Decomposition of Debt Intensity: A General Parametric Divisia Method

Abstract

Since 1992, significant changes in the Indian capital market, particularly in the equity market, have enhanced the Indian firms' flexibility in choosing their capital structure optimally. Thus in response to such reform led changes in the relative cost of external finance (debt and equity) there has been a significant change in the aggregate debt (debt to total asset ratio) over this period. This paper makes an attempt to decompose such changes in aggregate debt into disaggregated structural and intensity effect to understand the impact of reform on the firm's capital structure choice. The intensity effect primarily captures the changes in the aggregate debt due to the changes in the debt of various sectors, while effect concentrates on the changes in the aggregate debt resulting from the changes in the composition of asset formation across various sectors. The paper begins with a general parametric divisia method which is then used to develop five specific divisia indices by imposing certain initial conditions. A comparative analysis of various indices, particularly looking into the reliability aspect of these methods, is one of the objective this paper. The paper also highlights the biases involved in periodwise (i.e., point-to-point) divisia indices proposed in this paper and develops a time series decomposition that takes into account interim time period to avoid such biases. Paper finds that changes in aggregate debt over the reform period can mainly be attributed to effect.