1

What Determines Capital Structure of Listed Firms in India?

Some Empirical Evidences from Indian Capital Market

Joy Pathak

Baruch College, City University Of New York,

55 Lexington Ave
New York, 10010, United States

&

Odette School of Business

University of Windsor
Windsor, ON, N9B 3P4, Canada

1 This study was performed as an ‘independent study’, during the author’s stay at University of Windsor.
2 Presently, author is graduate student in financial engineering at Baruch College, CUNY, New York.
 2

What Determines Capital Structure of Listed Firms in India?

Some Empirical Evidences from Indian Capital Market

Abstract

This paper examines the relative importance of six factors in the capital structure decisions of

publicly traded Indian firms. Existing empirical research on capital structure has been largely

confined to developed countries. The papers related to emerging economies usually group

several countries together. The Indian Financial Market has been developing at an exponential

rate and dedicated research in the field in required. The paper utilises a larger data set in

comparison to the earlier studies on India and examines additional factors. We use over 135

firms in the period of 1990-2009 listed on the Bombay Stock Exchange (aka as Mumbai Stock

Exchange). The objective of this paper is to build on previous studies on the Indian capital

market and model all the important factors affecting capital structure decisions of Indian firms

post liberalization policy by Government of India. We find that factors such as tangibility of

assets, growth, firm size, business risk, liquidity, and profitability have significant influences on

the leverage structure chosen by firms in the Indian context.

Keywords: Capital Structure, Indian Financial markets, Mumbai, pecking order, trade off,

corporate finance.
 3

1.0 Introduction:

What factors affect the firm‘s financing decisions? Researchers in the corporate finance area

have devoted extensive time and effort to ascertain the answer to this important research question

through theoretical and empirical means. This question acquired special significance after the

publication of seminal papers by Modigliani and Miller (1959, 1963). Several researchers have

investigated the determinants of capital structure, often limited to North America from various

perspectives. However, there is still no unifying theory of capital structure even after decades of

serious research, which leaves the topic open for further research. The choice of capital structure

for firms is one of the most fundamental premises of the financial framework of a corporate

entity. The method by which public corporations finance their assets sets up their ownership

structure and influence whether their corporate governance is of high standard. We examine over

135 publicly traded firms in India and test a range of hypotheses to determine which factors

affect the capital structure decisions. We find strong correlations between leverage and

tangibility of assets, growth, firm size, business risk, liquidity, and profitability. We also use

R&D expenses as a possible factor but are unable to find any significant relation with leverage.

We use two definitions of leverage; Long Term Debt Leverage and Total Debt Leverage. We

provide justification behind using two definitions of leverage in section 3.1.

The research conducted on developed markets is extensive whereas emerging economies is still

deficient of meticulous investigation. There have been quite a few significant papers conducted

on country-to-country comparisons (De Jong et al., 2008; Rajan and Zingales, 1995; Booth et al.,

2001). Researchers like Bhaduri (2002), Harvey et al (2004) etc have focused on a few European

and Asian countries. Bhaduri has conducted research specific to India with highly significant
 4

results but chose a limited number of variables and small sample due to limitation of data.

Theoretical papers in this field have been even rarer. We provide a brief description of some of

the significant prior studies relevant to the Indian context in the literature review section of the

paper to motivate our study.

It could be argued that the spotlighting on India should not be a concern, because we could

merely take the results of the prior studies that have already been conducted in the context of the

developed markets. And, in reality, several researchers including Mitton(2006), have already

exposed the tendency of convergence between emerging markets and developed economies. The

emerging markets are steadily reaching the debt levels of developed countries. It would be

convenient if we could apply the finding of the developed markets research when dealing with

any capital structure problems on emerging markets. However, the matter is not as

straightforward as that seems to be. It is crucial to be sure that the companies, operating in

emerging or developed capital market, actually follow the worldwide tendencies and that they

choose their capital structure following the same logic. Alves and Ferreira (2007); La Porta et al

(1998, 2000) and several others argued that the determinants of Capital Structure are

significantly affected by jurisdictional factors like Corporate and Personal Tax System,

Corporate Governance, Laws and Regulations of the country. Similarly, the development of the

bond/capital markets, Rule of Law, Credit/Share holders Protection, etc, are quite specific to

individual countries. It is therefore, very important to study individual emerging countries by

themselves rather than the countries pooled together. Due to the uniqueness of India as a country

as explained here, it is important to understand the behaviour of the firms by studying the

country individually.
 5

India has made noteworthy reforms since the Asian Financial crisis causing companies to look at

alternative forms of external funding in addition to internal funding. The Indian bond market and

credit holder‘s rights have been improving significantly. De Jong et al (2008) mentioned that

these determinants are significant in a company‘s decision for capital structure. A brief review of

reforms in India is presented in the next section. There is also limited work done specific to

India related to capital structure theories and determinants (Booth (2001), Bhaduri (2002); Singh

and Kumar (2008); Farhat et al (2009),). Our study contributes beyond the previous research on

capital structure determinants in India on two counts: addition of new specific determinants; and

a larger sample space. In addition, our paper utilises two different definitions of leverage.

