends. These are

i. Common Stock: Common stock is a type of capital that gives the capital provider the
ownership of the company and voting rights in management. So, the common
stockholders have the right to take control over the company. Directors elected by the
stockholders manage the company as the stockholders wish. But, common stockholders
do not have preference in dividend payment.
ii. Preferred Stock: Preferred stock gives the stockholders preference in dividend
payment before the common stockholders. They also get preference during distribution
of corporate asset at the moment of liquidation. But, preferred stockholders get no
voting right like common stockholders. So, although they get the ownership of the firm,

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 they have no direct control over the company. The preferred stockholders actually get
a fixed percentage of dividend payment and gets it after the payment to debtholders.

2.2.2 Types of Debt Capital

Debt capital does not give the capital provider the ownership of firm. But, the provider of debt
capital gets a fixed percentage of interest payment irrespective of firm’s profitability. Various
types of debt capital are discussed below

i. Loans: Loans are most common types of debt capital. Loans can be obtained from
financial institutions or individuals. It is also the easiest way of getting fund for
business. The provider of loan gets a percentage of interest annually on the amount of
loan provided. The borrower can borrow a specific sum from the lender and make
repayment after a specific period of time.
ii. Bonds: Bonds are another type of debt capital. Government or business institutions
can issue bond. The investor provide the issuer the market value of the bond and in
exchange gets a guaranteed amount per period and scheduled payment of coupon.
Bonds are backed by asset of the issuer company and so if the company becomes
bankrupt after the issuance of the bond, the investor has the right to obtain payment
from the assets of the company.
iii. Debenture: Debenture is the same as the bond in all respects but the asset backing.
Debenture has no such security like bonds. And so these are mainly used as short to
medium term source of financing. Such debt instruments are backed only by the
general agreement and trust of the issuer and the investor. So, investment in debenture
is riskier than that of bonds.

2.3 Determinants of Capital Structure

There are various factors that affect the capital structure of a firm. These factors may be from
the economy, the industry on which the firm belongs to or from the company itself. The factors
under these three sources are discussed below.

2.3.1 Economic Factors

i. Condition of Business Activity: If the economy is in good condition and the firm is
expected to do better in the near future, it is better to search for alternative sources of
financing to get additional fund to meet the requirement of expansion and also equity

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 capital should be given preference in financing. Issuing bonds with restrictive
covenants should be prohibited in such circumstance.
ii. State of Capital Market: If the capital market is in good condition and the price of
share is in increasing trend, the firm should issue equity capital. Otherwise issuing bond
will be preferable. For this reason it is important to analyze the trend of capital market
to obtain idea about the types and cost of capital.
iii. Tax Policy: When there is higher percentage of tax on the income of the company, it
is advantageous to obtain debt capital as there is option for interest tax saving. It can be
said undoubtedly that the tax will not be adjusted downward in the future. So, debt
capital is preferable.
iv. Policy of Term-Financing Institutions: If there is hard lending policy and very
restrictive terms taken by financial institutions, it is better to avoid financing from such
institutions. In that case, the firm should think about equity financing rather than debt.
It will give the firm flexibility in financing and may also reduce the cost of capital.

2.3.2 Industrial Factors

i. Cyclical Nature: Some industries have product demand over the years and in all
conditions. They have less income elasticity and the demand of such product do not
move much with the changes in the income level. Example of such industries can be
food industry and clothing, which are basic needs of people. Again, there are some
industries the demand of whose products is cyclical in nature. So, during a period of
the year the demand increases and in other time there is less demand. And the demand
of such products also varies depending on income level. So, the management of the
firms in cyclical industry should choose the source of fund that is more flexible and
also considers the risk principle so that depending on the condition of the business firms
may expand or contract the resources used in the business.
ii. Level of Competition: Level of rivalry among the firms in an industry also affects the
choice of capital structure. If there is huge competition among the firms in an industry,
firms should consider the risk of the market share being taken away by the competitors.
On the other hand, if there is less competition among the firms in the industry, then
firms should choose the low cost source of capital.
iii. Lifecycle Stage: The lifecycle stage of and industry also affects the choice of the source
of financing. The infant industries should consider the risk associated with failure while
selecting sources of fund. On the other hand, the industries which are in the stage of

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 growth should choose the financing source that is flexible, so that the firm can expand
the fund easily depending on the duration of the growth stage.

2.3.3 Company Specific Factors

i. Size of the Business: Small scale firms faces some problems in collecting funds for the
operation of the business, as they have poor creditworthiness. In that case, the firm
should go for such sources of fund from which it can collect fund easily depending on
its requirement as a result of growth. For such small scale firms common stock is the
major source of fund. As the firm grows in size, it can issue more shares of common
stock to obtain fund. The firms which are larger in size, needs to employ different types
of securities to obtain their desired capital. So, they should collect fund from various
sources of equity and debt capital. On the other hand, medium scale firms tries to obtain
fund from a single source and so debt capital is more suitable for such firms.
ii. Type of Business Organization: For sole proprietorship or partnership organizations
in which the control over the organization is more important, the owners’ own fund and
some debt capital is preferable. For private limited companies, the ownership is closely
held in few hands. So, more preference should be given on the control of the firm. In
case of public limited company, control of the firm is not that important and so such
firm can easily use a combination of debt and equity capital.
iii. Earnings Stability: The firms that have stability in earnings can choose debt as a
source of financing. As they have stable earnings, they can meet the debt obligation
easily and the firms will have to bear low risk. On the other hand, if the earnings is not
stable, equity is the preferable source of financing as they do not have to take the burden
of debt which has more risk.
iv. Age: As younger companies can face difficulty in raising capital in the first few years
of their inception, they should look for more flexibility in collecting fund. So, they
should search for alternative sources of funds so as to meet their future capital
requirement. On the contrary, the companies that have already completed initial stage
should choose for low cost source of financing.
v. Asset Structure of the Firm: When a company has investment in mainly fixed assets
and the demand of its product is high and assumed to be higher in the future, it should
choose the low cost source of financing. In that case, debt financing is preferable to
equity financing which needs only a fixed percentage of interest payment. On the other

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 hand, if the company has most of its investment in short term assets like receivables
and inventories, it should go for equity financing as there is less risk.
vi. Credit Position of the Firm: The firm that have better credit standing can have more
alternatives of financing. So, the firm can adjust its financing source depending on the
position of the business which gives it more flexibility.
vii. Attitude of Firm’s Management: Attitude of the persons who looks over the affairs
of the company should also be taken into consideration when choosing for the better
source of financing. When the management has preference for exclusive control, more
weights should be given to debt capital or borrowing. When the management chooses
to stay in office, they prefer low risk source of financing. On the other hand, the
members of board of directors who have been in management for a long term prefers
to choose low cost source of financing as their existence in the firm is assured.

2.4 Guiding Principles of Capital Structure

Firms follow some principle while selecting the source of financing. These principles
determines which source of financing a firm should go for depending on the condition of the
firm. The guiding principles of capital structure are:

i. Risk Principle: The idea of the risk principle is that the firm should select such sources
of capital that have least risk. Thus the firm should try to avoid the risk of failure and
loss. In that case, the common stock is more preferable as no fixed payment is required
to be paid if the company makes loss or profit. It also calls for no use of debt in the
capital structure.
ii. Cost Principle: Cost principle says that the firm should select the source of capital so
as to minimize its cost of capital. Therefore, it will be able to maximize earnings per
share. The cost of capital depends on the rate of interest to be paid to the lenders and
the tax status of such payments.
iii. Flexibility Principle: This principle suggests that the firm should such a combination
of capital sources that is easier for it to obtain and also can easily be adjusted depending
on the condition of the business. Therefore, the firm should have several investment
alternatives so as to strengthen its bargaining power while it goes for negotiating with
fund providers.
iv. Control Principle: The idea of the control principle is that the managers should
consider the controlling position of the existing owners while deciding for new source

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 of capital. They should keep in mind that the position of existing owners should not be
diluted. For this, they can choose preferred stock or bond as the source of financing.
v. Timing Principle: Time of the collection of fund is very important thing to be
considered. It is more important if the business is assumed to continue forever. The firm
may need more capital when it is in growing stage of its lifecycle. So, the demand for
a particular security also depends on the business cycle. When the economy is in
expansion stage, the investors get interest in investment. In such situation, issuing
equity is preferable. On contrary, when the economy is in recession, the preferable
source will be debt financing as the fixed interest on bond will attract the investors to
invest.

2.5 Theories Related to Capital Structure

Over the periods many researchers have conducted research on capital structure and developed
a number of theories that are now followed by the firms. These theories are of importance in
modern finance. The firms follows these theories while choosing the appropriate capital
structure. Some of these theories are discussed here.

