ON

“Financing Of Capital Expenditure: A Study Of Indian

Corporate Sector”
A report submitted in partial fulfilment of the requirements for the award of the
degree of
“BACHELOR OF COMMERCE”
SUBMITED BY:

UNIVERSITY OF LUCKNOW
 Declaration
I, hereby declare that the project titled Financing of capital expenditures: a study
of Indian corporate sector submitted in partial fulfilment for the award of Degree
of Bachelor of Commerce is a record of work done by me under the guidance of
Dr. Arun Kumar Shrivastava. This report has not previously formed the basis for
the award of any degree, diploma, or similar title of any University.

(ANKUR AGRAWAL)

2140012010024

SEMESTER 6TH
 ACKNOWLEDGEMENT
No project report ever reflects the efforts of a single individual. The report
owes its existence to the constant support and guidance of people. I am
grateful to all of them. I owe a never ending debt of gratitude to Dr. Arun
Kumar Shrivastava for their expert guidance and support. I would like
to thank all the respondents for giving their valuable time and providing
useful information. I am also grateful to all those who have either directly
or indirectly contributed toward the completion of the project, for their
support and encouragement.
Last but not least, many thanks go to DR. ANUBHAV VISHWKARMA
who has invested his full effort in guiding me in achieving the goal. I have
to appreciate the guidance given by other supervisor as well as the panels
especially in research project presentation that has improved my
presentation skills thanks to their comment and advices.

(ANKUR AGRAWAL)

2140012010024

SEMESTER 6TH
 Table Of Content

SR. NO. PARTICULAR PAGE NO.

CHAPTER 1
1 1-10
INTRODUCTION

CHAPTER 2
2 11-22
LITERATURE REVIEW

CHAPTER 3
3 23-27
RESEARCH METHODOLOGY

CHAPTER 4
DATA ANALYSIS
4 & 28-48
INTERPRETATION

CHAPTER 5
5 49-53
FINDINGS AND CONCLUSIONS

BIBILOGRAPHY
6 53-55
 CHAPTER 1

INTRODUCTION

The pattern and peace of long-term investment is crucial in the development of every economy.
The rate of capital accumulation fixed investment is one of the key determinants of economy’s
long term growth rate and is indispensable for overall economic development. The role of
Indian corporate sector has always been instrumental in this regard. Moreover, the same has
become even more significant after the liberalization, privatization and globalization measures
Post Industrial Policy 1991 in Indian economy. “Investment spending is devoted to increasing
or maintaining the stock of capital. The stock of capital consists of factories, machines, offices
and other durable man-made products used in the process of production. The capital stock also
consists of residential housing as well as investors.”

This study confines itself to the consideration of business fixed investment (corporate
capital expenditure). The primary aim of the study is to analyze the importance of various
sources of finance in corporate capital expenditures in India.

CAPITAL EXPENDITURES:

In the words of Gitman (2001), “Capital budgeting is the process of evaluating and selecting
long-term investments consistent with the firm’s goal of owner’s wealth maximization.”

Capital expenditure decision are made with different motives in mind by different
firms. The growth plans of an existing firm require the acquisition of more fixed assets whereas
a newly incorporated firms needs to build resources to implement its plans. Further, when a
budding firm is progressing towards its goals, it requires replacing of renewing the obsolete or
worn-out assets. Costs and benefits of repairs and replacements have to be compared.

However, the proposals have to be formally revised by the requisite authority I the light
of firm’s objectives and growth plans to evaluate their economic validity. First, a preliminary
screening of all the capital expenditure proposals is done in light of the broad objectives. A
stricter control is required after approval and funding. Further, the actual and estimated costs
and benefits have to be compared. The firm has to study its relevant cash flow patterns that
include ‘initial investment’, ‘operating cash inflows and outflows’ and ‘terminal cash flows’ of
the project.

1
 At times, the managers are faced with more than one feasible proposal but the funds
may fall short of the requirements. Hence, the next step in capital expenditure decision making
process is to ration the available funds among the feasible proposal(s) optimally. The
controlling aspect comes into picture once the project is finally selected and implemented. Pre-
completion control refers to the comparison of estimated and actual benefits of the project
during its various stages. Lastly, post-completion audit is caried out to evaluate the total return
from the project with targets set in the beginning to improve the future analysis of capital
expenditure proposals.

FINANCING OF CAPITAL EXPENDITURE PROPOSALS:

As the capital expenditures involve huge investment, availability of funds is a prerequisite in

undertaking them. The companies usually have access to a wide array of funds for the said
purpose but the choice of a particular source depends on the associate pros and cons.

Purohit, Lall and Panda (1994) have observed, “Because of indispensability of adequate
finance, it warrants that we should have sufficient knowledge about different sources of
corporate financing. As no source of financing is an unmixed blessing, we should underscore
the suitability of each source of finance.”

The sources may be broadly categorized as internal and external. Cashflows primarily
make up for the internal source of funds may be raised either in the form of fresh issue of equity
or new debt. There are various factors involved in establishing the capability of a firm to raise
fresh funds from the market such as economic conditions, inflation, and goodwill and so on.

The relationship between investment and financing decision in quite evident from the
use of ‘cost of capital’ in various capital budgeting techniques. McCabe (1979) remarked that
since the publication of the work of Modigliani and Miller (MM) in the late 1950s there has
been a recurrent controversy in the finance and economic literature about the interdependence
of investment and financing variables. MM suggested that investment and financing decision
of a firm are independent of each other in perfect capital markets. Some others argue that
market imperfection is a reality and it is necessary for the firms to consider financing options
while making investment decisions. Even MM recognized this interaction of decisions after
incorporating taxes in their model.

2
RATIONALE OF THE STUDY:

The previous sections have emphasized the significance and impact of capital budgeting
decision on long – term performance of a company. Both financing and investment decision
involve huge stakes of the companies. Moreover, the rate of and trends in corporate investment
help explain the future prospects of Indian corporate sector in a better manner. These decisions
clearly leave an impact over the universally accepted objective of financial management, i.e.,
shareholder’s wealth maximization. The issue of interaction between investment and financing
decision, more particularly financing of the investment (capital expenditure) proposals has long
been in the loop at the international front but not much research work has been undertaken on
this subject in India.

CAPITAL EXPENDITURES-A THEORITICAL FRAMEWORK:

Capital expenditure decisions are one of the most important decisions for the growth of a
company. The success of long-term investment decisions of the companies is crucial for
economy’s growth. These decisions pertain to building up the infrastructural bases of the
company by investing in land, building, plant, machinery, furniture, transportation and such
other assets for utilizing them in their physical from throughout their working life.

Business fixed investment is either intended to replace the old utilities or create new
capacity in the firm. It is, however, difficult to separately analyse the investments incurred for
replacement or expansion on account of data unavailability. Various studies in the past have
considered either gross or net investment (net of depreciation) as the dependent variable in
estimating the impact of financing on investment decisions. The studies with gross investment
(Krishna murti and Sastry (1975), Hoshi Kashyap and Scharfstein (1991), Athey and Laumas
(1994) etc.) as the dependent variable consider total increase in business investment including
replacement and expansion investments.

CAPITAL EXPENDITURE DECISION:

The capital expenditure decision plays a key role in this process because of their magnitude
and impact on company’s overall performance. Wealth maximization is the preferred objective
over profit maximization and earning per share (which is at time considered as an improved
version of profit maximization). It takes into account the present and expected future earnings
per hare along with the timing of benefits, qualitative factors (risk attached to expected

3
earning), dividend policy of the company and various other factors. Hence, the management
should evaluate the investment, financing and asset management decision on the yardstick of
shareholder’s value maximization. This objective can further be broadened by adding other
stake holders (such as managers, creditors, customers, suppliers and society as a whole) into
the ambit.

“Investing is commitment of resources made with the expectation of realizing future

benefits over a reasonably long period.”

CAPITAL EXPENDITURE DECISION MAKING PROCESS:

Capital Expenditure decision making involves the scrutiny, review, analysis, implementation
and follow-up of such long-term investments to achieve the goal of shareholder’s wealth
maximization.

In the words of Gitman (2001), “Capital budgeting is the process of evaluating and selecting
long-term investments consistent with the firm’s goal of owner’s wealth maximization.” The
decision process typically follows the following displayed route:

4
THEORIES OF INVESTMENT:
Investment implies an incremental flow to the existing stock of capital. This addition may be fixed
(long-term) or inventory (short-term), replacement or expansionary. The different theories of
investment primarily revolve around the writings of Fisher and Keynes and primarily involve the
concepts like marginal efficiency of capital (MEC) or marginal efficiency of investment (MEI). MEC
of an investment as per Keynes is the discount rate at which the demand price exactly equals the supply
price. This concept is quite equivalent to Fisher’s internal rate of return. MEC schedule presents the
optimal level of capital stock as a function of rate of interest. MEI schedule shows how much investment
would be profitable to carry out in current period for different levels of cost of capital given the initial
level of capital stock. The other notable factors affecting investment are:

• Expectations regarding demand factors which determine the position of MEC schedule are to
be specified.

• Adjustment of capital stock to the desired level cannot be instantaneous for a variety of reasons.

1. Accelerator Theory:

The accelerator theory of investment, in its simplest form, is based upon the nation that a
particular amount of capital stock is necessary to produce a given output.

For example, a capital stock of Rs. 400 billion may be required to produce Rs. 100 billion
of output. This implies a fixed relationship between the capital stock and output.

Thus,

X = Kt /Yt

where x is the ratio of K t, the economy’s capital stock in time period t, to Y t, its output in
lime period t. The relationship may also be written as

Kt = xY t …(i)

If X is constant, the same relationship held in the previous period; hence

Kt-1 = xY t-1…………(ii)

5
By subtracting equation (ii) from equation (i), we obtain

Kt –Kt-1 = xY t.x Yt-1 = x(Y t-Yt-1) …(ii)

Since net investment equals the difference between the capital stock in time period t and
the capital stock in time period t – 1, net investment equals x multiplied by the change in
output from time period t – 1 to time period t.

By definition, net investment equals gross investment minus capital consumption

allowances or depreciation. If I t represents gross investment in time period t and
Dt represents depreciation in time period t, net investment in time period t equals I t – D.

It-D t = x (Yt – Yt-1) = x ∆ Y.

Consequently, net investment equals x, the accelerator coefficient, multiplied by the

change in output. Since x is assumed constant, investment is a function of changes in
output. If output increases, net investment is positive. If output increases more ra pidly,
new investment increases.