Previous studies have only been able to use book values due to limitations of data, but we have

used market values also to show the leverage from the security market perspective. This

increases the contribution of our study. Our study adds to the literature an examination of the

factors of capital structure for non-Financial and non-regulated Firms in India.

The remainder of this paper is organised as follows: Section 2 explains the rationale and

motivation for studying the Indian capital market, and provides a brief review of the previous

studies focused on the emerging economies like India and China. Section 3 briefly explains data

used in this study and the description of variables. It is followed by section 4 describing the

model development and research hypotheses. Section 5 provides analysis and interpretations.

Section 6 concludes this study by providing limitations and the future directions.
 6

2.0 Why India?

India is the most populous democracy in the world. India has seen an enormous expansion in its

economy in the last decade1. It has grown 9% per year since 2004. India has an open and

democratic government, and has rule of law based upon the common law. It has a comfortable

external debt and inflation within acceptable range. These are major points suggesting the Indian

economy will grow significantly in the coming years.

The unusual history of India has made the Indian capital markets unique. The Government of

India‘s division, Controller of Capital Issues (CCI), controlled the Indian capital markets until

mid 1992. There were several scandals during the period when CCI was in charge and the

markets were very inefficient. The only major source for organisations to get financing was

through long-term loans from financial institutions. To make the markets more efficient, the

central government set up the Securities and Exchange Board of India (SEBI) under an Act of

1992. Under the SEBI regulations, firms had the freedom of designing and pricing securities in

the market along with the decision to increase the principal amounts of issuance. This instantly

caused several private firms to go public to gain funding from the markets. Major public

companies also went to the capital markets to raise money. In the year 2005-06, INR 27,382

crores2 was raised through equity issuances which rose to INR. 33,508 crores in the following

year i.e. 2006-07. The Indian wholesale debt market (WDM) raised INR. 2, 19,106 crores in the

year 2006-07 and INR 4, 75,523 crores in the year 2005-063.

1
Financial liberalization policies started from 1990 in India. Most corporate debts in India is convertible into
ordinary shares. Controls on the issue price of equity shares were phased out by 1992 by the Government of India.
2
The monetary term ‘crore’ in India is equal to 10 million in Indian Rupees (INR) and $225,520 (American).
3
Source: annual report of Reserve Bank of India (RBI) for the year 2006-07.
 7

According to the Economic Survey of India in 2007 by OECD, these reforms have had a major

impact on the economy. Inflows of foreign investment in India increased to 2% of the GDP from

less than 0.1% in 1990. The average share of imports and exports in the GDP had risen to 24% in

2006 up from 6% in 1985. The combined fiscal deficit of central and state governments fell from

10% of GDP in 2002 to just over 6% of GDP by 2006, with the ratio of debt to GDP falling from

82% in 2004 to 75% by March 2007. There has been a massive increase in output, with the

potential growth rate of the economy around 8½ per cent per year in 2006. GDP per capita is

now rising by 7½ per cent annually, a rate that leads to its doubling in a decade. This contrasts to

annual growth of GDP per capita of just 1¼ per cent in the three decades from 1950 to 1980.

Faster growth has resulted in India becoming the third largest economy in the world (after the

United States and China and just ahead of Japan) in 2006, when measured at purchasing power

parities, accounting for nearly 7% of world GDP. Moreover, with increased openness and rapid

growth in exports of merchandise and IT-related services, its share in world trade in goods and

services had risen to slightly over one per cent in 2005, when measured at market exchange rates.

The current expansion, which started in 2003, has not led to an imbalance between supply and

demand, despite annual GDP growth reaching 9% in 2006 (OECD, 2007). However, the

monetary authorities are acting to ensure that any price increases in food and other essential

commodities do not become entrenched and announced in April 2007, that monetary policy will

aim at achieving an inflation rate of 4-4½ per cent per year over the medium term. Such a benign

outcome is helped by increased domestic saving including the recent fiscal consolidation. This is

only but a small percentage of the development in India over the last two decades. The Indian

economy is growing significantly, allowing for the increase in the development of capacities and

an increase in the standard of living. The low inflation rate is a benefit for Indian economy
 8

because it encourages investment and growth performance. India is on its way to become one of

the market-based superpowers in the world, therefore, it is extremely important for finance

policy-makers at the firm or aggregate level to understand what drives corporate financing.

