Determinants of Capital Structure

Nayyar & Muzammil

Introduction

 Attaullah Shah & Safiullah Khan

 Capital Structure
• Debt
• Equity
 Lower cost of capital
 Maximizing shareholder wealth
 Optimal capital structure
Cont….

 KSE listed 286 Non Financial Firms

 Period 1994-2002
 Pooled regression/constant coefficient model
 The fixed effects model
VARIABLES AND HYPOTHESES
Dependent and Independent Variables

Tangibility of Assets
(TG)

Size (SZ)

Growth (GT)
LEVERAGE
Profitability (PF)
Earning Volatility
(EV)

Non Debt Tax Shields

Measure of Leverage (Dependent)

 Three methods to measure leverage

• Market based
• Book value based
• Total debt/total asset based measure
Tangibility of Assets (TG) Independent

 Large amount of fixed assets, borrow at

lower rate of interest.
 Assets provide security to creditors.
 Positive relation between tangibility of assets
and Leverage.

H1:A firm with higher percentage of fixed

assets will have higher debt ratio.
Size (SZ)

 Two conflicting view points

• Don’t considered direct bankruptcy cost as an
active variable.
• There is less asymmetrical information about
larger firms.
 This means, there is negative relationship
between size and leverage.

H2: There is negative relationship

between size and leverage of the firm.
Growth (GT)

 Bond holder’s fear of risk

 Might invest in risky projects
 High lending rates
 Firm will prefer internal funding

H3: Firm with higher growth rate will

have lower leverage
Profitability (PF)

 High profitability high the internal funding,

followed by low leverage
 So negative inverse relation between
profitability and leverage

H4: firms with higher profitability will

have lesser leverage
Earning Volatility (EV)

 Business risk due to inefficient management

practices
 Firm should have to pay risk premium to
external fund providers
 So firm will prefer internal funding just to
reduce cost of capital
H5: Earning Volatility is negatively related
to leverage
Non Debt Tax Shields

 Firms use more debt for tax savings

 Because interest is paid on debt that will
decrease firms EBT so there would be less
taxable amount
H6: NDTS are negatively related to
leverage.
Descriptive Statistics
And Models
Leverage Ratios of firms

oTextile industry has average of 0.723 leverage against

the mean leverage of all industries i.e 0.666
oProfitability of power sector is 0.055
oCement industry tangibility 0.655
Model Specifications

 Panel data is used

 It combines the features of time series and
cross section.
 Panel data usually provides the researchers
a large number of data points, increasing the
degree of freedom and ambiguity among
explanatory variables.
 Improve the efficiency of econometric
estimates.
Constant Coefficient Model
Constant Coefficient Model

 Know as pooled regression model

 Simplest but disregards the time, space or individual
effects
 Hold the assumption that all firms are similar with
regard to capital structure and there is no significant
industry or time effect on leverage.
 Intercept values of all the firms and slope coefficients
of the all seven Xit variables are identical
 Therefore this model may distort the true picture of
relationship between leverage and independent
variables.
The Fixed Effects Model

 Individual firm effects, time, or to controll

omitted variables, that differ among firms
but are constant over time.
Discussion of the results
 Colour scheme

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