2.5.1 Capital Structure Irrelevance Theory of Modigliani and Miller

Capital structure irrelevance theory of Modigliani and Miller (1958) is the initiation of modern
theory of capital structure. In this theory Modigliani and Miller said that the value of the firm
is not affected by the capital structure chosen by the firm. That is, the value of the firm is
irrelevant to the capital structure selected by the firm. They called for a perfect market in which
there is free flow of information that is no information asymmetry, no transaction cost, no
bankruptcy cost and no tax. And the firms and individuals can borrow at the same percentage
of interest that creates the opportunity for homemade leverage and interest to be paid on debt
have no tax saving opportunity and firm pays 100% of its earnings as dividend. Based on such
assumption they have proved that there is no optimal debt to equity ratio and the choice of the
source is irrelevant of the shareholders wealth. So, the value of the firm that has debt in the
capital structure is equal to the value of the firm that does not have debt in the capital structure.
So, the managers are free to select the combination of debt and equity in their capital structure.

In their proposition II they explained that the risk of the firm increases with increasing amount
of debt in the capital structure. And so the cost of equity increases. But, the weighted average
cost of capital remains the same as cost of debt compensates for cost of equity.

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Although the theory is sound from the theoretical ground, it is not possible to have a world
where there is no tax and transaction costs. These unrealistic assumptions have made the
acceptance of the theory lost. In order to make the theory more realistic, Modigliani and Miller
(1963) taken into consideration the effect of tax on the cost of capital and the value of the firm.
When there is tax, the value of the firm will increase with leverage or increasing the amount of
debt in the capital structure. It is due to the impact of interest tax benefit. As interest reduces
the income of the firm, it reduces the amount of tax to be paid. And so, the value of firm will
be increased by additional benefit obtained from the interest tax shield. This modification of
the theory has made the firm value relevant to capital structure.

There are many other theories that are bases on this one. So, although the theory has some
drawbacks, the importance of it on further development of capital structure cannot be ignored.

2.5.2 Trade off Theory

The trade of theory is one of the important theories of capital structure. The theory says that
the optimal level of capital structure is the point in which marginal benefit of debt equals
marginal cost of debt. Thus, a firm can obtain the optimal capital structure by main adjustments
for benefits from tax shield from interest on debt and the cost of financial distress.

Figure 2.1: Trade-off between Interest Tax Shield and Financial Distress Cost
Source: Ross, Westerfield and Jaffe (2010)

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In the upper portion of the above figure, the straight line represents the value of the firm with
no debt in the capital structure. As debt is included in the capital structure, the value of the firm
is seen to be increasing because of the interest tax shield obtained from debt financing. This is
the situation when there is no cost of financial distress. When we consider the cost of financial
distress, the firm value will start to decrease. This is seen in the ‘∩’ shaped curve. The value
of the firm is increasing up to a point because of the interest tax benefit and then started to
decrease due to the cost of financial distress. Such costs may include bankruptcy and other
related costs. The point at which the curve representing the value of the firm with such cost
intersects the curve representing the value of the firm without such cost is the optimal level of
debt. This is denoted by B* in the figure. So, from the trade-off between tax benefit and
financial distress costs, optimal amount of debt can be obtained.

In the bottom portion of the figure, it is seen that the weighted average cost of capital is
decreasing with the inclusion of leverage in the capital structure. This decrease in cost of capital
goes up to point B* and then started to increase. So, in point B* the amount of debt incurs the
lowest weighted average cost of capital.

So, the implication of the theory is that a firm can determine its optimal capital structure or the
optimal amount of debt in its total capital by considering the trade-off between the tax benefit
obtained from the inclusion of debt and the cost of financial distress related to such debt.

2.5.3 Pecking Order Theory

Pecking order theory says that the managers of the firm prefer to get new financing from
internal sources rather than debt capital. It also says that the firms use internally generated
funds first and then take debt financing and lastly issue equity. The theory was developed by
Myers and Majluf (1984). According to the theory, when the firm has enough internally
generated fund, it should use such fund at first. And when such fund is not enough to meet the
firm’s financing need, only then the firm can issue debt. Again there is some risks associated
with the mispricing of equity or debt. So, the use of internal financing can avoid such risk. If
the firm needs external financing, it should issue debt first as the risk of debt is less if financial
distress can be avoided. As the firm reaches to its maximum debt capacity, then it should
consider issuing equity.

As the firm prefers internal financing, there is no such target amount of debt like that of trade-
off theory. The debt ratio of the firm depends on its need for outside financing. As the need for
external financing increases, the required debt ratio increases. And at a point the firm required

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to issue debt. The firm that has higher level of profitability uses less debt. Such firms finance
their new project with internally generated cash flows. As they have higher level of cash flows,
they try to finance their projects by their own cash flows. In this case the trade-off theory has
no implication. Such greater amount of cash flow increases the firms’ debt capacity. When the
firms think that they have projects that will need finance in the future, they start to accumulate
funds from their internal cash flows.

So, when the firms’ internal financing capacity is exhausted, then they issue debt first to obtain
external fund and then issue equity if they need more fund. This theory is only followed by the
firms that have much amount of internal financing capacity. The firms that do not have such
capacity, try to obtain an optimal mix of debt and equity.

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 Chapter- 3
Literature Review

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3.1 Literature Review
Choice of the financing source is one of the major decisions that a firm takes. A firm tries to
find lowest cost source of financing. An optimal capital structure will maximize the firm value
through greater return. According to Modigliani and Miller (1958) the capital structure or
firms’ choice of financing source is irrelevant. But, the assumption is only applicable in perfect
market condition where all investors have free access to information, there is no transaction
costs and no tax difference for dividend and capital gains. But, in real economy there is no
presence of such perfect market. Modigliani and Miller revised the theory and said that interest
expenses are tax deductible and firm value will increase with higher proportion of debt in the
capital structure.

Jensen and Meckling (1976) explained that capital structure that is the proportion of debt and
equity can mitigate agency costs of a firm. Thus improves firm value and performance. They
claimed that more use of debt in the capital structure may reduce agency costs through the
threat of liquidation, causing personal losses to managers’ salaries and pressures to generate
cash flow for interest payments. Thus, the use of debt in the capital structure seems to increase
the profitability of a firm as it reduces cost.

Harris and Raviv (1990) argue that debt in the capital structure gives more power to investors
and thus reduces discretionary power of managers and gives discipline on their use of free cash
flow of the firm. Such reduction in the power of management influences them to work for the
interest of the investors. Which in turn increases the cash flow of the firm as a result the firm’s
return is increased and it performs better.

Brigham and Gapenski (1996) found that optimal capital structure can only be obtained if there
exists tax benefits and considers financial distress costs. A firm manager should be able to
identify the level of optimal capital structure and try to maintain that. This can be obtained at
a point in which financing costs are minimized and firm performance is improved. This is
known as interest-tax shield. As interest gets tax shield, it increases the profitability of the firm
which goes to the equity holders.

Berger and Bonaccorsi di Patti (2006) employ profit efficiency as an indicator for firm
performance. They have estimated a simultaneous-equation model to take into account the
impact of reverse casualty on firm performance. This resulted in a statistically significant
relationship between higher level of leverage and higher profit efficiency. It indicates that the
higher the proportion of debt in a firm’s capital structure, the better the firm performs.

16 | P a g e
Leland & Pyle (1977) argue that difference in information about investment projects of firms
can affect the capital structure and thus performance of the firm. Managers or investors gives
indication about capital structure or reduces inefficiencies caused by asymmetric information.
Thus, when a firm is going to invest in a risky project, it may not be able to obtain proper equity
financing or may obtain at a higher cost. Such projects may have higher return or even no return
depending on proper implementation of the project.

Stulz (1990) stated that optimal capital structure can be obtained by a trade-off between benefit
of debt and cost of debt. He argues that managers issue debt only in case of takeover threat. So,
when the managers thinks that the company is at a risk of being taken over by another firm,
they will issue debt and make the takeover unattractive to the acquirer firm.

Diamond (1989) argued that as a firm gets older, it chooses projects that are less risky and thus
reduces its defaults resulting in lower cost of debt. This theory suggests that as the firms get
older they increase the proportion of debt in their capital structure. So, for the older firms that
invests in less risky projects, debt financing can contribute more than equity financing.

Myers and Majluf (1984) emphasized that if the investors have less information than the
company insiders while equity was being issued, it would result in mispricing. It can be avoided
by using external debt and then equity to finance new. So, before taking financing, the firm
should ensure that the investors have idea about where the fund will be used. If not, the firm
should go for debt financing first and after the information goes to the market, the firm can take
equity financing.

Korajczyk, Lucas, and McDonald (1991) argued that the under investment problem is reduced
after information releases. It can be said that firms with less tangible assets in relation to total
value would tend to have more information asymmetries. So, the firms that have less amount
of fixed assets is tend to make less investment in larger production facilities and thus tendency
to disclose information by the managers.

Mayston, Copeland and Weston (1982) emphasized that bankruptcy costs accounts for
differences in capital structure amongst firms. According to them, if bankruptcy costs were not
assumed, an optimal capital structure would probably exist and lead to a substitution between
leverage and likelihood of bankruptcy. Financial securities like convertible bond and
managerial incentives could be used to eliminate agency problem. So, if a firm faces the
tradeoff between leverage and bankruptcy, it may use debt securities that can be converted into
equity securities.

