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Abstract
Capital structure alludes to how an organization finances its operations whether through shareholders equity, debt or a blending of both. This study was aimed to find out the determinants of capital structure in Manufacturing and Service Sectors of Pakistan and examine which capital structure theory (Trade off theory or Pecking order theory) is relevant in Pakistani context. For study secondary data was collected from financial statements of 30 Companies and then data was analyzed through Correlation and Multi Regression analysis. Results showed that leverage has negative significant relationship with tangibility in both sectors which conformed Pecking order theory is followed by firms in both sectors. Profitability has negative significant relationship with leverage in manufacturing sectors whereas it has positive non-significant relationship with leverage in service sectors. This result revealed that manufacturing sectors follow Pecking order theory whereas service sectors support Trade off theory. Moreover in manufacturing sectors growth and leverage have negative significant relationship whereas in service sectors both variables show positive non-significant relationship. Manufacturing sectors support Trade off theory but service sectors support Pecking order theory. Size and leverage show positive non-significant relationship in manufacturing sectors whereas show positive significant relationship in service sectors. Due to positive sign, they follow Trade off theory. Effective tax rate has positive non-significant relationship with leverage. Positive sign shows firms follow Trade off theory in both sectors but due to non-significant result the effective tax rate not found to be a significant determinant of capital structure. This study will help corporate managers and decision makers to make optimal capital structure decision.
Highlights
Financing and investment are two major decision areas in a firm
Manufacturing support Trade off theory whereas service sectors support Pecking order theory due to correct prediction of sign which states that internally generated funds are not sufficient to meet additional financial needs so they use more debt in their capital structure ratio
In manufacturing sectors negative significant relationship was found between growth and leverage whereas in service sectors positive non-significant relationship was found between growth and leverage
Summary
Financing and investment are two major decision areas in a firm. In the financing decision, manager is concerned with determining the best financing mix or capital structure for the firm. The capability of firm to carry out stake holders’ requirement is closely linked to capital structure and it play vital role in maximizing the performance of firm and its value It tries to explain the mix of securities and financing sources used by companies to finance investments (Myers, 2001). Saad (2010) states that capital structure means the way a firm finances its assets across the mixture of debt, equity or hybrid securities. To cut in short capital structure is mixture of debt which classified into long-term and short-term debt and equity which comes from issuing common stocks, preferred stocks and retained earnings Beside these sources of finance, firms issue some hybrid securities that possess the characteristics of both equity and debt. Determining the precise optimal capital structure is not a science, so after examining a number of features, firms establish a target capital structure which it considers is most auspicious (Myers, 2001)
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