3.0 Literature Review

We review some of the most recent studies published in the relevant literature concerning the

emerging and non North American economies. For the sake of brevity we have not presented

reviews of highly cited studies of capital structure that are not explicitly related to the emerging

economies4.

Farhat et al (2009) test the trade-off and the pecking order models under a range of institutional

environments. They find that civil law countries follow the pecking order model and rely more

on internally generated funds. Based on the empirical results, they believe the common law

countries follow the trade-off theory and in India, being a common law country, the firms follow

trade-off theory.

In a recent paper De Jong et all (2008) analysed the importance of firm specific and country

specific factors in the leverage choice of firms across 42 countries. They found that firm specific

determinants differ across countries whereas earlier studies suggested that the determinants have

an equal impact. They also looked at direct country specific determinants like capital formation,

rule of law, stock market development, bond market development, etc. They found positive

relationships between tangibility, liquidity and leverage. They found non-significant inverse

4
Readers are recommended various review papers published on capital structure. (Frank & Goyal 2003)
 9

relationships between leverage and size, profitability, tax and risk. One of the possible reasons

why they did not have strong results for India was because they had only 226 observations.

Irina and Maria (2008) study focused on the capital structure decision in the BRIC 5 countries. It

was not a country-specific study with a focus on India. The authors applied a multistage research

model to a set of large non-financial firms from Russia, Brazil and China. They found, like

previous studies, that the impact of determinants of capital structure differs within national

samples. They showed that when comparing large-scale Russian firms to Brazilian firms the

opposite impact was noticed in terms of the influence of tangibility of assets and the firm size. At

the same time, they found similar influences of determinants between Chinese firms and

Brazilian firms.

Bhaduri (2002) studied the factors affecting capital structure in the Indian corporate sector. He

modeled the economic effects accounting from restructuring costs in attaining an optimal capital

structure. He also presented empirical evidence to show that factors such as growth, cash flow,

size, and product/industry characteristics affect the choice of optimal capital structure. The main

finding of this study is that capital structure choice in India is affected by factors such as growth,

cash flow, size, and product and industry characteristics. The results also confirm the existence

of restructuring costs in attaining an optimal capital structure. The model suggests a differential

cost of restructuring for long-term and short-term borrowing. He set up a benchmark model for

other researchers to use in ascertaining the capital structure determinants. The sample used in

Bhaduri study consisted of 363 firms collected across nine broad industries over the period of

1990-1995 and is drawn from the Centre for Monitoring Indian Economy (CMIE) database.

5
BRIC countries are defined by Brazil, Russia, India and China.
 10

Bhaduri mentioned limitations of his study and the main limitation relates to a moderate level of

`goodness of fit‘ which implies that one needs to incorporate more variables to increase the

explanatory power of the model. However, the available data in Bhaduri‘s study did not allow

for the introduction of more variables in this model. We expand Bhaduri‘s (2002) study by using

an extended set of variables and a much larger data set to build a stronger model for capital

structure determinants. We also confirm some of the results provided in Bhaduri‘s study. The

theoretical foundation of our study is based upon the capital structure studies undertaken prior to

our study and utilises the knowledge gained from the existing literature in the empirical

corporate capital structure domain with special reference to India.

4.0 Data

The major type of variables for this study are firm specific6. The firms in our study include non-

financial and non-regulated firms. The data for leverage and firm specific variables were taken

from COMPUSTAT Global Fundamentals database. The data for the country-specific variables

was taken from the Economic Intelligence Unit database of World Development Indicators. The

sample period covers the years 1990-2009. We require that the firms in our sample have at least

three years of available data over the study period. The total number of observations were 11439

which included over 135 firms.

4.1 Leverage

As can be seen in the literature, various definitions of leverage exist. All these characterizations

of leverage revolve around some form of debt ratio. The definitions depend on whether market

6
I have NOT provided “country specific variables” in this submission due to the obvious length issues. The country
specific variables will be provided in the next study being conducted by us.
 11

value or book values are used. In addition, definitions also depend on whether short term debt,

long-term debt or total debt is used. Firms have several types of assets and liabilities and there

can be further adjustments made to the definition. For this study, we use two definitions of

leverage and present the data accordingly.