17 | P a g e
Mayer (1990) examined the level of development between financial markets and banks and
concluded that the level of development of financial market could have an impact on the capital
structure of firms. For instance, if the bond market was more developed than the banking sector
and rest of the financial market, more bonds and debt securities would be used by the firms.
So, firms’ capital structure largely depends on the type of capital available to them and the cost
of such capital.

Titman (1984) stated that capital structure was designed to ensure that only the debtholders
would liquidate a firm only when it declares bankruptcy. And the firm would default if net
gains to liquidation exceed the cost to company’s customers. It indicates that when a firm is in
default or is not able to meet its financial obligation, the debt holders of the firm can apply for
the liquidation of the firm as they have claim on the firm’s assets.

Masulis (1988) reviewed the empirical literature on event studies related to security offerings
and stock repurchases. He concluded that equity increasing transactions result in stock price
falls while leverage increasing transactions result in stock price rises. This indicates that the
firm value can be increased with low cost debt in the capital structure. So, if a firm increases
debt in its capital structure, it is assumed to perform better and thus the price increases.

18 | P a g e
 Chapter- 4
Methodology

19 | P a g e
4.1 Techniques of Analysis
Several methods will be used to test the models considered. Ordinary Least Squares, Fixed
effect with entity specific intercepts and random effects will be used here. The Hausman test
will be performed to determine the better model. If, the p value of Hausman Test is greater than
5%, then Random Effects Generalized Least Square method will be appropriate. Otherwise,
Fixed Effects regression model will be appropriate. Using the appropriate model the strength
of relationship between capital structure and firm performance will be analyzed. Fixed Effect
method assumes that the companies have their own characteristics that influence the
relationship. On the other hand Random Effect Generalized Least Squares method imply a
random variation across the companies uncorrelated to explanatory variables.

Some econometric tests are also done for having better implication. Two of these are Stationary
Test and Granger Causality Test.

i. Stationary Test (Unit Root Test): It is necessary to test each of the variables of the
model before applying them to econometric case. If, non-stationary variables are used
it may give incorrect result or result which is not feasible. For this reason, using unit
root test the order of integration of several variables is checked here. And, the variables
which are not stationary at level are further checked at 1st difference. Then, these
variables are used for regression.
ii. Granger Causality Test: Granger Causality Test is performed to examine the impact
of one variable on another of a model. It is assumed at first that the independent
variables only have impact on dependent variable. But, it may also happen that the
dependent variable affects one or more of the independent variables. The test also
examines the mutual impact of one independent variable to another. For each pair of
variables (X, Y) two null hypotheses are obtained. One is ‘X does not Granger-cause
Y’ and another one is ‘Y does not Granger-cause X’. These two hypotheses are then
tested to see the impact of one variable on another.

4.2 Model Specification

The relation between firms’ capital structure as measured by degree of leverage and financial
performance as measured by return on equity will be shown. Here, the financial performance
or return on equity and return on assets will be used as dependent variable. Some variables will
be used to determine their impact on firm performance over the 2000-2018 periods.

20 | P a g e
After identifying the problem, next task is to formulate the model for the problem. The model
explains a variable in terms of explanatory and control variables. Model is formulated based
on considering the theory rather than empirical evidence. In an Ordinary Least Square model a
variable is used to show the relationship between explanatory variable and control variable and
the variable to be explained. The regression analysis has three steps namely model formulation,
estimation of parameters and interpretation of parameters. Before parameters are calculated, it
is necessary to formulate the regression model or equation. Next two steps depend on the
correct formulation of the model. As we have the information about the variable to be
determined and the variables that will be used in determination of the variable, we can form
the equation. The regression equation is as follows:

ROEit = α + β1 tdebt_assetit + β2 equity_assetit + β3 lntait + β4 tangibilityit + β5 liquidityit +

β6 tax_ebtit + β7 tatoit + β8 Ageit + εit……. (1)

ROAit = α + β1 tdebt_assetit + β2 equity_assetit + β3 lntait + β4 tangibilityit + β5 liquidityit +

β6 tax_ebtit + β7 tatoit + β8 Ageit + εit…….. (2)

Where,

ROE= Return on equity is a measure of firms financial performance which is calculated by

dividing the net profit by total equity
ROA= Return on equity is a measure of firms financial performance which is calculated by
dividing the net profit by total assets
α= Intercept of the model
β= Coefficient of each variable
tdebt_asset= Debt ratio as a measure of financial leverage of a firm
equity_asset= It is a measure of the portion of equity on total assets
lnta= It is the natural logarithm of total asset
tangibility= The firm’s tangibility is measured by the proportion of fixed asset to total asset
liquidity= The ratio of current asset to current liability will be used as the measure of liquidity
tax_ebt= The ratio of tax to earnings before tax (EBT) will be used as measure of tax
tato= Total asset turnover
age= Indicator of learning effect

ε= Random error term

i= Name of the company

21 | P a g e
t= Time (year)

4.3 Variables
Here, three types of variables are used to analyze the impact of capital structure on performance
of firms in engineering industry.

Dependent Variables
 ROE= Return on equity is a measure of firms financial performance which is calculated
by dividing the net profit by total equity
 ROA= Return on equity is a measure of firms financial performance which is calculated
by dividing the net profit by total assets

Explanatory Variables
 tdebt_asset= Debt ratio as a measure of financial leverage of a firm
 equity_asset= It is a measure of the portion of equity on total assets

Control Variables
 lnta= It is the natural logarithm of total asset
 tangibility= The firm’s tangibility is measured by the proportion of fixed asset to total
asset
 liquidity= The ratio of current asset to current liability will be used as the measure of
liquidity
 tax_ebt= The ratio of tax to earnings before tax(EBT) will be used as measure of tax
 tato= Total asset turnover
 age= Indicator of learning effect

4.4 Variable Definitions

The variables that are used needs to be defined for having a clear view. These variables are
explained below:

4.4.1 Dependent Variables

Return on equity: Return on equity is the ratio of net income to total equity of a firm. It is a
measure of firms’ financial performance. The data for the calculation is collected from financial
statements of the selected firms. The effect of capital structure will be examined on return on
equity.

22 | P a g e
Return on asset: Return on asset is the ratio of net income to total assets of a firm. It is a
measure of firms’ financial performance. The data for the calculation is collected from financial
statements of the selected firms. The impact of capital structure will be examined on return on
asset.

4.4.2 Explanatory Variables

Total debt to total assets: It is calculated by dividing total debt by total assets. It is a measure
of financial leverage. It indicates the proportion of debt in total asset of the firm. It will be used
as explanatory variable.

Total equity to total assets: It is calculated by dividing total equity by total assets. It is a
measure of financial leverage. It indicates the proportion of equity in total asset of the firm. It
will be used as explanatory variable.

4.4.3 Control Variables

Size: Size of a company is measured by its total assets. Firms with higher level of assets are
often more diversified and have more stable cash flows; the probability of defaults for large
firms is smaller compared to smaller ones. Thus the financial distress risk can be considered
lower for larger firms.

Log of total assets: It is natural logarithm of total assets. Some data are not normally
distributed, so logarithm is taken to make that data set normally distributed one.

Tangibility: Tangibility refers to the availability of tangible assets that possesses some degree
of debt capacity. There is positive relationship between asset tangibility and firm performance
as tangibility increases the investment capacity of a firm. Asset tangibility also reduces the
probability of financial distress.

Liquidity: It is the ability to convert an asset into cash immediately. Liquidity is calculated by
dividing the total current assets by total current liabilities. The higher the liquidity the lower
the risk of default.

Tax to earnings before tax: It is the measure of tax rate. It depends on the profit of a firm.
Different rates are used for different levels of profit. Corporate taxes are usually levied by all
levels of government.

Total assets turnover: It is calculated by dividing sales by total assets. So, it shows the
relationship between sales and total assets. It is a measure of operating efficiency.

23 | P a g e
Age: Age of a firm is the difference between its year of commencement and the year which is
considered. It is an indicator of learning effect. As the firms get older they change their
behavior. So, the age of earlier commenced firms is greater than that of recently commenced
firms. A firm’s performance changes as it gets older.

4.5 Sample and Sources of Data

For the purpose of analysis 37 companies have been selected that have publicly traded shares
and listed in Dhaka Stock Exchange. All the companies are from engineering industry. Here,
data are collected for 2000-2018. But, some companies are listed after 2000. So, data for these
companies have been collected from their listing years. Data are collected from the financial
statements of the companies which are found in specific annual reports of the companies.

