Corporate leverage: structural equations framework in an emerging economy

Abstract

PurposeThe purpose of this paper is to investigate the financing behavior of firms in Pakistan. Previous studies have investigated corporate leverage determinants within any particular industry, such as manufacturing industry, textiles industry, etc., with varying results. This is one of the few studies that examine the determinants of leveraging attitude of firms across industrial sectors for textiles, large industries, and small industries. Thus, the study provides an insight into the general debt financing behavior in Pakistan and allows a basis for comparison of the leveraging decisions across industries.Design/methodology/approachThe study employs the structural equations methodology which captures the endogenous relationship between profitability and leverage. Thereby, eliminating bias and providing more accurate results.FindingsThe findings suggest that the leveraging decisions differ across sectors and that each industry has its own distinctive debt requirements/characteristics. The authors conclude that a singular approach taken by investors and analysts would provide inaccurate assessment of firms’ debt financing policies and strategies.Research limitations/implicationsThere is a limitation on data availability in emerging countries, and a larger sample would have provided more robust results. Therefore, the study has only taken three sector sub-divisions, and more industry categories would have provided in-depth insights into the industry-wise leveraging behavior.Practical implicationsThis is the first study to suggest that the borrowing attitude of firms differ across industries and vary due to their specific needs. This has implications for government regulators, investors, and creditors in providing a more customized approach to analyzing and meeting the external financing needs of firms.Originality/valueThis study is the first to use simultaneous equations model to eliminate bias that is prevalent in similar studies in Pakistan. The SEM captures the endogenous relationship between profitability and leverage. The research provides important information about the underlying financing behavior across industries, which has largely been ignored.