1) Total Debt Leverage: This leverage definition uses a sum of debt in current liabilities and

long term debt over the total assets (De Jong et al (2008)).

2) Long Term Debt Leverage: This leverage characterization utilises just the Long term

debts over the total assets. Titman and Wessels (1988) and others used long-term debt in

their determinants study. Since short-term debt consists of trade credit, which is under the

influence of completely different determinants, the examination of total debt ratio may

generate results which are difficult to interpret.

Views on which is the optimum gauge for leverage differ. Due to the difficulty of attaining

market data, many researchers have chosen to use book data instead. According to Myers (1977),

managers focus on book leverage because debt is better supported by assets in place than it is by

the growth opportunities. Book leverage is also preferred because financial markets fluctuate a

great deal and managers are said to believe that market leverage numbers are capricious as a

guide to corporate financial policy (Frank & Goyal 2003, Myers 1977). In addition for debt

contracts, firms prefer to use book value. Hence, we measure debt in terms of book value rather

than market values.

 12

4.2 Impact of Firm Specific Factors

4.2.0 Hypothesis

Myers (2003) argues that no universal theory of capital structure exists, and there is no reason to

expect one. We have useful conditional theories, however.... Each factor could be dominant for

some firms, or in some circumstances, yet unimportant elsewhere. Frank & Goyal‘s (2003) &

Booth et al‘s (2001) surveys suggest that capital structures of firms arise from the various

theories such as static trade-off and pecking order theory. Farhat et al(2009) conducted a test of

the pecking order and trade-off theory and concluded that Indian firms follow the trade-off

theory. In a static trade-off framework, the firm is visualised as setting a particular target

leverage ratio and adjusting their debt/equity accordingly to take advantage of various benefits

associated with leverage. Recent studies suggest that the trade-off theory predictions about

profitability are more complex than those based on static models (Strebulaev, 2007). Because of

the lack of consensus on the determinants of capital structure, we do not follow the specific

conventions of an individual capital structure theory while studying the Indian scenario. The list

of firm-specific hypotheses investigated in this paper are presented in Table 1.

4.2.1 Firm Specific Independent Variables

a) Tangibility (Hypothesis FS1)

Tangibility (TANG) is the characteristic that an asset can be used as collateral to secure debt.

Myers and Majluf (1984) argued that firms with more collateral value in their assets tend to issue

more debts to take the advantage of low cost. The higher tangibility of assets indicates lower risk

for the lender as well as low bankruptcy costs. Among the various factors that decide the capital
 13

structure chosen by a firm as mentioned above bankruptcy cost is important. Jensen & Meckling

(1976) and Myers (1977) indicated that stockholders of the leveraged firms tend to invest sub-

optimally to expropriate wealth from the firm‘s bondholders, and thus, a positive relation

between debt ratios, i.e. leverage, and the collateral value of assets, i.e. tangibility, exists. A good

proxy for this is asset tangibility which is measured as the ratio of the net fixed assets to total

assets. Consistent with Jensen & Meckling (1976) and Myers (1977) proposition, it would be

expected that higher tangibility would result in higher leverage.

b) Business Risk (Hypothesis FS2)

In addition to Tangibility, the Firm‘s business risk is also a good proxy for variables associated

with bankruptcy costs. Business risk (BR) is the risk that a company will not have adequate cash

flow to meet its operating expenses. Business risk should have a negative effect on leverage.

Business Risk was calculated as the earnings volatility before depreciation (Change in Operating

Income before Depreciation). The higher risk indicates increased volatility of earnings and

therefore higher probability of bankruptcy. Several authors in prior studies argued that a firm‘s

optimal debt level is a decreasing function of the volatility of earnings7. Since, debt involves a

continuous commitment of periodic repayment, highly leveraged firms become vulnerable and

less likely to remain leveraged. Following the arguments of various studies (De jong et al

(2008), Frank & Goyal (2003)), we, therefore, propose that higher the business risk, the lower

the debt levels in order to avoid bankruptcy issues.

c) Firm Size– Hypothesis FS3

7
However, we have also noticed arguments opposing this hypothesis in Castanias & DeAngelo (1981), Jaffe and
Westerfield (1984), and Bradley et al (1984). Thies & Klock (1992) examined such inconsistencies where they find
the existence of cross sectional relationship between earnings variability and the capital structure.
 14