24 | P a g e
Chapter- 5 Analysis
and Findings

25 | P a g e
 5.1 Descriptive Statistics
Table 5.1: Descriptive Statistics
Statistical Variables
Measure roe roa tdebt_ equity_ lnta tang. liquid. tax_ tato age
asset asset ebt
Mean 0.085 0.038 0.327 0.421 20.740 0.315 1.995 0.231 0.845 28.671
Median 0.081 0.031 0.274 0.448 20.603 0.275 1.501 0.250 0.682 27.000
Maximum 4.593 0.479 1.441 1.044 24.545 0.850 27.859 3.173 15.794 66.000
Minimum -2.801 -0.321 0.000 -0.816 16.316 0.012 0.107 -1.555 0.000 5.000
Std. Dev. 0.363 0.062 0.272 0.296 1.683 0.219 2.412 0.246 0.944 13.386
Skewness 1.981 0.079 1.235 -1.021 -0.154 2.009 7.504 4.120 9.759 0.521
Kurtosis 76.047 14.257 4.892 5.410 2.720 13.978 70.554 62.576 150.164 2.848
Observations 423 423 423 423 423 423 423 423 423 423
Source: Author’s Calculation
From the table it is seen that the mean of return on equity is 8.5% whereas the mean of return
on asset is 3.8%. It indicates that, for each Tk. 100 investment the equity holders get about Tk.
8.5 as return whereas for the same amount of asset the return is Tk. 3.8. The engineering
industry is a very volatile one and so the return generated from investment varies time to time.
The standard deviation of 36.3% for return on equity indicates that it is highly volatile and
6.2% for return on asset indicates that it is less volatile.

From the statistics of independent variables it is evident that the mean of debt ratio is 32.7%
and the mean of equity to total asset is about 42.1%. It indicates that the firms of that industry
is financed mostly by equity capital that indicates lower level of leverage. The maximum debt
ratio is 144.1%. It happens when a firm performs very poorly and it generates negative return
for very long time making the shareholders equity negative.

Mean tangibility is about 0.315 and liquidity ratio is about 1.995. It indicates that the liquidity
position of the firms in engineering industry is somewhat good. The average total asset turnover
of 0.845 indicates that against Tk. 1 asset firms generate about Tk. 0.845 amount of sell. The
mean tax to earnings before tax ratio of 23.1% indicates that the firms pay tax about 23.1% of
earnings before tax that they generates.

26 | P a g e
 0.0
0.5
1.0
1.5
2.0
2.5
0.00
0.25
0.50
0.75
1.00
1.25
1.50

0
4
8
12
16
1 - 00 1 - 00 1 - 00
2 - 06 2 - 06 2 - 06
3 - 12 3 - 12 3 - 12
4 - 18 4 - 18 4 - 18
6 - 05 6 - 05 6 - 05
7 - 11 7 - 11 7 - 11
8 - 17 8 - 17 8 - 17
10 - 04 10 - 04 10 - 04
11 - 10 11 - 10 11 - 10
12 - 16 12 - 16 12 - 16
14 - 03 14 - 03 14 - 03
15 - 09 15 - 09 15 - 09
16 - 15 16 - 15 16 - 15
18 - 02 18 - 02 18 - 02
19 - 08 19 - 08 19 - 08

tato
20 - 14 20 - 14 20 - 14
22 - 01 22 - 01 22 - 01

tangibility
tdebt_asset

23 - 07 23 - 07 23 - 07
24 - 13 24 - 13 24 - 13
26 - 00 26 - 00 26 - 00
27 - 06 27 - 06 27 - 06
28 - 12 28 - 12 28 - 12
29 - 18 29 - 18 29 - 18
31 - 05 31 - 05 31 - 05
32 - 11 32 - 11 32 - 11
33 - 17 33 - 17 33 - 17
35 - 04 35 - 04 35 - 04
36 - 10 36 - 10 36 - 10
37 - 16 37 - 16 37 - 16

10
20
30
40
50
60
70
10
15
20
25
30
-1.0
-0.5
0.0
0.5
1.0
1.5

0
0
5
1 - 00 1 - 00 1 - 00
2 - 06 2 - 06 2 - 06
3 - 12 3 - 12 3 - 12
4 - 18 4 - 18 4 - 18
6 - 05 6 - 05 6 - 05
7 - 11 7 - 11 7 - 11
8 - 17 8 - 17 8 - 17
10 - 04 10 - 04 10 - 04
11 - 10 11 - 10 11 - 10
12 - 16 12 - 16 12 - 16
14 - 03 14 - 03 14 - 03
15 - 09 15 - 09 15 - 09

the firms are generating less sales over the years.

16 - 15 16 - 15 16 - 15
18 - 02 18 - 02 18 - 02
19 - 08 19 - 08 19 - 08

age
20 - 14 20 - 14 20 - 14
liquidity

22 - 01 22 - 01 22 - 01
equity_asset

23 - 07 23 - 07 23 - 07
24 - 13 24 - 13 24 - 13
26 - 00 26 - 00 26 - 00
27 - 06 27 - 06 27 - 06
28 - 12 28 - 12 28 - 12
29 - 18 29 - 18 29 - 18
31 - 05 31 - 05 31 - 05
32 - 11 32 - 11 32 - 11
33 - 17 33 - 17 33 - 17
35 - 04 35 - 04 35 - 04
36 - 10 36 - 10 36 - 10
37 - 16 37 - 16 37 - 16
-2
-1
0
1
2
3
4
16
18
20
22
24
26

1 - 00 1 - 00
2 - 06 2 - 06
3 - 12 3 - 12
5.1.1Trend line in Company Specific Independent Variables

4 - 18 4 - 18
6 - 05 6 - 05
7 - 11 7 - 11
8 - 17 8 - 17
10 - 04 10 - 04
11 - 10 11 - 10
12 - 16 12 - 16
14 - 03 14 - 03

Figure 5.1: Trend line in company specific independent variables

15 - 09 15 - 09
16 - 15 16 - 15
18 - 02 18 - 02
19 - 08 19 - 08
lnta

20 - 14 20 - 14
tax_ebt

22 - 01 22 - 01
23 - 07 23 - 07
24 - 13 24 - 13
26 - 00 26 - 00
27 - 06 27 - 06
28 - 12 28 - 12
29 - 18 29 - 18

27 | P a g e
higher over the years which indicates that the larger size of the firms. Tangibility is seen to be
graph it is seen that debt ratio was higher in two periods when the equity ratio is seen to be

position over the period of analysis. Tax as a percentage of earnings before tax indicates that
the firms are paying about 25% of earnings before tax as tax. Total asset turnover indicates that
The figure shows the trend of company specific independent variables over the years. From the

about 0.5 to 0.85. Liquidity ratio is nearly 2 which indicates that the firms have good liquidity
lower. In other years these ratios are seen to be very closer. The asset base is seen to be mostly
31 - 05 31 - 05
32 - 11 32 - 11
33 - 17 33 - 17
35 - 04 35 - 04
36 - 10 36 - 10
37 - 16 37 - 16
5.1.2 Quantiles of different factors of model

Figure 5.2: Quantiles of Different Factors of Model

The figure above shows the quantile values of different factors of the model. It is seen that debt
ratio lies mostly in between 0 to 1. It deviates to upper side. Again, equity ratio lies in between
0 to 1 and deviates to lower side as the equity becomes negative. Tangibility is not much
deviated from its normal value whereas liquidity is seen to be deviated upper side from its
normal value. Tax to earnings before tax is seen to be almost stable over the year which
indicates that the level of tax rate is not deviated much. Total asset turnover is seen to be upward
sloping. Some firms failed to generate sales in some and so the turnover became zero for those
companies in those years.

28 | P a g e
5.1.3 Scatter Graphs of Relationship between ROE (Dependent variable)
and other variables
1.50 1.5 26

1.25
1.0 24

1.00

equity_asset
tdebt_asset

0.5 22

lnta
0.75
0.0 20
0.50

-0.5 18
0.25

0.00 -1.0 16
-4 -2 0 2 4 6 -4 -2 0 2 4 6 -4 -2 0 2 4 6

ROE ROE ROE

2.5 30 4

25 3
2.0

20 2
1.5
tangibility

tax_ebt
liquidity

15 1
1.0
10 0

0.5
5 -1

0.0 0 -2
-4 -2 0 2 4 6 -4 -2 0 2 4 6 -4 -2 0 2 4 6

ROE ROE ROE

16 70

60
12
50

40
tato

age

8
30

20
4
10

0 0
-4 -2 0 2 4 6 -4 -2 0 2 4 6

ROE ROE

Figure 5.3: Scatter Graph (ROA as Dependent Variable)

The figure shows the scatter graphs of the relationship between return on equity as dependent
variable and other variables. Debt ratio is seen to have positive relation with return on equity
which indicates that return increases with debt capital. On the other hand, equity ratio is
negatively related to return on equity. Size of the firm as measured by total asset also has much
impact in return on equity. Tangibility and liquidity is not that much related to return on equity.
Return on equity does not seem to be fluctuated much with the changes in total asset turnover.
Return on equity is seen to be fluctuating somewhat with change in tax as a percentage of
earnings before tax. So, tax has some impact on return on equity.