From an economic standpoint, the reasoning is straightforward. According to the theory,

a particular amount of capital is necessary to produce a given level of output. For example,
suppose Rs. 400 billion worth of capital is necessary to produce Rs. 100 bi llion worth of
output. This implies that x, the ratio of the economy’s capital stock to its output, equals 4.

If aggregate demand is Rs. 100 billion and the capital stock is Rs. 400 billion, output is
Rs. 100 billion. So long as aggregate demand remains at the Rs. 100 billion level, net
investment will be zero, since there is no incentive for firms to add to their productive
capacity. Gross investment, however, will be positive, since firms must replace plant and
equipment that is deteriorating.

Suppose aggregate demand increases to Rs. 105 billion. If output is to increase to the Rs.
105 billion level, the economy’s capital stock must increase to the Rs. 420 billion level.
This follows from the assumption of a fixed ratio, x, between capital stock and output.
Consequently, for production to increase to the Rs. 105 billion level, net investments must

6
equal Rs. 20 billion, the amount necessary to increase the capital stock to the Rs. 420
billion level.

Since x equals 4 and the change in output equals Rs. 5 billion, this amount, Rs. 20 billion,
may be obtained directly by multiplying x, the accelerator coefficient, by the change in
output. Had the increase in output been greater, (net) investment would have been larger,
which implies that (net) investment is positively related to changes in output.

2. The Internal Funds Theory of Investment:

Under the internal funds theory of investment, the desired capital stock and, hence,
investment depends on the level of profits. Several different explanations have been
offered. Jan Tinbergen, for example, has argued that realized profits accurately reflect
expected profits.

Since investment presumably depends on expected profits, investment is positively related

to realized profits. Alternatively, it has been argued that managers have a decided
preference for financing investment internally.

Firms may obtain funds for investment purposes from a variety of sources:

(1) Retained earnings,

(2) Depreciation expense (funds set aside as plant and equipment depreciate),

(3) Various types of borrowing, including sale of bonds,

(4) The sale of stock.

Retained earnings and depreciation expense are sources of funds internal to the firm; the
other sources are external to the firm. Borrowing commits a firm to a series of fixed
payments. Should a recession occur, the firm maybe unable to meet its commitments,
forcing it to borrow or sell stock on unfavorable terms or even forcing it into bankruptcy.

Consequently, firms may be reluctant to borrow except under very favourable circumstances.
Similarly, firms may be reluctant to raise funds by issuing new stock. Management, for
example, is often concerned about its earnings record on a per share basis. Since an
7
increase in the number of shares outstanding tends to reduce earnings on a per share basis,
management may be unwilling to finance investment by selling stock unless the earnings
from the project clearly offset the effect of the increase in shares outstanding.

Similarly, management may fear loss of control with the sale of additional stock. For these
and other reasons, proponents of the internal funds theory of investment argue that firms
strongly prefer to finance investment internally and that the increased av ailability of
internal funds through higher profits generates additional investment. Thus, according to
the internal funds theory, investment is determined by profits.

In contrast, investment, according to the accelerator theory, is determined by output. Since

the two theories differ with regard to the determinants of investment, they also differ with
regard to policy. Suppose policy makers wish to implement programs designed to increase
investment.

According to the internal funds theory, policies designed to increase profits directly are
likely to be the most effective. These policies include reductions in the corporate income
tax rate, allowing firms to depreciate plant and equipment more rapidly, thereby reducing
their taxable income, and allowing investment tax credits, a device to reduce firms’ tax
liabilities.

On the other hand, increases in government purchases or reductions in personal income

tax rates will have no direct effect on profits, hence no direct effect on investment. To the
extent that output increases in response to increases in government purchases or tax cuts,
profits increase. Consequently, there will be an indirect effect on investment.

In contrast, under the accelerator theory of investment, policies designed to influence

investment directly under the internal funds theory will be ineffective. For example, a
reduction in the corporate tax rate will have little or no effect on investment because, under
the accelerator theory, investment depends on output, not the availability of internal funds.

On the other hand, increases in government purchases or reductions in personal income

tax rates will be successful in stimulating investment through their impact on aggregate
demand, hence, output. Before turning to the neoclassical theory, we should note in
fairness to the proponents of the internal funds theory that they recognize the importance

8
of the relationship between investment and output, especially in the long run. At the same
time, they maintain that internal funds are an important determinant of investment,
particularly during recessions.

3.The Neoclassical Theory of Investment:

The theoretical basis for the neoclassical theory of investment is the neoclassical theory
of the optimal accumulation of capital. Since the theory is both long and highly
mathematical, we shall

not attempt to outline it. Instead, we shall briefly examine its principal results and policy
implications.

According to the neoclassical theory, the desired capital stock is determined by output and
the price of capital services relative to the price of output. The price of capital services
depends, in turn, on the price of capital goods, the interest rate, and the tax treatment of
business income. As a consequence, changes in output or the price of capital services
relative to the price of output alter the desired capital stock, hence, investment.

As in the case of the accelerator theory, output is a determinant of the desired capital stock.
Thus, increases in government purchases or reductions in personal income tax rates
stimulate investment through their impact on aggregate demand, hence, output. As in the
case of the internal funds theory, the tax treatment of business income is important.

According to the neoclassical theory, however, business taxation is important because of

its effect on the price of capital services, not because of its effect on the availability of
internal funds. Even so, policies designed to alter the tax treatment of business income
affect the desired capital stock and, therefore, investment.

In contrast to both the accelerator and internal funds theories, the interest rate is a
determinant of the desired capital stock. Thus, monetary policy, through its effect on the
interest rate, is capable of altering the desired capital stock and investmen t. This was not
the case in regard to the accelerator and internal funds theories.

9
CONCLUSION:

This chapter outlines the capital expenditure decision making process generally used by
various companies. Moreover, it also throws light on theories of investment and various studies
related to external sources of funds. The present study intends to analyze financing of capital
expenditures in Indian corporate sector to understand the relative importance of internal and
external sources of finance in explaining investment equation. The next chapter focuses on
literature review of various researches conducted in India and abroad on this vital topic.

10
 CHAPTER 2

REVIEW OF LITERATURE

In this section an attempt has been made to review the empirical studies conducted with United
States (US) companies as a sample. As the empirical studies are many, an attempt has been
made to review some of the important studies.

GORDON M.J. (1963):

Gordon reviewed whether a corporation’s share price is independent ofdividend rate or not and
the validity of Modigliani and Miller’s3 conclusions with certainty assumption in his article
“Optimal investment and financing policy”. In the beginning of the critique he accepted
Modigliani and Miller’s4 proof of theorem under the assumption of future certainty. However,
later on Modigliani and Miller themselves withdrew their assumption but affirmed that
postulates of “imputed rationality” and “symmetric market rationality” help in holding the
fundamental conclusion good. He added that the corporate announcement regarding retention
of earnings of a specified amount changed the dividend expectations as well as raises the
discount rate. This according to him occurred as the reduction in near dividend but increased
the distant dividends and caused a rise in the discount rate which in turn resulted in a fall in
share price. He further clarified that the profitability of investment was neutralized because
when rate of return on investment is set equal to discount rate; change in level of investment
has no influence on share price.
He has further stated that investors have an aversion to risk or uncertainty and this may lead to
uncertainty regarding dividends in the future. Hence, it is quite possible that investors may use
a discount rate which is an increasing function ofrate of growth of dividends. This will lead
to an impact on share price. He further gave empirical support to his views by presuming that a
corporation will:
(1) retain the fraction b of its income in each future period;
(2) earn a rate of return, r, on the common equity investment in each future period;
(3) maintain the existing debt- equity ratio; and
(4) undertake no new outside equity financing.

11
Hence, under the above assumptions the current dividend is D0 = (1 – b) Y0, and its rate of
growth is br and the entire dividend expectation is as follows:
(𝟏 − 𝑩)𝒀𝟎
𝑷𝟎 =
𝑲 − 𝒃𝒓

Here, Y0 is earning in time t = 0.

He accepted the limitations but at the same time argued that perhaps his model presented a
rich and accurate statement of dividend expectations. Further, by holding r = k, the price of
share become independent of dividend, satisfying Modigliani and Miller (MM)’s position.
His empirical findings suggested k to be an increasing functional of br and that price was a
function of dividend, k and all variables other than dividend. He concluded that the subject
required further study as the axiomatic basis of Modigliani and Miller (MM)’s position was
not powerful enough to force acceptance of their conclusions.

Fazzari, Steven and Hubbard, R. Glenn and Petersen, Bruce C. (1988):

A study of financing constraints and corporate investment was conducted by Fazzari, Hubbard
and Peterson. The work revolved around Q theory of investment and empirical implementation
relied upon cost of adjustment approach. They developed a model to show that capital market
imperfections could limit the availability of external finance to particular types of firms. They
demonstrated the result by modifying a simple model of firm’s financial and investment
decisions developed in the public finance literature. They first analyzed the “full information”
firms that did not face financing constraints due to asymmetric information and later on with
constrained firms. Differences were identified in Q, financing behavior and investment across
the firms classified by their retention behavior. The two predictions that served as a base for
the work were that for firms facing asymmetric information in capital markets, q can fluctuate
over a substantial range in excess of unity with little or no response of investment and
investment can be “excessively sensitive” to cashflow fluctuations. They framed a
mathematical model for maximizing the value of the firm subject to certain explicit and
implicit constraints relating to capital accumulation, new shares, sources, “uses and dividend”
constraints. Lagrangian multipliers were also associated with the constraints. The data was
compiled from value line data for the period of 1969-84. The data of 1969 was used to construct
lag variables. 421 United States (US) manufacturing firms satisfied the three point sample
selection criterion which was as follows:
a) Consistent data availability
b) No mergers (because they could pose problems in constructing lags)
12
 c) Not financially distressed (i.e. only those firms were considered that had positive sales
growth from 1969 to 1984).
Financially constrained firms were classified in four classes according to their retention
behavior in the presence of information asymmetries. This was a robust approach because it
limited the sensitivity of the classification of outliers of dividend-income ratio. The theory also
tried to estimate the contribution of cashflow towards explaining investment and it was found
that estimated coefficients onlagged cashflow were positive, statistically significant and of
comparable magnitudefor all classes. The study concluded that imperfect information could
create “financing hierarchies” in the use of internal and external finance. Many developing firms
in rapidly growing industries might have faced a significant range of Q values over which no
dividends were paid and external finance was very costly to obtain and the investment was
constrained by current cashflow. It was also revealed that financial constraints were important
even for relatively large firms. Hence the research provided empirical support to the existence
of imperfect capital markets and financing constraints.
Pruitt, S. W. and Gitman, L. J. (1991):

Pruitt and Gitman (1991) analyzed the opinions of practicing finance managers by a mail
questionnaire based survey of 1000 largest United States (US) firms in 1988. The purpose
of the study was to collect the opinions of finance managers regarding the interplay of
investment, financing and dividend decisions.

