Capital structure in the construction industry: theory and practice

Abstract

Starting with the seminal work of Modigliani and Miller in 1958, various capital structure theories have been set forth by corporate finance researchers, such as the trade-off and financial hierarchy theories. The present research uses data from the survey questionnaire conducted with 158 Turkish construction companies to explain the financial decisions of contractors in terms of capital structure theories. Results reveal that firm age, size, and asset values appear to be positively correlated to debt–equity ratio and the volatility of earnings and cashflows are important determinants of leverage, confirming the trade-off theory. On the other hand, the construction sector clearly follows a financial order consistent with the financial hierarchy theory, but other propositions of the theory are not supported. Overall, it is concluded that capital structure decisions of construction firms cannot fully be explained by the existing models. Rather, firms appear to exploit “windows of opportunity” emerging from changes in macroeconomic indicators, such as interest rates, GDP, and resulting market conditions.