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5.1.4 Scatter Graphs of Relationship between ROA (Dependent variable)
and other variables

Figure 5.4: Scatter Graph (ROA as Dependent Variable)

The above scatter graph shows the relationship between return on asset as dependent variable
and other variable. Return on asset fluctuates with the fluctuation in the proportion of debt on
a firm’s total asset. It is somewhat negatively related to debt ratio. Return on asset fluctuates
with changes in proportion of equity in total asset. It goes upside as proportion of equity
increases. It is seen to be highly volatile to the changes in the firms’ total asset. Tangibility and
liability do not affect the return on asset much. Return on asset fluctuates with changes in the
tax as a percentage of earnings before tax. Total asset turnover does not affect the return on
asset that much to be considered. Age as some impact on return on asset as the firm’s asset
base increases over time.

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5.2 Regression Analysis
The objective of the study is to show the impact of capital structure on firm performance. Here,
return on equity and return on asset is used as dependent variables which measure the
performance of firms. Debt ratio and equity to total asset ratio is used as explanatory variables.
Other variables are included as they are likely to have some control over the firm performance.

5.2.1 Results of Unit Root Test

It is important for the variables of a regression model to be stationary before they are used in
the model. Unit root test is performed to examine the stationary of the variables used in the
model. The test is used for both dependent and independent variables to be used. The results
of unit root test is given below.

Table 4.2: Results of Unit Root Test

Variable Status Statistic Probability
roe Level -4.3460 0.0000
roa Level -5.1189 0.0000
tdebt_asset Level -3.8291 0.0001
equity_asset Level -2.2042 0.0138
lnta First Difference -0.4519 0.3256
tang. Level -6.9525 0.0000
liquid. Level -3.5669 0.0002
tato First Difference -0.9923 0.1605
tax_ebt Level -1.8275 0.0338
Source: Author’s Calculation
From the table it is seen that most of the variables are stationary at level. Only natural logarithm
of total asset (which measures size) and total asset turnover was to stationary at level. They
have become stationary at first difference. So, these two variables are used at first difference
in regression analysis.

5.2.2 Result of Multicollinearity Test

When there is very high correlation between two independent variables, it affects the outcome
of the study. The problem is known as multicollinearity. To identify the multicollinearity
problem there is as test called Variance Inflation Factor (VIF). If the variance inflation factor
of an independent variable is greater than 10, the variable is said to have multicollinearity

31 | P a g e
problem and it is reasonable to exclude the variable from analysis. The result of Variance
Inflation Factor (VIF) test is shown below.

Table 4.3: Results of Variance Inflation Factor (VIF) Test

Variable VIF 1/VIF
tdebt_asset 2.21 0.45215
equity_asset 2.44 0.40990
d(lnta) 1.06 0.94556
tangibility 1.22 0.81978
liquidity 1.22 0.82211
tax_ebt 1.04 0.95797
d(tato) 1.04 0.96294
age 1.06 0.94286
Mean VIF 1.41
Source: Author’s Calculation
From the table it is seen that the highest variance inflation factor is 2.44 for equity ratio. But,
there is no such variable for which variance inflation factor is greater than 10. It indicates that
there is no multicollinearity problem as the value (1/VIF) is above the minimum tolerance level
of 0.1 in this case. And so, no variable is needed to be excluded from the model. So, the
regression analysis using all the independent variables will be performed.

32 | P a g e
5.2.3 Ordinary Least Squares (OLS) Regression
In Ordinary Least Squares (OLS) regression the sum of squared deviation between the observed
and predicted values of the dependent variables are minimized to examine the relationship
between independent variables and the dependent variables.

The result of ordinary least squares regression model is explained below.

Table 4.4: Result of Ordinary Least Squares Regression

ROE (Dependent Variable) ROA (Dependent Variable)
Variables Coef. t p>│ t │ Coef. t p>│ t │
tdebt_asset -0.18003 -2.39 0.0171 -0.05645 -3.69 0.0003
equity_asset -0.02327 -0.32 0.7485 0.01566 1.06 0.2896
d(lnta) 0.17309 3.27 0.0012 0.04193 3.89 0.0001
tangibility -0.19463 -2.79 0.0056 -0.05156 -3.62 0.0003
liquidity 0.00412 0.56 0.5729 0.00307 2.06 0.0398
tax_ebt 0.10706 1.91 0.0569 0.01109 0.97 0.3315
d(tato) 0.03212 1.76 0.0799 0.00744 1.99 0.0466
age 0.00148 1.35 0.1769 0.00020 0.91 0.3633
R-sq = 0.1073 R-sq = 0.2041
Adjusted R-sq = 0.0883 Adjusted R-sq = 0.1872
F-statistic = 5.66 F-statistic = 12.08
Prob > F = 0.0000 Prob > F = 0.0000
Source: Author’s Calculation
From the table it is seen that when return on equity is dependent variable, debt ratio, natural
logarithm of total asset, tangibility, tax to earnings before tax and total asset turnover are
significant variables as the value of P>│t│ is less than 0.10. Among them, debt ratio and
tangibility have negative coefficient and others have positive coefficient. Value of R-square is
0.1073, which indicates that 10.73% of the changes in return on equity can be observed by the
changes in independent variables.

When, return on asset is used as dependent variable, debt ratio, natural logarithm of total asset,
tangibility, liquidity and total asset turnover are significant variables as the value of P>│t│ is
less than 0.10. Among them, debt ratio and tangibility have negative coefficient and others
have positive coefficient. Value of R-square is 0.2041, which indicates that 20.41% of the
changes in return on asset can be observed by the changes in independent variables.

33 | P a g e
5.2.4 Fixed Effects (within) Regression
In a fixed effect model the parameters are fixed or non-random. Here, the group means will be
non-random. On the other-hand in random effect model the parameters are random sample of
the population. The results of fixed effect model are explained below.

Table 4.5: Results of Fixed Effects (within) Regression

ROE (Dependent Variable) ROA (Dependent Variable)
Variables Coef. t p>│ t │ Coef. t p>│ t │
tdebt_asset -0.36567 -3.26 0.0012 -0.09064 -4.60 0.0000
equity_asset -0.20931 -2.06 0.0402 -0.05457 -3.06 0.0024
d(lnta) 0.13645 2.45 0.0149 0.02763 2.82 0.0051
tangibility -0.09559 -1.12 0.2628 -0.01417 -0.95 0.3447
liquidity 0.01708 0.81 0.4187 0.01553 4.19 0.0000
tax_ebt 0.12837 2.14 0.0332 0.01668 1.58 0.1148
d(tato) 0.04376 2.37 0.0181 0.00878 2.71 0.0071
age 0.00176 0.57 0.5665 -0.00062 -1.14 0.2546
R-sq = 0.2244 R-sq = 0.0376
Adjusted R-sq = 0.1269 Adjusted R-sq = 0.0618
F-statistic = 2.30 F-statistic = 7.49
Prob > F = 0.0000 Prob > F = 0.0000
Source: Author’s Calculation
From the above results it is found that when return on equity is used as dependent variable,
debt ratio, equity ratio, natural logarithm of total asset, tax to earnings before tax and total asset
turnover are significant as the value of P>│t│ is less than 0.10. Among them, debt ratio and
equity ratio have negative coefficient and others have positive coefficient. Value of R-square
is 0.2244, which indicates that 22.44% of the changes in return on equity can be observed by
the changes in independent variables.

When return on asset is used as dependent variable, debt ratio, equity ratio, natural logarithm
of total asset, liquidity and total asset turnover are significant as the value of P>│t│ is less than
0.10. Among them, debt ratio and equity ratio have negative coefficient and others have
positive coefficients. Value of R-square is 0.0376, which indicates that 3.76% of the changes
in return on asset can be observed by the changes in independent variables.

The F-statistic for return on equity and return on asset models are 2.30 and 7.49 respectively.

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5.2.5 Random Effects Generalized Least Squares Regression
Random effects generalized least squares regression model assumes that the differences across
entities are random or uncorrelated with the control variables of the model. It is a special case
of fixed effects model. The result of random effects generalized least squares regression is
given below.

Table 4.6: Results of Random Effects Generalized Least Squares Regression

ROE (Dependent Variable) ROA (Dependent Variable)
Variables Coef. t p>│ t │ Coef. t p>│ t │
tdebt_asset -0.19768 -2.54 0.0115 -0.08477 -4.79 0.0000
equity_asset -0.04318 -0.58 0.5640 -0.02703 -1.65 0.0994
d(lnta) 0.16884 3.24 0.0013 0.02947 3.09 0.0021
tangibility -0.17873 -2.53 0.0117 -0.02780 -1.98 0.0490
liquidity 0.00402 0.55 0.5854 0.00400 2.26 0.0245
tax_ebt 0.11178 2.01 0.0450 0.01299 1.26 0.2076
d(tato) 0.03459 1.92 0.0554 0.00833 2.59 0.0100
age 0.00145 1.26 0.2086 -0.00020 -0.62 0.5344
R-sq = 0.1004 R-sq = 0.1343
Adjusted R-sq = 0.081292 Adjusted R-sq = 0.1160
F-statistic = 5.26 F-statistic = 7.31
Prob > F = 0.0000 Prob > F = 0.0000
Source: Author’s Calculation
From the result, it is seen that, when return on equity is used as dependent variable, debt ratio,
natural logarithm of total asset, tangibility, tax to earnings before tax, and total asset turnover
are significant variables as the value of P>│t│ is less than 0.10. Among them, debt ratio and
tangibility have negative coefficient and others have positive coefficient. Value of R-square is
0.1004, which indicates that 10.04% of the changes in return on equity can be observed by the
changes in independent variables.

