Capital Structure and its Determinants in the UK - A Decompositional Analysis

Abstract

Prior research on capital structure by Rajan and Zingales (1995) suggests that the level of gearing in UK companies is positively related to size and tangibility, and negatively correlated with profitability and the level of growth opportunities. However, as argued by Harris and Raviv (1991), interpretation of results must be tempered by an awareness of the difficulties involved in measuring both leverage and the explanatory variables of interest. In this paper we focus on the difficulties of measuring gearing, and test the sensitivity of Rajan and Zingales' results to variations in gearing measures. Based on an analysis of the capital structure of 822 UK companies, we find Rajan and Zingales' results to be highly definitional-dependent. The determinants of gearing appear to vary significantly, depending upon which component of debt is being analysed. In particular, we find significant differences in the determinants of long and short-term forms of debt. Given that trade credit and equivalent, on average, accounts for more than 62 percent of total debt, the results are particularly sensitive to whether such debt is included in the gearing measure. We argue, therefore, that analysis of capital structure is incomplete without a detailed examination of all forms of corporate debt.