The sample firms included all companies in the 1987 Fortune 500 listing plus the second 500
largest firms drawn from the Compustat industrial files. Due to the large number of statements
included in the study, two separate survey instruments were developed and employed on the
basis of a random process with the first one addressing issues related to investment and
financing interactions and the second restricted to dividend and financing practices.
A seven-point semantic differential scale was employed to allow the respondents to indicate
their degree of “disagreement” or “agreement” with each of the 30 survey statements. Finally,
three “open-ended” questions in which respondents were asked to list those variables they felt
would be most valuable to an analyst seeking to econometrically describe his firm’s future
investment expenditures, external capital requirements and dividend payments. A total of 104
usable responses were received. Of this total, 49 of the received surveys were concerned with
investment-financing interactions and 65 dealt with dividend-financing issues. Most of the
survey respondents were top management executives with an average work experience of
“20+” years. The funds-flow approach was followed where the firm is assumed to allocate

13
funds raised from operations and external financing between research and development, capital
investment expenditures and cash dividends. Thus, an insight into the impact of endogenous
and exogenous variables on the investment, financing, and dividend decisions of major United
States (US) firms could be drawn.
Whited, Toni M (1992) :

Debt, liquidity constraints and their impact on corporate investment was studied by Whited
(1992) using panel data. He addressed the question of the interdependence of financing and
investment using the Euler equation of a structural model of investment to isolate the precise
role of financing constraints in the investment process. He did not rely on reduced-form
regression of investment on q, cashflow and output due to divergence of measured average q
from marginal q. He asserted that cashflow might proxy for an accelerator effect or for future
investment opportunity information albeit not covered by q.

The work of Fazzari et al (1988) was extended by concentrating on debt instead of equity
finance. In fact a large number of studies have proved debt to be the primary marginal source
of external funds. The work was based on the premise that small firms with low liquid asset
positions have limited access to debt markets. Due to this the financial variables should enter
directly into the Euler equation through their effect on the Lagrangian multiplier on a
constraint restricting debt issuance. Also, the investment Euler equation of the standard neo-
classical model should hold across adjacent periods for a priori unconstrained firms but be
violated for constrained firms. He stated the basic model as maximizing the value of a firm
subject to four constraints. Here, value of the firm was defined as present discounted value of
the expected after-tax dividend stream and the constraints were related to definition of
dividends and capital stock, non negativity of dividends and transversality condition which
prevented the firm from borrowing an infinite amount to payout as dividends. An additional
borrowing constraint specified that the maximum amount that a company could have in a given
period was determined by the lending sector for each period according to an assessment of
firm’s ability to repay. Proxies for marginal product of capital and assumption of quadratic
adjustment costs were taken to parameterize the model. The data was taken from the combined
annual and over-the- counter COMPUSTAT industrial files to maintain diversity for studying
cross sectional differences. Moreover, firm specific time-series on output, costs, investment,
and the tax adjusted price of capital goods, the interest coverage ratio, and the market debt-to
asset ratio as well as of other instruments were also collected.
Devereux, Michael and Schiantarelli, Fabio (1989) :
14
Devereux and Schiantarelli provided economic evidence of the impact of financial factors like
cashflow, debt and stock measures of liquidity on the investment decisions of U.K. firms. The
study supported the view that differential information and incentive problems make external
finance costlier than internal finance. While agency costs on one hand made debt issues less
attractive, the tax deductibility of interest payments on the other hand made it more attractive.
New share issues were at the same time disadvantageous because of transaction costs, tax
reasons or asymmetric information. Informal evidence on transactions costs in the United
Kingdom (UK) suggested that there were large fixed costs in issuing newequity.
The empirical importance of financial variables, in particular cashflow and stock measures of
liquid assets as stressed by many econometric studies of investment based on firm level data
was carried forward in this study. These variables were introduced via an extension of Q model
of investment to analyze the significance of cashflow and effect of financial factors across
different types of firms, according to size, age and type of industry. The model included
financial distress/ agency costs as an increasing function of stock of debt and decreasing
function of stock of liquid assets and cashflow. Capital stock was also an explanatory variable.
Moreover, perfect competition, linear homogeneity of theproduction, adjustment and agency
costs function were the underlying assumptions. Debt and liquid assets were chosen
endogenously together with investment and new share issues. The study was based on a sample
of 720 firms in the United Kingdom (UK) manufacturing sector over the period 1969-1986,
quoted on the London Stock Exchange. Accounting data of each firm was collected by
Datastreams and market valuations were taken from London Shareprice Database. The results
indicated that in all cases cashflows were significantly associated with investment. Stock
measures of liquidity did not play an important empirical role. The stock of debt gave a negative
impact on investment although its significance depended on sample size. Q played a significant
role in the full sample but not for a sub-sample of typicallysmall firms. Cashflows played
more important role for larger firms than smaller apparently due to lower relative cashflow or
higher agency costs of large firms.

15
Hoshi, Takeo; Kashyap, Anil and Scharfstein, David (1991) :

Corporate structure, liquidity and investments were examined by Hoshi, Kashyap and
Scharfstein (1991) with two sets of Japanese firms. The objective of the study was to present
evidence that the information and incentive problems in capital markets affect investment. The
first set of firms had close financial ties with large Japanese banks that served as primary source
of external finance and were a part of Keiretsue (industrial group/institution that coordinates
activities of member firms and has both shareholders and creditors of group firms). However,
the second set of firms had weaker links with the main bank and was usually independent. The
paper was devoted towards exploring the importance of liquidity for investment decisions and
role of banks and other financial intermediaries in channeling funds into productive
investment. They expected that liquidity would be more important for independent firms than
the affiliated ones.
The data of about 337 firms continuously listed on Tokyo Stock Exchange between 1965 and
1986 (having fiscal year ending in March) was collected from Nikkei Financial Data Tapes.
Fiscal year ending March was chosen to simplify the construction of (tax-corrected) Tobin’s
average q, used further in the analysis. The companies were selected on the basis of Nakatani’s
(1984) refinement of Keiretsue no Kenkyu’s classification (This scheme focused on the
strength of a firm’s relationship to the financial institutions in the group) and eliminated the
firms that switched groups. 121 firms were from affiliated group, 24 independent and 192
were a hybrid mix of affiliated and independent firms. The study of the two set of firms showed
that gross investment normalized by the beginning of the period capital stock; liquidity-capital
and production-capital ratios were just about the sameacross the two sets. However, the ratios
were a little larger and more volatile for independent firms’ along with a higher Tobin’s q.
Estrada, Angel and Valles, Javier (1998) :

Estrada and Valles conducted a study titled “Investment and FinancialStructure in Spanish
Manufacturing Firms” to empirically analyze the interrelatedness of investment and financing
variables within a non-linear Euler equation set-up. They followed Bond and Meghir (1994)45
by considering the endogenity of investment relationship between two consecutive periods by
setting a supply function of funds.

They tested the influence of financial variables on investment decisions within neo- classical
framework in which all the firms faced same marginal cost of debt. Further, they accepted an
alternative model with an elastic credit supply function of the current level of external funds

16
and the asset structure. An attempt was made to collectevidence about group of firms that was
financially constrained. Moreover, the relevance of bankruptcy risk in the determination of
financial constraint could help explain the differences on the cyclic behavior of investment and
other real variables in response to monetary and fiscal policies.
The study was based on the itemized information about non-financial firms in Centre de
Balances Del Banco De Espana (CBBE) during the period from 1983-92. The firms listed for
five consecutive periods or more were selected except those with agriculture, energy,
construction or services as their main activity. The final sample had 1,508 firms with 12,205
observations. Capital stock series was obtained using the perpetual inventory method with
constant sectoral depreciation rate and a sectoral deflator. The Euler equation of investment
model was set up with the assumption of independence from the financial variables. The
investment demand function was not linear in the variables and in structural parameters.
Generalized method of moments was used as the estimation procedure.
Goergen M. and Renneboog, L (2000) :

Goergen and Renneboog (2000) conducted a study titled “Investment Policy, Internal
Financing and Ownership Concentration in the United Kingdom (UK)” to investigate
whether investment spending of firms was sensitive to the availability of internal funds. They
focused on the impact of relative voting power and liquidity of investment spending in United
Kingdom (UK) firms. The empirical version of the Bond and Meghir (1994)47 Euler-equation
model was extended by including variables capturing ownership concentration and
shareholder coalition. They categorized four broad classes of models as neoclassical model,
the sales accelerator model, the Tobin’s q model and the Euler-equation model, quite in line
with Clark et al (1979)48 but with certain extensions and modifications. In the neoclassical
model, the relative cost of capital was the main determinant of corporate investment along
with cash flow sensitivities for firms and the model did not include any forward-looking
variables. Similarly, the sales accelerator model did not include expectations about the
company’s growth potential and assumes that investment grows along with total sales.

They further added that as data on expectations was not available; the relations between
investment decisions, expected future levels of output and the hurdle rate(the minimum
required rate of return acceptable for investment projects) could not be estimated. Even the
Tobin’s q based models were criticized due to difficulty in measuring the replacement value
of assets.

17
Moreover, Tobin’s q would only include future expectations if the firm was a price taker
in perfectly competitive industries,had constant returns to scale and if the stock market value
correctly measured the fundamental expected present value of the firm’s future net cash
flows. In practice, these conditions may not be fulfilled. Finally, they suggested the Euler-
equation model used by Bond and Meghir (1994)49 was based on the first-order conditions
of a maximizing process.