When return on asset is used as dependent variable, debt ratio, equity ratio, natural logarithm
of total asset, tangibility, liquidity and total asset turnover are significant as the value of P>│t│
is less than 0.10. Among them, debt ratio, equity ratio and tangibility have negative coefficient
and others have positive coefficients. Value of R-square is 0.1343, which indicates that 13.43%
of the changes in return on asset can be observed by the changes in independent variables.

The F-statistic for return on equity and return on asset models are 5.26 and 7.31 respectively.

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 5.2.6 Hausman Test
Hausman test is used to select the appropriate model between fixed effects model and random
effect generalized least squares model. In this test, the null hypothesis, H0: Random effect
model is appropriate and alternative hypothesis, H1: Fixed effect model is appropriate. The
results of Hausman test are shown below.

Table 4.7: Results of Hausman Test

ROE (Dependent Variable) ROA (Dependent Variable)
Coefficients Coefficients
Variable (b) (B) (b-B) (b) (B) (b-B)
Fixed Random Difference Fixed Random Difference
tdebt_asset -0.365665 -0.197680 0.006502 -0.090642 -0.084768 0.000076
equity_asset -0.209305 -0.043184 0.004736 -0.054573 -0.027029 0.000051
d(lnta) 0.136445 0.168840 0.000390 0.027625 0.029474 0.000005
tangibility -0.095598 -0.178726 0.002282 -0.014170 -0.027797 0.000026
liquidity 0.017083 0.004017 0.000391 0.015527 0.004002 0.000011
tax_ebt 0.128367 0.111779 0.000516 0.016679 0.012991 0.000005
d(tato) 0.043757 0.034592 0.000016 0.008778 0.008333 0.000000
age 0.001764 0.001454 0.000008 -0.000617 -0.000208 0.000000
Chi-sq= 17.13 Chi-sq= 27.69
Prob Chi-sq= 0.0288 Prob Chi-sq= 0.0005
Source: Author’s Calculation
For return on equity as dependent variable, the probability of chi2 is 0.0288 which is less than
5% or 0.05. In this case, Fixed Effect Regression model is appropriate. When the dependent
variable is return on asset, the probability of chi2 is 0.0005 which is less than 5% or 0.05. So,
in this case also Fixed Effect Regression model is appropriate. The results of the selected
models are discussed in the next section.

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5.3 Interpretation of Selected Models
The results of selected models for two dependent variables will be discussed separately and
then a comparison will be made. Here, the significant variables will be discussed.

5.3.1 Appropriate Model for Return on Equity (Dependent Variable)

From Hausman test it is found that the appropriate model for return on equity is Fixed Effects
model. There are five variables which have been determined as significant to have impact on
return on equity from fixed effects model. These are debt ratio, equity ratio, natural logarithm
of total asset, tax to earnings before tax and total asset turnover. The results are interpreted
below.

Table 4.8: Interpretation of Relationship between Return on Equity and Significant

Variables
Variables t Relation
tdebt_asset -3.26 Negative
equity_asset -2.06 Negative
lnta 2.45 Positive
tax_ebt 2.14 Positive
tato 2.37 Positive

From the table it is seen that three variables have positive relationship with return on equity
and two variables have negative relationship.

Debt has negative coefficient when return on equity is dependent variable. So as the proportion
of debt is increased in the capital structure the firm’s return on equity is decreased. It is true as
the interest on debt goes to the debtholders which decreases the profitability of the equity
holders.

Equity also has negative coefficient, but it is lower than debt. This is because, equity does not
affects the return on equity in such a way as debt does. When debt is increased, the return is
decreased due to interest payment. On the other hand when equity is increased, the return on
equity is reduced due to the increased proportion of equity. That is, the interest of the
shareholders is diluted and less return is received against the higher amount of equity.

37 | P a g e
Total asset is positively related to return on equity. The amount of total asset is considered to
be investment by the firm. So, if the firms increases investment, they will be able to generate
higher return on equity.

Tax is positively related to profitability. This may be much unexpected, but this is because
when the firms face tax burden, they become very careful about allocating their funds to less
risky investments and thus increases profitability. Thus tax increases the cautiousness of firms
and helps in increasing profitability.

Total asset turnover is positively related to return on equity. As a firm increases its amount of
sell per against unit of total asset, its profitability increases. So, total asset turnover has impact
on firm’s profitability.

5.3.2 Appropriate Model for Return on Asset (Dependent Variable)

The appropriate model when return on equity is used as dependent variable is Fixed Effect
Regression Model. In this case five variables have been determined to have impact on return
on asset. These are debt ratio, equity ratio, natural logarithm of total asset, liquidity and total
asset turnover. The results are interpreted below.

Table 4.9: Interpretation of Relationship between Return on Equity and Significant

Variables
Variables t Relation
tdebt_asset -4.60 Negative
equity_asset -3.06 Negative
lnta 2.82 Positive
liquidity 4.19 Positive
tato 2.71 Positive

From the table it is evident that three variables are positively related to return on asset and two
variables are negatively related.

Total debt is negatively related to return on asset. So, when the amount of debt is higher in a
firm’s asset base, it decreases the profitability of the firm. This is because the firm has to pay
fixed amount of interest on its debt financing which will decrease the amount of profit it earns.

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Equity has negative coefficient. So, as the proportion of equity is increased in a firm’s asset
base, the return on asset is decreased. This is because, the amount of asset is increased but the
profit is not increased at the same proportion as there is agency cost related to equity.

Total asset is positively related to return on asset. The higher the firms asset base, the larger
the size of that firm. So, larger firms can be able to earn higher return on asset. As a firm
becomes larger, it will have more opportunity to invest in different product segments which
will increase its profitability.

Liquidity is seen to be in positive relation with return on asset. As a firm has more liquidity, it
will reduce the firm’s risk of default.

Total asset turnover is in positive relation with return on asset. As firms become able to
generate more amount of sells, they can increase their profitability. So, firms’ profitability will
increase with the increase in total asset turnover.

5.4 Result of Granger Causality Test

The significant results of pairwise Granger Causality Test is given in the table below. Others
are not significant and so it is assumed that they do not impact each other that much to be
considered. The overall result is given in ‘Appendix B’ of the report

Table 4.8: Results of Granger Causality Test

Type of
Null Hypothesis F-Statistic Probability Direction Causality
LNTA does not Granger
0.25846 0.7724
Cause ROE Uni-
ROE does not Granger directional
4.14766 0.0166
Cause LNTA ROE →LNTA Causality

TATO does not Granger

6.70977 0.0014
Cause ROE Uni-
ROE does not Granger directional
0.42598 0.6535
Cause TATO TATO → ROE Causality

LNTA does not Granger

0.27841 0.7572
Cause ROA Uni-
ROA does not Granger directional
3.29832 0.0381
Cause LNTA ROA → LNTA Causality

TANGIBILITY does not TANGIBILITY →

3.10701 0.046
Granger Cause ROA ROA

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 Uni-
ROA does not Granger
0.57030 0.5659 directional
Cause TANGIBILITY
Causality

EQUITY_ASSET does not

Granger Cause 1.02813 0.3588
TDEBT_ASSET
TDEBT_ASSET does not Uni-
Granger Cause 3.69321 0.0259 TDEBT_ASSET → directional
EQUITY_ASSET EQUITY_ASSET Causality

TAX_EBT does not

Granger Cause 4.65063 0.0102
EQUITY_ASSET Uni-
EQUITY_ASSET does not TAX_EBT directional
2.51710 0.0822
Granger Cause TAX_EBT → EQUITY_ASSET Causality

TANGIBILITY does not

6.71827 0.0014
Granger Cause LNTA Uni-
LNTA does not Granger TANGIBILITY → directional
0.43506 0.6476
Cause TANGIBILITY LNTA Causality
Source: Author’s Calculation
At 1st pair of the test, the first null hypothesis of LNTA does not granger cause ROE, is accepted
as the p value is greater than 5% level of significance and the second null hypothesis of ROE
does not granger cause LNTA is rejected as the p value is less than 5% level of significance.
So, there is unidirectional causality that is from ROE to LNTA. It indicates that return on equity
has impact on total asset and will increase total asset.

At 2nd pair of the test, the first null hypothesis of TATO does not granger cause ROE, is rejected
as the p value is less than 5% level of significance and the second null hypothesis of ROE does
not granger cause TATO is accepted as the p value is greater than 5% level of significance. So,
there is unidirectional causality that is from TATO to ROE. It indicates that as total asset
turnover increases, return on equity increases.