Firm size has been suggested to be an important variable related to the leverage ratios of the

firm8. It is also argued that relatively large firms tend to be more diversified and thereby less

prone to bankruptcy. Consistent with these arguments, we use firm size as an inverse proxy for

the probability of bankruptcy, i.e larger firms are less likely to face distress. These arguments

also provide basis to suggest that large firms should be highly leveraged. Similarly, the cost of

issuing debt and equity securities is also related to size, and as suggested by Smith (1977)

smaller firms pay many times more to issue new equity and even more in case of debt. The firm

size can be measured either as a Log of total Sales or as the Log of total Assets. Titman &

Wessels (1988) suggested that logarithmic transformation of sales reflects the size effect and

therefore we take the Log of Total Sales as our proxy.

d) Growth-Hypothesis FS4

We have mentioned in earlier sections that equity controlled firms have a tendency to invest sub

optimally to expropriate wealth from the firm‘s bondholders. Such agency costs are likely to be

higher for growing firms that are relatively flexible in their choice of capital structure. Agency

conflict related theories suggest that due to issues with asset substitution and underinvestment,

firms with high growth opportunities tend to opt for equity related financing. The firm growth

opportunities are capital assets adding value to the firm but not collateralizable, hence do not

generate taxable income. Expected future growth should thus be negatively related to the

leverage of such growth firms. The growth is indicated as the capital expenditures per year over

the assets. We thus propose that growth opportunities therefore have a negative effect on

leverage

8
A number of authors have suggested it. For example, see Warner (1977) and Ang et al (1982).
 15

e) Profitability & Liquidity - Hypothesis FS5 & 6

To take into account asymmetric information issues9 it is common to use variables such liquidity

and profitability. A study by Booth et al (2001) suggested that profitable firms might be able to

finance their growth internally by using retained earnings while maintaining a constant debt-

equity ratio whereas, less profitable firms have no such choice and are forced to go for debt

financing. We propose that Profitability has a negative effect on leverage since more profitable

firms will have more financial resources and will use debt as a last issue. Profitability was

proxied as the ratio of the Operating income before depreciation to total assets.

Consistent with De Jong et al (2008) we agree that the liquidity that is the accumulated cash and

other liquid assets will serve as the internal source of fund and will be utilised first instead of

debt. Therefore, we propose that liquidity has a negative effect on leverage. Liquidity was

calculated by dividing the total current assets over the total current liabilities.

f) Research And Development (R&D)-Hypothesis FS7

A positive link is expected between R&D and leverage. Since there will be higher expenditures

on R&D the firm will need to raise new capital for projects through issuance of debt or equity.

Under the assumption that the trade-off theory is the dominant theory in India, a positive linkage

is expected.

4.2.3 Research Methodology

In the first part, we test the explanatory power of the conventional theoretical framework of firm

specific determinants of capital structure. Two independent Ordinary Least Square (OLS)

9
See, Myers & Majluf (1984) for issues decribed related to information asymmetry.
 16

regressions are run on firm level data, with leverage (TD) and leverage (LTD) as the dependant

variable and the firm specific factors as the independent variables.

The regression equations are shown below:

𝐿𝐸𝑉 𝑇𝐷 𝑖 = 𝛽0 + β1 TANG + β2 BR + β3 SIZE + β4 GROWTH + β5PROFIT + β6LIQUID + β7R&D+ εi (1)

LEV (LTD)I = β0 + β1 TANG + β2 BR + β3 SIZE + β4 GROWTH + β5PROFIT + β6LIQUID + β7R&D+εi (2)

4.2.4 Model Diagnostics

Table 2 provides the descriptive statistics for all the variables. Now looking at the diagnostics in

Table 3 of the regression model it can be seen that the adjusted R square values are satisfactory

in all cases. The explanatory power of this model is very strong and consistent to Titman and

Wessels (1988) study. We used ‗Top Tax Rate‘ as taken from the World Development Indicators

database, to check the robustness of the model. It was seen that the results of the main variables

did not change significantly hence proving the strength of the research model.

5.0 Results

The results are presented in Table 2 and 3, and 4 below. Table 2 provides descriptive statistics on

the variables chosen for this study. Table 3 shows the results of the OLS regressions of equation

1 and 2. Table 4 provides correlations..

We see that the coefficients for Tangibility in Table 4 and the regression models results in Table

3 are consistent with our hypothesis (FS1). The results are also statistically significant. The

results are consistent with the results achieved by De Jong et al (2008) and Booth et al (2001)

studies.
 17

The results of business risk although satisfying the hypothesis show mixed results compared to

previous studies. Mixed results (some positive, other negative) on this variable have also been

found in previous studies (e.g. Booth et al (2001), Deeomsak et all (2004), De Jong et al (2008)).