Galizia, Federico and Brien, Dermot O’ (2002) :

Galizia and Brien investigated whether the capital expenditures explained the determination of
debt issues for listed companies in United Kingdom (UK), Germany, France and Italy over a
decade. They suggested funds flow perspective because cashflow statements could only
present sum of sources and sum of uses. The major concern of the study was to understand
and establish an econometrics relationship between capital expenditure and new debt
despite the fact that theabove mentioned companies had high debt component in existing
capital structure along with consistent data availability of excess internal funds over investment
needs. The sample included only consolidated accounts for companies with consistent data
availability. However, those with negative net worth and/or large outlier (extremely high
values than rest of the sample) values for profitability and market-to-book were rejected. The
companies were grouped in five categories, namely, United Kingdom (UK) manufacturing
(192), United Kingdom (UK) services (120), French (60), Italian (43) and German (36)
companies. The relevant data was extracted from Worldscope database compiled by Bureau
Van Djk. The study maintained an eclectic approach and included elements from both trade-
offand pecking order theory of capital structure stating that companies issue debt only after
consuming internal sources.
They refuted the circulatory problem given that leverage could be predicted on the basis of
pre-determined variables other than past issues of debt. Broad similarities in the balance
sheets of companies in different countries and sectors were found along with fundamental
differences in cashflow statements between United Kingdom (UK)and continental companies.
A strong negative relationship was found between debt issued and profitability in United
Kingdom (UK), while no significant relationship could be found for Germany, France and
Italy.The results were consistent with dynamic models of leverage and applied to all countries.
The availability of collateral had a significant positive influence on debt issues in all countries
except France.
Also, the measure of fit for the cross-sectional regressions was quite high. On the other hand,
18
descriptive statistics suggested that debt issues were infrequent while capital expenditures were
non-zero for almost all companies/years. Lastly, debt issues were more frequent in companies
with “financial surplus” as compared to those in financial deficit.
Bruinshoofd, W.A. (2004) :

Corporate investment and financing constraints were studied by Bruinshoofd (2004) for
research department of De Nederlandsche Bank to explore the relevance of financing
constraints and to build a flexible reduced-form model for simultaneous analysis of financial
and investment between capital structure and investment subject to financing constraints. Q
model, reduced-form regression and Euler’s investment equation were analyzed to find the
suitability of identifying financially constrained firms. The major advantage of reduced-form
model is to abstain from explicit modeling of the adjustment cost technology. It was further
asserted that validity of reduced-form models was sustained if mismeasurement of investment
opportunities was same for constrained and unconstrained firms.

On the other hand, Euler’s equation had an edge over the reduced-form models because of
abstinence from using noisy stock market information to characterize investment
opportunities. However, they might encounter difficulty in picking upeffects of financing
constraints when they remained equally tight over time. The author further discussed the
inability of factors like, size, leverage or cash holdings in identifying financially constrained
firms due to univariate stratification. He focused on debt and cash holding because these
variables produced some of the most striking and contradictory results when applied as
sample stratification devices to the financing constraints analysis. He further maintained that
a firm may rationally keep precautionary spare debt capacity to avoid costs of financial
distress and to maintain financial slack.
Cava, Gianni La (2005):

Cava carried out a study of financial constraints and cost of capital to examine the factors
driving corporate investment in Australia by using panel data of listed companies covering the
period from 1990 to 2004. He also explored the effect of cashflow on investment to highlight
the significance of internal funds for financially constrained companies. He asserted that panel
data could help in minimizing the simultaneity problem, usually encountered in macro studies
of investment. Moreover it allowed to determine if changes in financing costs mattered more
for certain type of firms and with a fairly short time-series.

The study focused on a reduced-form model instead of an explicit model as the main focus was

19
to uncover determinants of investment and while not explicitly derived, the investment
equation still allowed for short-run adjustment and expectation lags. Even other
microeconomic studies supported the performance of implicit model over the structural ones.
The ECM specification was derived fromthe static capital demand equation which defined
natural log of firm’s desired capital stock as a function of lagged capital stock, current and
lagged sales and cashflows. Financial constraints were modeled by augmenting the basic ECM
with a dummy variable for dividend cut. Further, three separate dummies were used for
financially constrained, distressed and loss makers to cover distress effect.A form of fixed
effects estimation was adopted because firm-specific effects were expected to be present either
as a result of technological heterogeneity or non-random sampling. The ECM was estimated
using Arellano-Bond two step Generalized Method of Moments estimator in the dynamic
setting. This helped in eliminating firm specific effects by differencing the equations and used
lagged values of endogenous variables as instruments. Sargan test for identifying the
restrictions and direct test of serial correlation in residuals was used to validate the instruments.
The results indicated a negative and significant lagged investment rate across successive time
periods. The speed of adjustment parameter also had the expected negative sign implying that
the firms with excess capacity cut back on their investment plans. Short-run effects showed
positive and significant real sales. Cashflow did not seem to affect the investment of either
unconstrained or constrained firms on an average. The study concluded real sales and user cost
of capital as significant determinants of firm-level investment in both short and long run. It
also suggested that internalfunds would play an important role for financially constrained
firms which could not obtain enough external funding to meet the desired level of investment.
Krishnamurty, K. and Sastry, D.U. (1975) :

Krishnamurty and Sastry (1975) conducted one of the earliest studies on investment and
financing in Indian corporate sector. The study analyzed the determinants of fixed and
inventory investment, dividends (savings) and external finance. Additionally, the factors
governing disposition of profits between dividends and savings, the forces influencing external
financing were also studied. The study covered a wide spectrum of Indian manufacturing sector
covering consumer, intermediate and capital goods industries with 310 companies. The
analysis was done industry wise due to different growth rates and government policies faced
by them.
The relevant data was collected from Profit and Loss Statements and Balance Sheets
from Bombay Stock Exchange Official Directory for a period of 1960-70. The cross-section

20
analysis was supplemented by time-series analysis. Investment behavior was studied in the
context of flexible accelerator model with financial variables. This implies that company
moves from current to the desired level of capital stock at a particular speed of adjustment and
not instantaneously. Such lags arise on account of technological, institutional factors and
expectations. However, it was also highlighted that accelerator based models may not be apt
for developing economies like India due to government supported investment promotion.
Furthermore, accelerator principle would apply to new investment only.
Athey, M. J. and Laumas, P. S. (1994) :

Athey and Laumas conducted a study on internal funds and corporate investment in India. The
study of interaction of investment and financing decisions using firm level data in less
developed countries or developing countries drew attention as most of the research till date has
been done in developed economies. The data for the study was collected from Stock Exchange
Official Directory covering almost all the listed firms and the data was confined to the
manufacturing firms for a period of 1978 to 1986.
Finally, the sample included 256 firms which were selected by excluding those firms
which did not have continuous data availability or changed the financial year during the study
period. The sample was further classified according to size and type of industry which showed
that almost two-fifth of the firms were from chemical or general engineering, depicting the
general structure of Indian manufacturing sector.
Another purpose of the study was to investigate the importance of internal funds for investment
by comparing the sensitivity of investment to the changes in internal funds for different groups
of firms as the firms were classified on the basis of priority and non-priority sector.

21
CONCLUSION:
This chapter has presented a summarized view of some finance researches on the issue of
financing of capital expenditures across different industries spanning over a number of
countries. The review of empirical studies conducted hereinsuggests that there are significant
differences between the financing patterns of the firms of developed and developing countries
and their impact on investment. Firms of the developed countries tend to rely more on external
funds than developing countries. However, the contribution of equity as a significant
explanatory variable for investment has been largely refuted in both developed and developing
economies. It is noticeable that underdeveloped and imperfect capital markets discourage the
firms from raising capital market funds and induce the corporate sector to largely base their
investment decisions on internally generated funds.
On the basis of the review of empirical work done so far, it can be concluded that the
various sources of funds have varied degree of significance in explaining investment
behavior. The present study aims to make a comprehensive study on the financing of capital
expenditures in Indian corporate sector by considering five industries and companies in both
the sectors – private and public. Therefore, the present study is an attempt to bridge the gap
in this vital area in the Indian content.

22
 CHAPTER 3

RESEARCH METHODOLOGY
The relevance and reliability of a research work heavily rests upon the nature of the database.
The present chapter describes process and sources of data selection and collection,
specification of model and analyticaltools used to meet the objective of this research work.

OBJECTIVES OF THE STUDY:

The objectives laid down in the introductory chapter have been revisited andthey are as
follows:
a) To identify the trends about the frequency and size of capital expenditures.

b) To study the significance of various sources of funds for financing long-term

investment decisions.
c) To analyze the importance of cashflows in firm’s investment decisions andthe nature
of its relationship with corporate investment.
d) To examine the relationship between financing and capital expendituredecisions.
HYPOTHESES OF THE STUDY:
The hypotheses for the study have been framed with respect to above mentioned specific
objectives.

1. As regards the first objective, the hypothesis is that routine investments are more
frequent than growth related investments. The sub- hypotheses are as follows:
a) Change in net fixed assets (capital expenditure) has taken place in every year of the
study period.
b) Rate of increase in capital expenditures incurred by sample companies has increased
over the study period.
2. As regards the second objective of the study, it is hypothesised that borrowed funds
are most frequently used for financing capital expenditures. Further, the following sub-
hypothesis have been developed:
a) Flow of new equity has a significant relationship with change in net fixed assets.
b) Flow of borrowings has a significant relationship with change in net fixed assets.
c) The coefficient for flow of borrowings is larger than coefficient of flow of new equity
in investment equation.

23
 d) The coefficient for flow of borrowings is larger than coefficient of operating cashflows
(proxy used for internal funds) in investment equation.
e) Change in inventory has a negative and significant relationship with change in net fixed
assets.
f) Trade credit has a positive and significant relationship with change in net fixed assets.
Data Source:

The study is based on firm level data which in turn has been obtained from secondary sources
for the purpose of analysis. The relevant data was available in audited financial statements
of the sample companies. This has been sourced primarily from a firm-level micro database;
PROWESS administered by the Centre for Monitoring Indian Economy (CMIE). In India,
CMIE has the largest database on the Indian economy and companies. Prowess is a database of
large and medium Indian firms. It contains detailed information on over 23,000 firms
comprising all companies traded on India's major stock exchanges and several others including
the central public sector enterprises. Minor gaps have been filled with information from
published annual reports and company websites.
Time Span of the Study:
The study focuses on Indian corporate sector. It aims to examine and accomplish the objectives
stated above over a fourteen years period from 1994-95 to 2008-09. The period after
liberalization has seen changes in the asset structure of all companies irrespective of industries.
The requirement of consistent data for balanced panel was reasonably met from 1994-95
onwards. The study covers a fourteen years period till 2008-09. Besides, a study spread over
more than a decade can be expected to give reliable and representative results.
Sample:
A sample of 70 large sized Indian companies spread across different industries has been
analyzed to test study objectives. These companies have been selected from top 500 companies
of India (turnover basis) as per the ET500 list published by Economic Times Group in 2008.
The aforesaid list is publicly available at The Economic Times’ website
(www.etintelligence.com) and attached as Annexure.
The companies meeting the following selection criteria have been chosen for thefinal sample:
• Continuity of operations

• Consistent data availability

• Common and consistent accounting year from 1st April to 31st March.