At 3rd pair of the test, the first null hypothesis of LNTA does not granger cause ROA, is
accepted as the p value is greater than 5% significance level and the second null hypothesis of
ROA does not granger cause LNTA is rejected as the p value is less than 5% significance level.
So, there is unidirectional causality that is from ROA to LNTA. It indicates that return on asset
has impact on total asset and will increase total asset.

At 4th pair of the test, the first null hypothesis of TANGIBILITY does not granger cause ROA,
is rejected as the p value is less than 5% significance level and the second null hypothesis of

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ROA does not granger cause TANGIBILITY is accepted as the p value is greater than 5%
significance level. So, there is unidirectional causality that is from TANGIBILITY to ROA. It
indicates that Tangibility has impact on return on asset.

At 5th pair of the test, the first null hypothesis of EQUITY_ASSET does not granger cause
TDEBT_ASSET, is accepted as the p value is greater than 5% significance level and the second
null hypothesis of TDEBT_ASSET does not granger cause EQUITY_ASSET is rejected as the
p value is less than 5% significance level. So, there is unidirectional causality that is from
TDEBT_ASSET to EQUITY_ASSET. It indicates that when the amount of debt is increased
in the capital structure, the proportion of equity is reduced.

At 6th pair of the test, the first null hypothesis of TAX_EBT does not granger cause
EQUITY_ASSET, is rejected as the p value is less than 5% significance level and the second
null hypothesis of EQUITY_ASSET does not granger cause TAX_EBT is accepted as the p
value is greater than 5% significance level. So, there is unidirectional causality that is from
TAX_EBT to EQUITY_ASSET. It indicates that tax has impact on equity capital as the firm
should be cautious in allocating its investments when it is in tax burden.

At 7th pair of the test, the first null hypothesis of TANGIBILITY does not granger cause LNTA,
is rejected as the p value is less than 5% significance level and the second null hypothesis of
LNTA does not granger cause TANGIBILITY is accepted as the p value is greater than 5%
significance level. So, there is unidirectional causality that is from TANGIBILITY to LNTA.
It indicates that tangibility or level of fixed asset will strengthen a firm’s asset base.

5.5 Findings
The main objective of the study was to determine the impact of capital structure on financial
performance of the firms in the engineering industry of Bangladesh. Beside this, some other
variables are used to examine the combined effect on the financial performance of firms. For
this purpose the impact of these variables on two performance measures are analyzed with the
help of multiple regression analysis. The findings of the study are:

i. Both debt ratio and equity ratio are seen to have impact on both return on equity and
return on asset. These are the measure of firm performance. Both the ratios are seen to
be negatively related to performance measures. But, the impact of debt is more than
that of equity in the firm performance. So, with the increasing amount of debt in the

41 | P a g e
 capital structure the firms return on equity and return on asset decreases. This is due to
the fixed percentage cost of interest on debt financing.
ii. Among the control variables used, natural logarithm of total asset and total asset
turnover have positive impact on both return on equity and return on asset. So, when
the size of a firm increase with the increase in asset, the return of the firm increases as
more investment is made. Again, total asset turnover is higher with large amount of
sales. So, increase in total asset turnover increases the firm’s return on equity and return
on asset.
iii. Tax to earnings before tax has positive impact on return on equity. As the firms are in
tax burden they become cautious about their investment and more debt in the capital
structure gives the firms interest tax benefit. This affects the firms’ return on equity.
But, the ratio of tax to earnings before tax has not significant impact on return on asset.
iv. Liquidity has significant impact on return on asset. As the impact of liquidity on return
on equity is positive, the firm’s return on asset increases with the increase in liquidity.
v. From the Granger Causality Test it is seen that return on asset and return on equity has
impact on total asset. This is not likely as total asset is used as independent variable.
But, as the return on equity or return on asset increases, it goes to the shareholder
account on left side of the balance sheet and for this cash or receivable is increased in
the right side of balance sheet. So, the two measures of return affects the firm’s asset.

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Chapter- 6
Conclusion

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The objective of the study was to examine the impact of capital structure on the performance
of firms in the engineering industry of Bangladesh. From the study it is found that the capital
structure has impact on the performance of firms. Both the measures of profitability such as
return on equity and return on asset is affected by the capital structure. Both return on equity
and return on asset are in inverse relationship with proportion of debt in the capital structure.
It indicates that the firms holding larger portion of debt in their capital structure will perform
poorly than the firms having smaller portion of debt in their capital structure. This is because
of fixed charge of interest related to debt. The result has also made some confirmation to the
agency cost theory. The equity is inversely related to return on equity and return on asset. This
is because if the proportion of equity is increased in the capital structure the return may increase
but not in the same proportion as increased equity dilutes the shareholders ownership.

Some control variables are also seen to affect the performance of firms. Total asset as a measure
of size affects the firm performance in a positive way. So, the firms that have larger asset base
are likely to have higher return on equity and return on asset. So firms should try to increase
their size and make more investments in order to increase their return.

Asset turnover is also a major determinant of firm performance. It is positively related to return
on equity and return on asset. As the sales of a frim increases, the asset turnover increases and
the profitability of the firm increases. So, the firms that have higher product demand in the
market is likely to do better than the firms having lower demand in the market.

Although, the four factors have impact on both return on equity and return on asset, there are
two other factors that separately affect them. These are liquidity and tax to earnings before tax
ratio. Tax to earnings before tax is positively related to return on equity. When a firm faces tax
burden it is likely to be very cautious about its investment and so this results in greater
performance. Again, there is tax benefit from interest which goes directly to the equity holders
of a firm. So, tax has impact on return on equity. But, as it is a kind of expense to the firm, has
no significant impact on the return on asset.

Liquidity is found to be positively related to return on asset and not to return on equity. As, a
firm has higher liquidity, it is likely to face no problem in meeting its debt obligations. Higher
liquidity will ensure higher profitability to the firm. But, it does not significantly affect the
return on equity. So, if the firm has liquidity and it manages them properly it can generate profit
from those.

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The engineering industry of Bangladesh is a larger one in terms of number of firms listed in
Stock Exchange. The industry is emerging and is likely to be a major contributor to the
economy of Bangladesh. So, the analysis of its profitability of such an industry is important.
But, the price structure of the industry is fluctuating which will affect the profitability of the
firms in the industry. Which provides field for further research. For now, the firms in that
industry should try to make more investment as the demand for these products is increasing in
the local as well as in the global market.

It is clear from the study that there is significant relation between the capital structure and the
firm performance in that industry and it is also the result of other empirical studies conducted
earlier. So, the firms in that industry should try to increase their profitability by taking financing
with more equity and less debt and making proper investment of those. It will also ensure higher
return to investors and helps policy makers to make policy accordingly. Again, if the firms are
in tax bracket, the profitability will increase further.

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Appendix

Appendix A: Selected Companies and their Year of Commencement

Sl. Name of the Company Year of Establishment
1 Aftab Automobiles Limited 1967
2 Anwar Galvanizing Limited 1995
3 Appollo Ispat Complex Limited 1994
4 Atlas Bangladesh 1966
5 Aziz Pipes Limited 1981
6 Bangladesh Autocars Limited 1979
7 Bangladesh Building Systems Limited 2003
8 Bangladesh Lamps Limited 1960
9 BBS Cables Limited 2009
10 BD Thai Alumnium Limited 1979
11 Bengal Windsor Thermoplasctics Ltd. 2002
12 BSRM 1952
13 BSRM Steels Limited 1952
14 Deshbandhu Polymer Limited 2006
15 Eastern Cables Limited 1971
16 Golden Son Limited 1994
17 GPH Ispat Limited 2006
18 Ifad Autos Limited 1988
19 Kay & Que(Bangladesh) Ltd 1984
20 KDS Accessories Limited 1991
21 Monno Jute Stafllers Ltd 1978
22 Nahee Aluminum Composite Panel Ltd 2010
23 National Polymer Industries Ltd 1987
24 National Tubes Limited 1964
25 Navana CNG Limited 2001
26 Oimex Electrode Limited 2003
27 Olympic Accessories Ltd 2003
28 Quasesm Drycells Ltd 1980
29 Rangpur Foundry Limited 1981

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 30 Ratanpur Steel Re-Rolling Mills Limited 1984
31 Renwick Jajneswar & Co Ltd 1988
32 S.Alam Cold Rolled Steels Ltd 2000
33 Shurwid Industries Limited 1995
34 Singer Bangladesh Limited 1979
35 S. S. Steel Ltd 2001
36 Western Marine Shipyard Limited 2000
37 Yeakin Polymer Limited 2001

Appendix B: Results of Granger Causality Test

B1: Granger Causality Test for ROE as Dependent Variable

Pairwise Granger Causality Tests
Date: 08/21/19 Time: 15:00
Sample: 2000 2018
Lags: 2

Null Hypothesis: F-Statistic Prob.