Similar to the tangibility results, the firm size coefficients show a positive significance as stated

in hypothesis FS3. It can be seen that larger firms have more debt. Considering the fact that

larger firms are extensively diversified usually, and have more consistent cash flows, they can

afford higher levels of leverage.

The growth coefficients show positive and significant results. This is against the agency theory

and hypothesis FS4. We expected that firms with brighter growth opportunities would prefer to

keep leverage low so as to not give away their profits to creditors.

We can see that the results of profitability are consistent with the asymmetric information theory.

Firms‘ first use retained earnings for new investments and then move to debt and equity if

required. A negative relation is seen between the profitability and leverage. This is consistent

with the hypothesis FS5 and with the published results by several researchers in the field prior to

us. Liquidity also shows a negative correlation (hypothesis FS6). The results are not significant

as can be seen from the regression results of Leverage (LTD) definition. Conventional theories

suggest a negative relation should be expected between liquidity and leverage. De Jong et al

(2008) found insignificant results for the correlation between liquidity and leverage for India.

Finally, it can be seen that the results of R&D were insignificant. If the trade-off theory holds, a

company would utilise additional debt to make up for the R&D expenses whereas if pecking

order holds then equity would be the choice. It is hard to quantify what would be suitable for

India as there is very limited data on R&D expenditures for Indian firms.
 18

6.0 Conclusions

This paper studies the leverage decisions of Indian firms. This study explains the observed

variation in capital structure using a regression model. Six major factors (tangibility, firm size,

growth, profitability, liquidity) and one second tier factor (R&D) are identified and their

relations to leverage are studied. The results are mostly consistent with much of the previous

literature. We find that leverage increases with increase in Firm Size, Tangibility and Growth. In

contrast, we found that leverage increases with decrease in Business Risk, Profitability, and

Liquidity.

This study distinguishes itself from previous papers with the introduction of key variables that

have not been studied previously in papers related specifically to Indian firms such as

profitability, liquidity, R&D expenditure, and business risk. The study also has a significantly

larger data set than previous papers. Bhaduri (2002) used a 5-year span due to limitations on data

while setting up his benchmark model for further research in the field. This paper builds on

previous studies and sets itself as a compliment to previous benchmark papers, for future

research in determining factors for emerging economies. The paper is a major contribution to the

capital structure literature due to its large number of observations in comparison to previous

studies and the use of stronger proxies. For future research, the authors plan to study several

macro-economic factors that influence capital structure decisions. This will include factors such

as Capital Formation, Stock Market Development, Financial Stability of Country, Corporate Tax,

Terrorism Threat, Direct Foreign investment, etc.

 19

Researchers with the longer timeline data sets can develop a stronger model by including

additional firm specific factors like Uniqueness factor(uniqueness of product), Collateral Value

Factor, Carry Forwards, Discount Rates, Quality Spreads, etc. Although these factors are not the

core factors in financial structure decisions, they have been shown to have effects in previous

studies of developed economies. Researchers can utilise this paper to develop stronger models

