Capital Structure – Does Ownership Structure Matter? Theory and Indian Evidence

Abstract

Purpose – Based on the agency theory, the purpose of this paper is to theoretically argue and empirically investigate how ownership structure impacts the capital structure of the listed mid-cap companies in India and whether the capital structure as exogenous variable has a role in determining ownership structure as well. Design/methodology/approach – Simultaneity between capital structure and ownership structure is checked through Hausman specification test on endogeneity. Fixed effect panel regression model is used to analyze five years of data (2005-2009) on the sample units, to find the relation between leverage and ownership structure after controlling for profitability, risk, tangibility, growth and size. Findings – Empirical results on Indian firms suggest that the ownership structure does impact capital structure but not the vice versa. Consistent with theoretical prediction empirical results reveal that the leverage is positively related to concentrated shareholding and has a negative relation with diffuseness of shareholding after controlling for profitability, risk, tangibility, growth and size. The findings are consistent with “managerial entrenchment hypothesis” and “pecking order theory” of capital structure. Practical implications – The findings of the paper will enable the practitioners and analysts to understand as to why, in the bank and financial institution-dominated debt financing system in India, leverage is closely associated with concentrated ownership pattern and why retained earning is a preferred vehicle of financing for the firms with diffused shareholding. Originality/value – The results of the study enrich the literature on capital structure, agency cost and corporate governance issues in several ways.