24
Statistical Tools Used:
The methodology comprises of varied econometric and statistical tools. Frequency and trends
of capital expenditure decisions has been analysed with the help of tabulation of data, use of
frequency distribution, simple percentages, correlation, and cross tabulation. Since this is a
study of investment behaviour of Indian corporate sector, a cross-section comprising of 100
companies over fourteen years (1994-95 to 2008-09) has been analysed with the help of panel
data models.
The research methodology has been aptly designed to meet the study objectives. Frequency
and trends of capital expenditure decisions has been analysed with the help of tabulation of
data, use of frequency distribution, simple percentages, correlation, and cross tabulation. The
trends have been captured by tabulating the major variables used in the study for aggregate as
well as industry-wise samples. The same have been graphically depicted by using line charts.
Since this is a study of investment behaviour of Indian corporate sector requiring a cross-
section comprising of companies over fourteen years (1994-95 to 2008-09), panel data models
are used for regression and estimation. Balanced panel has been chosen for two reasons:
a) In case of unbalanced panel, the results have to be interpreted with caution and there
will be necessity of dropping the groups (firms) with many missing points; and
b) If firms with incomplete data for the entire period under study are included, it will
lead to an extremely large number of groups (firms) for analysis.
A brief literature pertaining to the above mentioned tools and techniques has been provided in
the following paragraphs.
Lagrange Multiplier Test:

This test was developed by Breusch and Pagan. The null hypothesis is that cross-sectional
variance components are zero;

𝑯𝟎 : 𝝈𝟐𝝁 = 𝟎

𝑯𝟏 : 𝝈𝟐𝝁 𝑮 = 𝟎

Large value of LM statistic suggests in favour of one of the one factor models (FEM/REM) against
the classical regression with no group effects.

25
Hausman Test:

The Hausman specification test compares the fixed effects versus random effects under the
null hypothesis that the individual effects are uncorrelated with the other regressors in the
model. If correlated, i.e. Ho is rejected; a REM produces biased estimators; so that the fixed
effect model is preferred. Hausman’s essential result is that the covariance of an efficient
estimator with its difference from an inefficient estimator is zero.
It is notable that an intercept and dummy variables should be excluded in computation. Large
volume of the Hausman statistic argues in favour of the fixed effects model over the random
effects model. A large volume of the LM statistic in the presence of a small Hausman statistic
argues in favour of the random effects model
SCOPE OF STUDY:

The objectives to be served largely govern the choice of data and its sources. The present study
aims at analyzing the financing of capital expenditures (corporate investment). Accordingly,
data on capital expenditures and its various possible determinants have been sourced from the
secondary data, as detailed below.
Sample of Companies and Data Collection:

This study is based on the analysis of firm level data. The objective of the study as stated earlier
requires the sample to have companies actively involved in capital expenditures. The initial
sample includes top 500 companies of India (turnover basis) as per the ET500 list published by
Economic Times Group in 2008. The aforesaid list is publicly available at The Economic
Times’ website (www.etintelligence.com) .
The study is based on the 500 largest companies of India on the premise that large
companies are actively involved in capital (investment) expenditures. Inclusion of the largest
Indian companies makes the sample more representative of Indian corporate sector rendering
authenticity to the results thereby. The scope of investigation has been confined to listed
companies because the financial and accounting information related to unlisted companies is
not available in detail. The parameters developed for the purpose of analysis required specific
details of the sample companies. The inclusion of unlisted companies would have led to gaps
in the dataset thereby rendering the results handicapped. Moreover, such companies are,
usually of small size and are generally funded through own savings, or the funds of friends and
relatives. Borrowings primarily comprise of short-term loans from banks.

26
Study Period:

The study period was planned to be 2005-06 to 2018-19, to virtually cover the growth of
Indian corporate sector after the structural adjustments, industrial policyand opening up of
Indian economy since 1991. The coverage of the companies and the relevant information
about the sample companies was insufficient for the initial years.
Limitations of the Accounting Data:
The objective of the study necessitates the use of secondary data; precisely, the published
accounting information of listed companies. The CMIE database is perhaps the most suited
available database for a study based on firms’ financing and investment decisions. Though
the data is maintained in standard format on daily/ weekly/ monthly and yearly basis, the
limitations of accounting data are bound to creep in.
The accounting practices employed by various companies in calculation of profit may differ,
leading to difference in valuation of assets within same industry. The difference may come
due to different policies followed for valuation of inventory, depreciation, goodwill, valuation
of assets and so on.
It is widely accepted that published annual accounts of listed companies are purely transparent
and also subject to independent audit mechanism. All the stockholders of various companies
use this data for their respective decisions. They are therefore considered as the most useful
source of economic and business information. Accounting data found in company annual
reports have been used to calculate and measure the financial variables employed in this
analysis.

27
 CHAPTER 4

DATA ANALYSIS & INTERPRETATION

TRENDS IN CAPITAL EXPENDITURES:

This chapter aims to analyze the capital expenditure trends of the sample firms of Indian
corporate sector for the period 1994-95 to 2008-09 in terms of their frequency, magnitude and
relation to external and internal funds for financing the same. The previous two decades have
seen an upsurge in the research on company finance and investments, particularly aimed at
understanding how the companies finance their planned expenses and the reasons behind the
preference for certain sources of finance for the said expenditures.
The study of trends in fixed investments involves determination of the amount of incremental
funds invested by a firm and thereby total sampled companies in fixed assets and the
corresponding sources of finance. This chapter presents various trends pertaining to fixed
investment of total sample, different sources of finance and other relevant variables for the
total sample over the entire period of the study.

FIXED INVESTMENT TRENDS

As a step towards capturing the fixed investment trends, the investments made by the sample
companies over the study period have been classified on the basis of rate of increase in fixed
assets during the year. This has been computed as percentage increase in net fixed assets over
the beginning of the year value of the same. These rates have been classified into two
categories: routine investments (up to 15 percent increase in the net fixed assets value) and
growth investments (more than 15 percent increase in net fixed assets over a year). This cut-
off rate has been fixed after taking in to account normal business practices and the findings of
the empirical analysis.Moreover, this criterion has been applied by Sahu (1989)169 and Purohit,
Lall and Panda (1994)170. The annual rate of change in net fixed assets from 1995-96 to 2008-
09 has been determined in percentages and the same has been presented in thefollowing, Table
1.

28
 Table 1: Net Fixed Assets and Rate of Change in Net Fixed Assets Statement
(RS. IN CRORES)

Net Fixed Assets Change in Rate of Change in Classification

Year at the Beginning Net Fixed Net Fixed Assets of the
of the Year Assets (%) Investment
2005-06 86,787.66 13,535.62 18.48 Growth
2006-07 101,890.42 15,102.76 17.40 Growth
2007-08 121,810.28 19,919.86 19.55 Growth
2008-09 132,493.35 10,683.07 8.77 Routine
2009-10 146,469.57 13,976.22 10.55 Routine
2010-11 153,422.44 6,952.87 4.75 Routine
2011-12 174,884.19 21,461.75 13.99 Routine
2012-13 186,006.92 11,122.73 6.36 Routine
2013-14 193,260.12 7,253.20 3.90 Routine
2014-15 202,417.93 9,157.81 4.74 Routine
2015-16 249,040.59 46,622.66 23.03 Growth
2016-17 280,648.40 31,607.81 12.69 Routine
2017-18 308,632.19 27,983.79 9.97 Routine
2018-19 385,831.68 77,199.49 25.01 Growth

As displayed in the Table 1, the overall change in net fixed assets gives an increasing trend
during the period of study. The average annual rate of increase in fixed assets is found to be
Rs 22,327.11 crores during the period. However the amount of investment varies from year
to year. Analysis shows that a higher growthin net fixed assets has been concentrated during
the earlier and latter years. Though an impressive two digit growth rate has been registered in
eight out of fourteen years, growth investments have been witnessed in only five years. Hence,
the hypothesis about routine investments being more frequent than growth related investments
has been accepted.
A maximum growth rate of 25.01 percent over the previous year has been witnessed in the last
year of study i.e. 2008-09 whereas the minimum increase in net fixed assets has been achieved
in the year 2003-04 at 3.90 percent. Moreover, the nominal amount invested in net fixed
assets by the sample companies has increased more than four times during the study period.
The fixed investment trends have beendisplayed in Figure 1

29
 40000
0
35000
0
Net Fixed Assets
30000
at the beginning
0
of the year
25000
0 Change in Net
Fixed Asset
20000

Figure 1: Net Fixed Assets and Change in Net Fixed Assets

A glance at the Figure 1 shows that in the middle period from 2000-01 to 2004-05; only one
year out of these five years has seen a double digites growth of net fixed assets over the
previous year. Moreover, though the rate of change in net fixed assets has experienced both
increasing and decreasing phases, the change in net fixed assets has shown a robust increasing
trend over a long fourteen years period.

The following figure 1.1 exhibits the distribution of routine and growth related investments
over the study period.

RATE
30.00 OF
25.00 CHANGE
20.00 IN
15.00 NET

10.00 FIXXED

5.00 ASSETES
1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

(%)

Figure 1.1 : Rate of Change in Net Fixed Assets

30
As displayed in Figure 1.1, when presented graphically, the rate of change innet fixed assets
gives a U-shaped curve of the trends. There might be a number of exogenous and
endogenous factors attributing to these trends. Most importantly, additional production
requirements are a necessitating factor for capital expenditures. Capacity expansions are
usually required to meet the growing demand in the existing market or to enter and capture
new markets. Renovation and modernization of existing production processes to reduce
the cost of production is also worth considering reason. Diversification in production
lines and refinements in existing products aiming to increase the revenues are also considered
as strong forces behind increase in capital expenditures. Most of the above mentioned factors
meet the objective of a firm’s growth and expansion over a period in the long-run. In this
study,an attempt has been made to correlate significant internal factors such as sales, change
in output, cashflows, and change in inventory, flow of equity and borrowings, and trade
credit with change in net fixed assets.
CHANGES IN NET FIXED ASSETS AND SALES
Increase in capital expenditures paves the way for increase in productioncapacity of the
company. This increased production capacity helps the company to boost its sales figures.
However, a time lag may be expected between increase in net fixed assets and its resultant
effect on sales. The reason behind this lag may be due to the time taken in installation and
use of increased production capacity, other sales and administrative efforts required on part
of the company and finally, tapping new markets or penetrating in the existing ones. Table
2 presents the relationship between change in net fixed assets and sales.