TDEBT_ASSET does not Granger Cause ROE 2.49714 0.0838

ROE does not Granger Cause TDEBT_ASSET 0.07425 0.9285

EQUITY_ASSET does not Granger Cause ROE 0.57094 0.5655

ROE does not Granger Cause EQUITY_ASSET 0.08861 0.9152

LNTA does not Granger Cause ROE 0.25846 0.7724

ROE does not Granger Cause LNTA 4.14766 0.0166

TANGIBILITY does not Granger Cause ROE 2.62762 0.0737

ROE does not Granger Cause TANGIBILITY 0.11925 0.8876

LIQUIDITY does not Granger Cause ROE 0.77858 0.4599

ROE does not Granger Cause LIQUIDITY 0.05102 0.9503

TAX_EBT does not Granger Cause ROE 1.15512 0.3162

ROE does not Granger Cause TAX_EBT 0.99633 0.3703

TATO does not Granger Cause ROE 6.70977 0.0014

ROE does not Granger Cause TATO 0.42598 0.6535
EQUITY_ASSET does not Granger Cause TDEBT_ASSET 1.02813 0.3588
TDEBT_ASSET does not Granger Cause EQUITY_ASSET 3.69321 0.0259

LNTA does not Granger Cause TDEBT_ASSET 0.56029 0.5716

TDEBT_ASSET does not Granger Cause LNTA 0.65438 0.5204

TANGIBILITY does not Granger Cause TDEBT_ASSET 0.61659 0.5404

TDEBT_ASSET does not Granger Cause TANGIBILITY 0.05968 0.9421

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LIQUIDITY does not Granger Cause TDEBT_ASSET 0.73677 0.4794
TDEBT_ASSET does not Granger Cause LIQUIDITY 0.38547 0.6804

TAX_EBT does not Granger Cause TDEBT_ASSET 2.92368 0.0551

TDEBT_ASSET does not Granger Cause TAX_EBT 2.02307 0.1338

TATO does not Granger Cause TDEBT_ASSET 1.14941 0.3180

TDEBT_ASSET does not Granger Cause TATO 0.07236 0.9302
LNTA does not Granger Cause EQUITY_ASSET 1.33971 0.2633
EQUITY_ASSET does not Granger Cause LNTA 0.15613 0.8555

TANGIBILITY does not Granger Cause EQUITY_ASSET 0.64019 0.5278

EQUITY_ASSET does not Granger Cause TANGIBILITY 0.77623 0.4609

LIQUIDITY does not Granger Cause EQUITY_ASSET 0.25094 0.7782

EQUITY_ASSET does not Granger Cause LIQUIDITY 2.45911 0.0870

TAX_EBT does not Granger Cause EQUITY_ASSET 4.65063 0.0102

EQUITY_ASSET does not Granger Cause TAX_EBT 2.51710 0.0822

TATO does not Granger Cause EQUITY_ASSET 0.52880 0.5898

EQUITY_ASSET does not Granger Cause TATO 1.71938 0.1807
TANGIBILITY does not Granger Cause LNTA 6.71827 0.0014
LNTA does not Granger Cause TANGIBILITY 0.43506 0.6476

LIQUIDITY does not Granger Cause LNTA 0.08219 0.9211

LNTA does not Granger Cause LIQUIDITY 1.67278 0.1892

TAX_EBT does not Granger Cause LNTA 2.55591 0.0791

LNTA does not Granger Cause TAX_EBT 2.11301 0.1224

TATO does not Granger Cause LNTA 2.67120 0.0706

LNTA does not Granger Cause TATO 1.84279 0.1599

LIQUIDITY does not Granger Cause TANGIBILITY 0.18375 0.8322

TANGIBILITY does not Granger Cause LIQUIDITY 1.01425 0.3638

TAX_EBT does not Granger Cause TANGIBILITY 0.18636 0.8301

TANGIBILITY does not Granger Cause TAX_EBT 0.57443 0.5636

TATO does not Granger Cause TANGIBILITY 0.21662 0.8053

TANGIBILITY does not Granger Cause TATO 2.74028 0.0660

TAX_EBT does not Granger Cause LIQUIDITY 0.45033 0.6378

LIQUIDITY does not Granger Cause TAX_EBT 0.37554 0.6872

TATO does not Granger Cause LIQUIDITY 0.30413 0.7380

LIQUIDITY does not Granger Cause TATO 0.35789 0.6994

TATO does not Granger Cause TAX_EBT 0.66880 0.5130

TAX_EBT does not Granger Cause TATO 0.16320 0.8495

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 B2: Granger Causality Test for ROA as Dependent Variable
Pairwise Granger Causality Tests
Date: 08/22/19 Time: 00:04
Sample: 2000 2018
Lags: 2

Null Hypothesis: F-Statistic Prob.

TDEBT_ASSET does not Granger Cause ROA 2.93545 0.0544

ROA does not Granger Cause TDEBT_ASSET 1.69411 0.1853

EQUITY_ASSET does not Granger Cause ROA 0.75707 0.4698

ROA does not Granger Cause EQUITY_ASSET 1.03962 0.3547

LNTA does not Granger Cause ROA 0.27841 0.7572

ROA does not Granger Cause LNTA 3.29832 0.0381

TANGIBILITY does not Granger Cause ROA 3.10701 0.0460

ROA does not Granger Cause TANGIBILITY 0.57030 0.5659

LIQUIDITY does not Granger Cause ROA 0.16609 0.8470

ROA does not Granger Cause LIQUIDITY 0.04148 0.9594

TAX_EBT does not Granger Cause ROA 0.13946 0.8699

ROA does not Granger Cause TAX_EBT 0.84876 0.4288

TATO does not Granger Cause ROA 16.4304 2.E-07

ROA does not Granger Cause TATO 0.30488 0.7374

EQUITY_ASSET does not Granger Cause TDEBT_ASSET 1.02813 0.3588

TDEBT_ASSET does not Granger Cause EQUITY_ASSET 3.69321 0.0259

LNTA does not Granger Cause TDEBT_ASSET 0.56029 0.5716

TDEBT_ASSET does not Granger Cause LNTA 0.65438 0.5204

TANGIBILITY does not Granger Cause TDEBT_ASSET 0.61659 0.5404

TDEBT_ASSET does not Granger Cause TANGIBILITY 0.05968 0.9421

LIQUIDITY does not Granger Cause TDEBT_ASSET 0.73677 0.4794

TDEBT_ASSET does not Granger Cause LIQUIDITY 0.38547 0.6804

TAX_EBT does not Granger Cause TDEBT_ASSET 2.92368 0.0551

TDEBT_ASSET does not Granger Cause TAX_EBT 2.02307 0.1338

TATO does not Granger Cause TDEBT_ASSET 1.14941 0.3180

TDEBT_ASSET does not Granger Cause TATO 0.07236 0.9302

LNTA does not Granger Cause EQUITY_ASSET 1.33971 0.2633

EQUITY_ASSET does not Granger Cause LNTA 0.15613 0.8555

TANGIBILITY does not Granger Cause EQUITY_ASSET 0.64019 0.5278

EQUITY_ASSET does not Granger Cause TANGIBILITY 0.77623 0.4609

LIQUIDITY does not Granger Cause EQUITY_ASSET 0.25094 0.7782

EQUITY_ASSET does not Granger Cause LIQUIDITY 2.45911 0.0870

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TAX_EBT does not Granger Cause EQUITY_ASSET 4.65063 0.0102
EQUITY_ASSET does not Granger Cause TAX_EBT 2.51710 0.0822

TATO does not Granger Cause EQUITY_ASSET 0.52880 0.5898

EQUITY_ASSET does not Granger Cause TATO 1.71938 0.1807
TANGIBILITY does not Granger Cause LNTA 6.71827 0.0014
LNTA does not Granger Cause TANGIBILITY 0.43506 0.6476

LIQUIDITY does not Granger Cause LNTA 0.08219 0.9211

LNTA does not Granger Cause LIQUIDITY 1.67278 0.1892

TAX_EBT does not Granger Cause LNTA 2.55591 0.0791

LNTA does not Granger Cause TAX_EBT 2.11301 0.1224

TATO does not Granger Cause LNTA 2.67120 0.0706

LNTA does not Granger Cause TATO 1.84279 0.1599

LIQUIDITY does not Granger Cause TANGIBILITY 0.18375 0.8322

TANGIBILITY does not Granger Cause LIQUIDITY 1.01425 0.3638

TAX_EBT does not Granger Cause TANGIBILITY 0.18636 0.8301

TANGIBILITY does not Granger Cause TAX_EBT 0.57443 0.5636

TATO does not Granger Cause TANGIBILITY 0.21662 0.8053

TANGIBILITY does not Granger Cause TATO 2.74028 0.0660

TAX_EBT does not Granger Cause LIQUIDITY 0.45033 0.6378

LIQUIDITY does not Granger Cause TAX_EBT 0.37554 0.6872

TATO does not Granger Cause LIQUIDITY 0.30413 0.7380

LIQUIDITY does not Granger Cause TATO 0.35789 0.6994

TATO does not Granger Cause TAX_EBT 0.66880 0.5130

TAX_EBT does not Granger Cause TATO 0.16320 0.8495

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