for research into the capital structure determinants for emerging economies.
 20

References

1. Alves P, Paulo F. And Ferreira, Miguel A., (2007),―Capital Structure and Law Around
the World (march). 14th Annual Conference of The Multinational Finance Society.
2. Ang, J. Chua, McConnell (1982), ―The Administrative Costs of Corporate Bankruptcy: A
Note‖, Journal of Finance, 37, 219-226.
3. Bhaduri, Saumitra N.(2002) 'Determinants of capital structure choice: a study of the
Indian corporate sector', Applied Financial Economics, 12: 9, 655 — 665
4. Booth, L., V. Aivazian, A. Demirguc-Kunt and V. Maksimovic, (2001) ―Capital structure
in developing countries‖, Journal of Finance, 56(1), 87-130.
5. Bradley, M., G.A. Jarrell and E. H. Kim, (1984) ―On the existence of an optimal capital
structure: theory and evidence‖, Journal of Finance 39, 857-877.
6. Castanias, R. & DeAngelo, H. (1981), ―Business Risk and Optimal Capital Structure‖,
unpublished working paper, University of Washington.
7. Abe de Jong,Rezaul Kabir,Thuy Thu Nguyen (2008),‖Capital Structure Around the
World: The roles of firm- and country-specific determinants‖, Journal of Banking &
FinanceVolume 32, Issue 9, September 2008, Pages 1954-1969
8. Deeomsak, R., Paudyal, K., Pescetto, G. (2004), ―The Determinants of Capital Structure:
Evidence from the Asia Pacific Region, Journal of Multinational Financial Management,
14, 387-405.
9. Fama, E. and French, K. "Testing Tradeoff and Pecking Order Predictions about
Dividends and Debt," Review of Financial Studies 15 (Spring 2002), 1-37
10) Farhat, Cotei and Abugri, (2006) ―The Pecking Order Hypothesis vs. the Static Trade-off
under Different Institutional Environments‖, working paper.
11) Frank and Goyal, ―Testing the pecking order theory of capital structure‖, Journal of
Financial Economics, 2003
12) Harvey, Campbell R., Karl V. Lins and Andrew H. Roper. The Effect Of Capital
Structure When Expected Agency Costs Are Extreme. Journal of Financial Economics,
13) 2004, v74(1,Oct), 330India‘s Economy: Open wide. (2008, March 8). The Economist,
386(8570), 94. Jensen,
14) Irina and Maria (2008),‖Capital Structure in BRIC countries‖, Independent Report
15) Jaffe, J. and Westerfield, R. (1984), ―Risk and Optimal Debt Level‖, Working Paper,
University of Pennsylvania.
16) Jensen, M.C., (1986) ―The Agency Costs of Free Cash Flow: Corporate Finance and
Takeovers‖, American Economic Review, 76, 323-329.
17) Jensen, M.C.and Meckling, W.H. (1976) ―Theory of the firm: managerial behavior,
agency costs and ownership structure‖, Journal of Financial Economics, 3, 305-360.
18) Kraus, A. and R.H. Litzenberger, "A State-Preference Model of Optimal Financial
Leverage", Journal of Finance, September 1973, pp. 911-922
19) La Porta, R., F. Lopez-de-Silanes, A. Shleifer and R.W. Vishny, (1998), ―Law and
Finance‖, Journal of Political Economy, 106, 1113-1155.
 21

20) La Porta, R., F. Lopez-de-Silanes, A. Shleifer and R.W. Vishny, (2000) ―Agency
problems and dividend policies around the world‖, Journal of Finance, 55(1), 1-33.
21) Miller, MH (1977), "Debt and Taxes",The Journal of Finance, 1977
22) Mitton(2006),, Modigliani, F. and Miller, M.H. (1958), ―The Cost of Capital, Corporate
Finance, and the Theory of Investment, American Economic Review, 48, 201-97.
23) Modigliani, F. and Miller, M.H. (1963), ―Corporate Income Taxes and the Cost of
Capital: A Correction‖, American Economic Review, Vol. 53,
24) pp. 433- 443. Myers (1977), ―Corporate Income Tax and the Cost of Capital: A
Correction‖, American Economic Review, 53, 433-443.
25) Myers, S.C., (2003), ―Financing of corporations.‖ Constantinides, G., M. Harris, and R.
Stulz (eds.) Handbook of The Economics of Finance: Corporate Finance Volume1A,
Elsevier North Holland.
26) Myers, S and Majluf, N. (1984), ―Corporate Financing and Investment Decisions When
Firms have Information Investors do not have‖, Journal of Financial Economics, 13, 187-
221.
27) Myers, S.C., (1977), ―Determinants of Corporate Borrowing‖, Journal of Financial
Economics, 9, 147-176.
28) Myers, S.C., (1984) ―The capital structure puzzle‖, Journal of Finance, 39, 575-592.
29) Rajan, R.G., and L. Zingales, (1995) ―What do we know about capital structure? Some
Evidence from international data‖, Journal of Finance, 50, 1421-1460.
30) Ross, S.A., (1977) ―The determination of financial structure: the incentive signalling
approach. Bell‖, Journal of Economics, 8, 23-40.
31) Shyam-Sunder, L. and S.C. Myers, (1999) ―Testing Static trade-off against Pecking
Order Models of Capital Structure‖, Journal of Financial Economics, 51, 219-244.
32) Singh, Priyanka and Kumar, Brajesh, Trade Off Theory or Pecking Order Theory: What
Explains the Behavior of the Indian Firms? (September 4, 2008)
33) Smith, C. (1977),‖Alternative Methods for Raising Capital: Rights Versus Underwritten
Offerings‖, Journal of Financial Economics, 5, 273-307.
34) Strebulaev, (2007), ―Do tests of capital structure theory mean what they say? , Journal of
Finance
35) Thies, C.F. & Klock, M.S., (1992),‖Determinants of Capital Structure‖, Review of
Financial Economics, 1, 40-52.
36) Titman, S., and R. Wessels, (1988) ―The determinants of capital structure choice‖,Journal
of Finance, 43, 1-21.
37) Wald (1999), ―How firm characteristics affect capital structure: An international
Comparison‖, Journal of Financial Research 22, 161–187.
38) Warner, J. (1977) , ―Bankruptcy Costs: Some Evidence‖, Journal of Finance, 32, 337-
347.
39) Wiwattanakantang, Y., (1999), ―An empirical study on the determinants of the capital
structure of Thai firms‖, Pacific-Basin Finance Journal, 7 (3-4), 371-403.
 22