31
 Table 2: Change in Net Fixed Assets and Sales Statement
(RS. IN CRORES)

Year Net Fixed Assets Change in Net Fixed Assets Sales

2005-06 86787.66 13535.62 171026.71
2006-07 101890.42 15102.76 194009.13
2007-08 121810.28 19919.86 216093.28
2008-09 132493.35 10683.07 236584.85
2009-10 146469.57 13976.22 284821.09
2010-11 153422.44 6952.87 337733.07
2011-12 174884.19 21461.75 360263.77
2012-13 186006.92 11122.73 413881.02
2013-14 193260.12 7253.2 472243.68
2014-15 202417.93 9157.81 578399.71
2015-16 249040.59 46622.66 695537.29
2016-17 280648.4 31607.81 873783.43
2017-18 308632.19 27983.79 1007298.78
2018-19 385831.68 77199.49 1145996.41
Total 2723595.74 312579.64 6987672.22
Average 363146.10 41677.29 931689.63

Standard 84967.28 19261.93 317555.32

Deviation

Coefficient of Correlation between Change in Net Fixed 0.76

Assets and Sales

As suggested by Table 2, the coefficient of correlation between change in net fixed assets and
sales is found to be 0.76. This coefficient is statistically significant and positive, implying a
strong positive relation between the two variables.
An attempt has been made to study if there is a time lag between the two variables. The
coefficient of correlation however, decreases when calculated for change in net fixed assets
and sales figure of the succeeding year. The trends of both the variables have been presented
in the following Figure 2.1

32
1400000
1200000

1000000 Sales
800000

600000
Change in
400000 Net Fixed
200000 Asset

0
1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09
Figure 2.1: Change in Net Fixed Assets and Sales

The Figure 2.1 indicates a steady rise in the sales figures of the sample companies over the
study period. Nonetheless, the rate of increase in sales is higher in the later years of the study
(Average rate of change in sales is 18.1 percent for 2002- 03 to 2008-09) as compared to the
initial years (Average rate of change in sales is 13.3 percent for 1995-96 to 2001-02). The
trend is visibly apparent in the Figure 2as well. However, such a clear demarcation of the
study period on the basis of rate of change in net fixed assets is not found because the average
rate of change in net fixed assets from 1995-96 to 2001-02 is 13.35 percent against 12.24
percent of 2002-03 to 2008-09. This shows that there is no time lag between the changes in
two variables during the period under study.
The reasons behind steady rise in sales figures along with a change in net fixed assets may be
attributed to easy availability of raw materials, adequate supply of energy, industrial
harmony, increase in efficiency of the sales staff and a robust economy. Timely and effective
sales strategy is also an important tool behind increase in sales. Though this study analyses firm
level data, a simultaneous increase in sales with change in net fixed assets can also be related
to the general economic conditions during the study period. The fourteen year study period is
the post ‘Industrial Policy 1991’ era marked with macroeconomic stabilization measures and
structural adjustments. The liberalization, privatization and globalization regime was
introducedduring this period which in general rose in the industrial production, national as well
as per capita income.

33
CHANGE IN NET FIXED ASSETS AND CHANGE IN OUTPUT

Change in output has been defined as sales during the year plus change in finished goods stock.
Various studies including, Chenery (1952), Eisner and Nadiri(1968), Krishnamurty and Sastry
(1975), Rao and Mishra (1976), Athey and Laumas (1994), Gangopadhyay et al (2001) ,
Bhattacharya (2007) have supported the predominance of flexible accelerator model along
with some financial variables in satisfactorily explaining the investment behavior of firms. The
following Table 5.3 depicts the relationship between Change in Output and Change in Net
FixedAssets and the correlation between the two.

Table 3: Change in Net Fixed Assets and Change in Output Statement

(RS. IN CRORES)

Year Net Fixed Assets Change in Net Fixed Assets Change in Output
2005-06 86787.66 13535.62 172519.39
2006-07 101890.42 15102.76 196108.86
2007-08 121810.28 19919.86 218281.19
2008-09 132493.35 10683.07 237202.19
2009-10 146469.57 13976.22 288029.3
2010-11 153422.44 6952.87 338508.98
2011-12 174884.19 21461.75 358970.68
2012-13 186006.92 11122.73 418183.32
2013-14 193260.12 7253.2 471771.23
2014-15 202417.93 9157.81 581747.56
2015-16 249040.59 46622.66 702759.09
2016-17 280648.4 31607.81 878249.34
2017-18 308632.19 27983.79 1012541.55
2018-19 385831.68 77199.49 1144093.85
Total 2723595.74 312579.64 7018966.53
Average 363146.10 41677.29 935862.20
Standard 318023.84
84967.28 19261.93
Deviation

Coefficient of Correlation between Change in Net Fixed 0.76

Assets and Change in Output

34
As shown by the Table 3, the coefficient of correlation between these two variables (0.76) is
the same as the coefficient of correlation between change in net fixed assets and sales (0.76).
The primary reason for the proximity that changes in output has been defined as the sum of
current year sales and change in stock of finished goods. As sales comprise the major
component of change in output, the resultant two coefficients of correlation have nearly the
same values. As change in output is considered as a better proxy for accelerator model than
current year sales, the same has been used in the investment equation of the present study.
The trends ofboth the variables have been represented by the following graph, Figure3.1.

1400000
1200000
1000000 Change in Output
800000 Change in
600000
Net FixedAsset
500000
400000
200000
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 3.1: Change in Net Fixed Assets and Change in Output

Even the graphical representation in Figure 3.1 highlights the similarities of change in output
with sales trends. It has been found that there has been a consistent rise in the change in output
figures of the sample companies over the study period. Nonetheless, the rate of increase in
change in output is higher in the later years of the study (Average rate of change in sales is
18.1 percent for 2002-03 to 2008-09) as compared to the initial years (Average rate of change
in sales is 13.1 percent for 1995-96 to 2001-02).

CONCLUSION:

This section summarizes the trends of the major variables used in the study over a fourteen
year period. The tables and figures presented in this chapter have displayed the results of 1995-
96 to 2008-09 because the figures of 1994-95 have been used to calculate the change in a
variable. It has been found that net fixed assets have quadrupled in the fourteen year study
35
period which marks a robust growth of Indian corporate sector. However, the rate of change in
net fixed assets shows that routine investments are more frequent than growth related
investments. This trend has been in line with hypothesis of the study.

FINANCING PATTERNS IN INDIAN CORPORATE SECTOR:

INDUSTRY WISE RESULTS
The analysis of fixed investments and financing patterns for the total sample has been made
in the previous chapter. It establishes an aggregate picture of thecapital expenditures and
major source of finance by the sample companies representing Indian corporate sector.
This chapter attempts to undertake industry-wise analysis of financing ofcapital expenditures
and relevant trends. Such analysis focuses on deviation of a particular industry from the
aggregate sample trend.
The aggregate sample of 70 companies spans over five industry groups with following
classification as shown by Table 4.

Table 4: Industrial Classification of the Sample Companies

Name of the Industry Group Number of Companies

Beverages, Tobacco and Tobacco Products 35

Chemical and Chemical products 35

Total Companies in the Sample 70

BEVERAGES AND TOBACCO AND TOBACCO PRODUCTS:

This section provides the details of the beverages and tobacco products companies covered in
the study. This is a rapidly developing industry covering consumption patterns of Indians in
various segments. A long study period of fourteen years has consistently seen a positive growth
rate in net fixed assets. The Table 7.6 exhibits the relevant data below.

36
 Table 5: Major Variables of Beverages, Tobacco and Tobacco Products Industry

(AMMOUNT IN RS CRORES)

Change in Change in Change in Cashflow Flow of Paid- up Flow of Borrowing Trade

Year
Fixed Asset Output Inventory Operating Equity Credit
2205-06 61.67 5975.21 179.27 275.16 2.57 -2.17 467.71
2006-07 256.48 6699.7 -50.35 619.34 0 -51.25 642
2007-08 76.8 7896.16 203 812.73 0 573.24 866.03
2008-09 169.93 8619.71 29.77 743.49 0 -25.01 803.63
2009-10 172.16 9030.23 -16.62 1159.31 0 -619.39 1121.75
2010-11 551.68 9721.43 229.96 970.67 0 221.69 1262.31
2011-12 747.66 10929.28 8.88 1834.14 0 -589.2 1639.66
2012-13 424.73 12086.44 74.96 1984.6 2.1 -174.78 2138.3
2013-14 241.33 13265.01 303.34 1870.23 0.17 -8.47 2905.7
2014-15 711.53 14764.66 471.72 1867.51 0.54 166.1 2015.14
2015-16 213.26 17821.07 655.19 1858.12 127.3 -113.41 2252.01
2016-17 553.69 21339.5 719.33 2080.24 0.7 67.49 2437.09
2017-18 1424.08 23350.26 783.24 2686.57 0.64 56.2 2908.91
2018-19 1172.52 26182.72 675.61 3119.45 0.58 -44.97 3162.38
Total 6777.52 187681.38 4267.3 21881.56 134.6 -543.93 24622.62
Average 484.11 13405.81 304.81 1562.97 9.61 -38.85 1758.76
Standard
412.88 6447.95 299.50 821.60 33.88 300.19 911.94
Deviation
Coefficient of Correlation
between Change in Net
0.77 0.60 0.80 -0.19 -0.033 0.68
Fixed Assets and the
Respective Variable

37
As shown in the Table 7.6 the output of the sample companies has increased at an average rate
of 10 percent per annum posing a consistent growth during the study period. A deeper look in
to the correlation coefficient of change in net fixed assets with the independent variables show
that as postulated, change in net fixed assets is highly positively correlated with change in
output, operating cashflows and trade credit. A further understanding of the relationship of
these variables has been depicted in the Figure 7.7 to Figure 7.12.