Table 1: Firm related Hypothesis

Firm Specific Factors Magnitude and Direction of Hypothesis

Hypothesis FS1 Tangibility has a positive effect on leverage

Hypothesis FS2 Business Risk has a negative effect on leverage

Hypothesis FS3 Firm Size has a positive effect on leverage

Hypothesis FS4 Growth has a negative effect on leverage

Hypothesis FS5 Profitability has a negative effect on leverage

Hypothesis FS6 Liquidity has a negative effect on leverage.

Hypothesis FS7 Research and Development has a positive link to leverage

 23

Table 2 Descriptive Statistics

Descriptive Statistics
Std.
Mean Deviation N
Leverage 2 0.19671 0.176852 9642
- Long
Term Debt
Leverage 1 0.29846 0.203428 9533
–Total Debt

Tangibility 0.360104 0.206798 9686

Business 2.208821 1.054107 11274

Risk

Firm Size 3.235385 0.828745 11107

Growth 0.091578 0.103263 8904

Profitability 0.129173 0.17707 9644

Liquidity 2.7002 11.90769 9683

R&D 1.61E+02 5.76E+02 2372

 24

Table 3: OLS Results for Firm level Data

Leverage 1 (TD) Leverage 2 (LTD)

Beta t Sig. Beta t Sig.

Tangibility 0.34 17.117 0 0.371 18.403 0

Firm Size 0.06 3.016 0.003 0.172 8.507 0

Growth 0.072 3.636 0 0.09 4.491 0

Profitability -0.372 -20.312 0 -0.332 -17.873 0

Liquidity -0.125 -7.018 0 -0.009 -0.522 0.601

R&D 0.001 0.047 0.963 0.015 0.817 0.414

Business -0.092 -4.824 0 -0.098 -5.039 0

Risk

Model Summary Leverage 1 (TD) Leverage 2 (LTD)

R square 0.329 0.297
Adjusted R square 0.321 0.294
 25

Table 4: Correlation chart for Firm Specific Determinants with the Leverage.

Business
Variables
risk
Business Pearson 1
Risk Correlation
Sig. (2-
tailed)
N 11145 R&D
**
R&D Pearson .176 1
Correlation
Sig. (2- .000
tailed)
N 2372 2372 Tangibility
**
Tangibility Pearson .058 - 1
**
Correlation .119
Sig. (2- .000 .000
tailed)
N 9644 2366 9686 Firm
Size
** ** **
Firm Size Pearson .314 .250 .086 1
Correlation
Sig. (2- .000 .000 .000
tailed)
N 11077 2370 9605 11107 Growth
**
Growth Pearson .020 .020 .415 -.018 1
Correlation
Sig. (2- .065 .336 .000 .098
tailed)
N 8882 2291 8904 8872 8904 Profitability
** ** ** ** **
Profitability Pearson .070 .061 .041 .157 .082 1
Correlation
Sig. (2- .000 .003 .000 .000 .000
tailed)
N 9644 2366 9644 9583 8882 9644 Liquidity
** ** * **
Liquidity Pearson -.011 .059 -.102 - -.021 -.027 1
**
Correlation .140
Sig. (2- .298 .004 .000 .000 .045 .007
tailed)
N 9637 2366 9679 9598 8904 9637 9683 Lev2(LTD)
** ** ** ** **
Leverage Pearson -.016 -.018 .443 .073 .205 -.107 -.042 1
2(LTD) Correlation
Sig. (2- .115 .381 .000 .000 .000 .000 .000
tailed)
N 9604 2358 9642 9565 8876 9604 9635 9642
Lev1(TD)
** ** ** ** ** ** **
Leverage Pearson -.046 - .391 .079 .138 -.138 -.090 .828 1
**
1 (TD) Correlation .067
Sig. (2- .000 .001 .000 .000 .000 .000 .000 .000
tailed)
N 9503 2347 9533 9463 8806 9503 9526 9533 9533
Note: ** = Correlation Significant at 0.01 level
*= Correlation Significant at 0.05 level