30000
25000
20000
15000
10000 Change in Fixed Asset
5000 Change in Output
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 5.1: Change in Net Fixed Assets and Change in Output: Beverages, Tobacco and
Tobacco Products Industry

1600
1400
1200 Change in fixed
1000 assets
800
600
Change in
400 inventory
200
0
-200
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 5.2: Change in Net Fixed Assets and Change in Inventory: Beverages,Tobacco
and Tobacco Products Industry

38
 3500
3000 Change in
2500 fixed assets
2000
1500
1000 Cash flow
operating
500
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
Figure 5.3: Change in Net Fixed Assets and Operating Cashflows: Beverages, Tobacco
and Tobacco Products Industry

1600
1400
1200 Change in fixed
1000 asset
800
600 Change in paid
400 up equity
200
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 5.4: Change in Net Fixed Assets and Flow of Paid-up Equity: Beverages,Tobacco and
Tobacco Products Industry

3500
3000
2500 Change in fixed
2000 asset
1500
1000 Trade credit
500
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 5.5: Change in Net Fixed Assets and Trade Credit: Beverages,Tobacco and Tobacco Products Industry
39
 2000

1500 Change in fixed

assets
1000

500 Flow of
borrowings
0

-500

-1000
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
Figure 5.5: Change in Net Fixed Assets and Flow of Borrowings:Beverages, Tobacco and
Tobacco Products Industry

Hence, as illustrated by figures, Figure 7.7 to Figure 7.12, change in net fixed assets is highly
correlated with four of the six independent variables. There has been only a single year with
major flow of equity making the rest of the study period to be fairly stable at a particular level.
Even the flow of borrowings has seen a negative growth rate showing outflows more than
inflows.
The empirical findings of this industry group have been put on view in the displays panel
data.
Table 6: Correlation Matrix of Beverages, Tobacco and Tobacco Products
Industry
VARIABLES F Y CHG_I CFO FEQ FB TC
F 1 0.24388 0.17644 -0.0787 -0.1879 0.3755 0.18192
Y 0.24388 1 0.27245 -0.0116 -0.6202 0.23311 0.58947
CHG_I 0.17644 0.27245 1 -0.4883 -0.197 0.2283 0.40488
CFO -0.0787 -0.0116 -0.4883 1 0.10785 -0.6644 0.04977
FEQ -0.1879 -0.6202 -0.197 0.10785 1 -0.3176 -0.6157
FB 0.3755 0.23311 0.2283 -0.6644 -0.3176 1 0.08343
TC 0.18192 0.58947 0.40488 0.04977 -0.6157 0.08343 1

40
 Table 7: Empirical Findings of Beverages, Tobacco and Tobacco Products
Industry

(t-statistic in parentheses)
Variables OLS/Classical Fixed Effects
Regression Group Group Dummy and
Dummy Period Effects
Constant 0.03 -0.125
(0.239) (-0.539)
Y 0.009 0.024 0.082
(0.232) (0.614) (1.096)
CHG_I 0.083 -0.11 -0.286
(0.203) (-0.264) (-0.425)
CFO 0.156 0.04 -0.148
(0.511) (0.131) (-0.273)
FEQ 0.508 3.134 1.023
(0.146) (0.825) (0.097)
FB 0.289 0.333 0.475
(1.724) (2.020)*** (1.754***)
TC -0.037 0.006 0.117
(-0.145) (0.027) (0.279)
LAGF -0.094 -0.054 0.792
(-0.212) (-0.127) (0.976)
LAGY -0.004 -0.008 -0.059
(-0.142) (-0.303) (-1.028)
R2 0.264 0.351 0.862
0.27
Lagrange Multiplier Test Statistic
df=1, Prob value=0.60
0.02
Hausman Test Statistic
df=8, Prob Value=1.00
*, ** and *** indicate the coefficient is statistically significant at 1%, 5%
and 10% significance level.

41
There seems to be no multicollinearity problem for this industry as per Table 7 as none of
the independent variables have a coefficient of correlation passing beyond the cut-off rate of
0.7.
Further, as demonstrated by Table 7.8, the D-W statistic value as high as 1.9793 is closely
accepted as 2, indicates zero auto-correlation between the independent variables. The LM test
values favor Panel OLS results over fixed effects or random effects. The review of Hausman
Test Statistic clearly supports fixed effects over random effects. The tabulated results of fixed
effects have been expounded along with classical regression to maintain uniformity in
presentation. As there are just two companies of this industry in the sample, the results may
not represent the industry trends. None of the variables has been found to be significant in panel
OLS results. However fixed effects results show that flow of borrowings is a significant
variable at 10 percent level of significance with a positive sign. Hence, there is a clear shift of
results in regression analysis as compared to trends established by pictorial presentation and
coefficient of correlation. It implies that debt/borrowing is predominant factor in financing
investment in this group. Moreover, the results of flow of borrowings are in tune with
aggregate sample results.

CHEMICAL AND CHEMICAL PRODUCTS

This section provides the trend analysis and empirical results of chemicals and chemical
products industry. Chemical Industry in India is one of the fastest growing industries under the
Indian Economy and close to one-third of the sample companies come from this industry. It
covers inorganic chemicals, drugs and pharmaceuticals, plastics and petrochemicals,
pesticides, fertilizers and other agro-chemical products and specialty and fine chemicals like
dyes and paints. The analysis of the relevant variables shows a steady rise in change in net
fixed assets over the study period. Coefficient of correlation has been found to be positive
between change in net fixed assets and change in output, operating cashflows, flow of
borrowings and trade credit. The Table 8 puts forward the significant trends of chemicals
industry.

42
 Table 8: Major Variables of Chemical and Chemical Products Industry

Change in Change in Change in Cashflow Flow of Paid- Flow of Trade

Year
Fixed Asset Output Inventory Operating up Equity Borrowing Credit

2005-06 3651.59 53584.45 918.8 5210.46 201.68 3808.96 5657.62

2006-07 5477.23 61034.84 1696.31 6102.18 80.76 6893.11 7908.98
2007-08 10351.92 70739.03 88.12 11532.07 536.76 3142.54 8680.29
2008-09 839.02 83299.44 1253.96 9262.81 50.49 4518.05 10482.34
2009-10 9217.36 97581.1 5863.42 6552.65 393.6 3116.75 9665.57
2010-11 -1527.06 131496.33 876.95 11578.67 298.35 767.43 9949.56
2011-12 19054.2 164953.46 1784.78 20069.99 -7.71 7087.41 12302.52
2012-13 423.94 178875.66 6413.67 17583.05 344.53 -1257.8 17862.79
2013-14 2505.81 210305.54 402.61 23558.93 58.85 1514.53 20570.04
2014-15 2661.6 226620.8 5135.1 25262.08 193.73 1718.44 28376.48
2015-16 30014.13 277341.07 9918.54 17302.9 133.47 15608.01 30495.34
2016-17 14340.95 347377.32 3686.52 33652.15 300.93 15616.75 37308.01
2017-18 5911.91 433102.6 11747.91 20886.03 -18.15 25622.22 47987.42
2018-19 35535.71 498375.8 -6346.33 40173.95 123.04 58055.89 46674.81
Total 138458.31 2834687.44 43440.36 248727.92 2690.33 146212.29 293921.8
Average 9889.88 202477.67 3102.88 17766.28 192.17 10443.74 20994.41
Standard
11266.05 141347.56 4529.98 10482.22 163.71 15559.19 14685.04
Deviation
Coefficient of correlation
between Change in Net Fixed
0.58 -0.18 0.54 -0.14 0.75 0.51
Assets and the Respective
Variable

43
As displayed by the table, the magnitude of flow of equity is only a fraction of the flow of
borrowings. The operating cashflows have shown a steady rise of approximately Rs.
17,766 crores per annum. The trends of change in net fixed assets along with the independent
variables have been presented graphically in Figure 8.1 to Figure 8.6.

600000
500000
400000
300000
200000
100000 Change in Fixed Asset

0
-100000 Change in Output
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
Figure 8.1: Change in Net Fixed Assets and Change in Output: Chemical
and Chemical Products Industry

400000

300000

200000

100000 Change in Fixed Asset

Change in Inventory
0

-100000
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 8.2: Change in Net Fixed Assets and Change in Inventory: Chemical and
Chemical Products Industry

44
500000
400000
300000
200000
Change in fixed Asset
100000
Cashflow Operating
0
-100000
1995-96
1996-97
1997-98
1998-99
1999-20
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
Figure 8.3: Change in Net Fixed Assets and Operating Cashflows: Chemical
andChemical Products Industry

40000
35000
30000
25000
20000
15000 Change in Fixed Asset
10000 d up Equity
Flow of Paid
5000

-5000
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

Figure 8.4: Change in Net Fixed Assets and Flow of Paid-up Equity: Chemical
and Chemical Products Industry

70000
60000
50000
40000
30000 F
Change in fixed asset i
20000
r
Flow of Borrowing x
10000
e
-10000 A
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09

s
s
e
Figure 8.5: Change in Net Fixed Assets and Flow of Borrowings: Chemicaland
t
Chemical Products Industry
r
o
w
i
n
45 g
 600000
500000
400000
300000
200000 Change in Fixed Asset
100000
0 Trade Credit
-100000
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
Figure 8.6: Change in Net Fixed Assets and Trade Credit: Chemical and
Chemical Products Industry

As exhibited, the Figure 8.1 to Figure 8.6 shows the major trends of chemical industry.
The Figure 7.18 shows a consistently upward sloping graph of change in output and trade
credit. No clear pattern has been established by change in inventory graph though a negative
relationship has been indicated by correlation coefficient.
Table 9 exhibits the correlation matrix for chemical industry and the empirical findings of
panel data analysis have been demonstrated in the Table 10.

Table 9: Correlation Matrix of Chemical and Chemical products Industry

Variables F Y CHG_I CFO FEQ FB TC

F 1 0.12952 0.20773 0.15665 0.1046 0.30608 0.09182

Y 0.12952 1 0.30948 0.40031 0.08077 0.04708 0.6446

CHG_I 0.20773 0.30948 1 0.05013 0.28086 0.29306 0.27918

CFO 0.15665 0.40031 0.05013 1 -0.0366 -0.0007 0.43606
FEQ 0.1046 0.08077 0.28086 -0.0366 1 0.10654 -0.0206
FB 0.30608 0.04708 0.29306 -0.0007 0.10654 1 -0.075

TC 0.09182 0.6446 0.27918 0.43606 -0.0206 -0.075 1

46
 Table 10: Empirical Findings of Chemical and Chemical products Industry
(t-statistic in parentheses)
Fixed Effects
OLS/Classical
Variables Group Dummy and
Regression Group Dummy
Period Effects
Constant -0.024 -0.105
(-0.683) ( -1.888***)
Y -0.022 0.076 0.068
(-1.617) -0.444 -0.392
CHG_I 0.272 0.253 0.247
(2.702*) (2.271**) (2.148**)
CFO 0.184 0.228 0.233
(3.586*) (3.707*) (3.713*)
FEQ 0.549 0.37 0.508
( -1.376) -0.862 -1.168
FB 0.278 0.238 0.234
(6.817*) (5.658*) (5.478*)
TC 0.029 -0.096 -0.091
( -0.631) ( -1.502) ( -1.4)
LAGF 0.031 -0.03 -0.031
( -0.82) ( -0.756) ( -0.762)
LAGY 0.027 0.36 0.031
(2.429**) (3.060*) (2.631*)
R2 0.146 0.209 0.224

Durbin-Watson Statistic 2.0017

0.84
Lagrange Multiplier Test Statistic
df=1, Prob value=0.36
22.59
Hausman Test Statistic
df=8, Prob Value=0.00
*, ** and *** indicate the coefficient is statistically significant at 1%, 5%
and 10%significance level.

47
As indicated by the Table 9, none of the variables have a higher correlation coefficient than
0.7. Hence, in tune with the aggregate sample results, Durbin-Watson statistic suggests no
autocorrelation.
As per Table 10, Lagrange Multiplier test statistic favors panel ordinary least squares (OLS)
over fixed effects model (FEM)/random effects model (REM) in this industry group. Further,
Hausman test statistics favors fixed effects model (FEM) over random effects model (REM).

Contrary to the hypothesis, change in inventory (CHG_I) has a positive and significant
coefficient. It seems that the firms in this group have increased their fixed investments even
when their inventories have gone up. This may also be an indication that this industry requires
simultaneous investment in capital assets and inventory to expand its scale of operations. It is
imperative, therefore, to look at effects of other variables in detail here. Operating cashflows
(CFO), flow of borrowings (FB) and change in output in the previous year (LAGY) have a
positive and statistically significant coefficient. A significant coefficient for change in output
in the previous year (LAGY) accompanied by an insignificant coefficient for change in output
(Y) implies that the accelerator operates with a lag in case of chemicals industry. It may well
be the case here that the firms’ investment decisions are influenced by medium term targets.
This may also be the reason for fixed investment’s positive relationship with change in
inventory (CHG_I).

48
 CHAPTER 5
FINDINGS AND CONCLUSIONS

OBJECTIVES AND RESEARCH METHODOLOGY REVISITED

The present study primarily aims to study the financing of capital expenditures in Indian
corporate sector. Within this primary objective, the specific objectives of study are:
i. To identify the trends about the frequency and size of capital expenditures.
ii. To study the significance of various sources of funds for financing long-term
investment decisions.
iii. To analyze the importance of cashflows in firm’s investment decisions andthe nature
of its relationship with corporate investment.

iv. To examine the relationship between financing and capital expenditure decision

MAJOR FINDINGS
This section has been sub-divided into three sub-sections to discuss the findings of the study.
Section 8.2.1 deals with findings related to trend analysis and Section 8.2.2 presents Empirical
findings related to aggregate sample. Empiricalfindings related to industry wise sub-samples
have been provided in Section 8.2.3.
Findings Related to Trend Analysis

The major findings trend analysis pertaining to major variables of the study have been captured
below.
a. The rate of change in net fixed assets over the study period shows that routine
investments are more frequent than growth related investments. This trend has been
in line with the hypothesis for the study.
b. There has been a consistent rise in the change in output figures of the sample
companies over the study period. Change in output and change in net fixed assets have
significant and positive correlation. This variable has been used as a proxy for
accelerator for both current and previous year values.
c. A significantly positive correlation amongst flow of borrowings and change in net
fixed assets lend support to the hypothesis of importance of borrowings in explaining
capital expenditure decisions of the firms. It seems that external funds are heavily
employed for sponsoring the capital expenditures of Indian corporate sector.
d. Trend analysis pattern of sales and change in output have been largely similar and the degree

49
 of their correlation with net fixed assets has been found to be significant and positive.
Empirical Findings Related to Aggregate Sample

The panel regression results for the aggregate sample of 100 large sized Indian companies have
been presented below.
a) The results for the aggregate sample have been robust and majorly in line with the pre-
established hypothesis that all explanatory variables except change in inventory have a
positive relationship with change in net fixed assets (corporate investment) and are
significant at different significance levels.
b) Accelerator (change in output) theory of investment plays a determining role in firm’s
fixed investment behavior. Change in output (Y) representing accelerator has found
empirical support as an important factor in influencing the investment decision. Both
changes in output (Y) and change in output in the previous year (LAGY) are found to
be statistically significant at 1 percent and 10 percent level of significance in fixed
effects results with group dummy variables. It is pertinent to note here that fixed effects
results have beenfavored over classical regression and random effects model as per
Lagrange Multiplier Test Statistic and Hausman Test Statistic.
c) The coefficient of change in net fixed assets in the previous year (LAGF) has not been
found to be significant which in turn indicates that investments in fixed assets are not
dynamically related to the level of investment in the previous period.
d) Change in inventory has been found as negatively significant. This suggests the
substitution relationship between fixed and inventory investment due to significant
negative coefficient of change in inventory. Hence, this finding confirms the theoretical
belief that in order to commit a greater share of funds towards long-term investment,
inventory investment of a company has to be streamlined.
e) The results confirm a highly significant and positive relation of trade credit with change
in net fixed assets as postulated thereby paving way for acceptance of null hypothesis.
Therefore, the sample from Indian corporate sector confirms the theoretical
justification that increase in short-term funds through better bargains with creditors and
acceptances effects the change in net fixed assets in a positive and significant manner
Empirical Findings Related to Industry-Wise Sample
This section presents the regression results of financing of capital expenditures for twelve of
fourteen industry groups. Panel regression has not been carried out for coal mining and paper
industry as there is only one company each from these industry groups in the aggregate sample.

50
A) Beverages, Tobacco and Tobacco Products Industry

• Classical regression results have been preferred over fixed and/or random
effects model.

• Accelerator theory has not been found operational due to insignificant

coefficient assigned to both change in output in the current and previous year.

• Flow of borrowings (FB) has statistically significant and positive coefficient

as hypothesized. It implies that external funds raised in the form of borrowings
are predominantly used for financing investment in this industry group. The
other three variables representing sources of finance, viz. cashflows from
operating activities and flow of equity and trade credit have insignificant
coefficient.
• In regressions with higher powers of cashflow, it has been found that only flow
of borrowings (FB) have a significant coefficient. The U- shaped relationship
between investment and cashflows lacks empirical support in this industry
group.
B) Chemical and Chemical Products Industry

• A significant and positive coefficient for change in output in the previous year
(LAGY) while insignificant coefficient for change in output (Y) implies that
the accelerator operates with a lag in case of chemicals industry.

• Contrary to the hypothesis, change in inventory (CHG_I) has a positive and

significant coefficient. This implies that the firms in this group have increased
their capital investment even when their inventories have gone up.

• Though operating cashflows (CFO) and flow of borrowings (FB) have a

positive and statistically significant coefficient, flow of equity (FEQ) is
insignificant. Positive and significant coefficient for operating cashflows (CFO)
along with borrowings (FB) indicates that both internal as well as external
sources of finance are crucial in shaping capital expenditures of this industry
group.

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 • In regressions with higher powers of cashflow, operating cashflows (CFO)’s
coefficient turns negative. Operating cashflow square (CFSQ) has a positive
coefficient and operating cashflow cube (CFCUBE) has a negative coefficient
(significant only in ordinary least squares (OLS)). Thus there is some empirical
evidence against U-shaped relationship in this group of industry.
CONCLUSION:
This chapter studies the major variables of different industry groups alongwith panel data
analysis to outline the importance of various sources of finance in investment decisions. Trends
for the major variables have been presented in tables along with correlation coefficients of
change in net fixed assets with the respective variables. To conclude the major trends observed
in various industry groups, it has been found that accelerator theory has gathered strong support
with a positive and significant relationship between change in net fixed assets and change in
output in ten industry groups. As far as the various sources of finance are concerned, both flow
of borrowings and operating cashflows have been heavily raised and employed by various
industry groups and better results about preferred source of finance has been analyzed with
panel data results.
The rate of change in capital expenditures has been robust in all industry groups. It is pertinent
to note here that industry group specific results are at variance with the composite results.
Change in output has been used as a proxy for accelerator. Accelerator theory has been found
in operation in basic metal, electricity, food products, textiles and transport industry only.
Moreover, in chemicals and non- metallic mineral products industry there is evidence of
accelerator theory with a lag due to positively significant coefficient of previous year’s change
in output.
Further, to analyze the significance of various sources of finance in defining the investment
behaviour of the sample firms, operating cashflows, flow of borrowings and flow of equity
have been added to the investment equation along with trade credit. Flow of Borrowings
appears to be more important variable as compared to other sources of finance across most of
the industry groups (basic metal, beverages, chemicals, food articles, food products,
machinery, non-metallic mineral products, rubber and paper and textiles). This finding has
been observed despite the fact that Indian capital markets developed tremendously during the
period of study. Flow of equity has been found to be positively significant variable in only
basic metal, food products and minerals industry. Additionally, this result is in line with the
hypothesis that borrowed funds are most frequently used for financing capital expenditures.
This apparently implies that either the firms find it easier to borrow rather than raising capital
52
through equity route and/or borrowings are a cheaper source of funds as compared to equity
capital. This finding of the study signals toward existence of financing constraints but the same
is beyond the scope of the study. Moreover, the significant and positive coefficient of
cashflow from operations (basic metal, chemicals, food products, machinery, non-metallic
mineral products, rubber and paper industry) approves other hypothesis, i.e., investment
decisions of firms are sensitive to cashflows. Hence, during the study period, both internal
(cashflow from operating activities) as well as external funds (flow of borrowings) have been
heavily employed by various industries in order to meet investment requirements.
Consequently it can be concluded that the industry group specific results have wide divergence
from the hypothesis, whereas composite results are broadly in line with the hypothesis. Thus
it is plausible to argue that the composite panel is more representative than the industry specific
panels

53
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