Firm-specific and Macroeconomic Determinants of Capital Structure: Evidence from Pharmaceutical Industry in Bangladesh

K.M Zahidul Islam,Meskat Ibne Sharif,Md Nurul Hoque

doi:10.35649/kubr.2016.11.12.4

K.M Zahidul Islam, Meskat Ibne Sharif + Show 1 more

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https://doi.org/10.35649/kubr.2016.11.12.4

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Abstract

Purpose: This study explores the significance of firm-specific and macroeconomic factors to explain variation in leverage using a sample of twenty listed pharmaceutical firms in Dhaka Stock Exchange over a six year period of 2008-2012. Design: In this study, panel data has been used and both firm specific and macroeconomic factors are analyzed as the determinants of leverage for pharmaceuticals firms in Bangladesh. Findings: This study employs leverage measure (book leverage) as dependent variable and ten factors (liquidity, profitability, tangibility, debt coverage, growth rate, firm size, GDP growth, and inflation, interest rate, and stock market development) as determinants of capital structure. Around 51% variation in leverage is explained by selected macroeconomic and firm specific factors, while the remainder is explained by unobserved macroeconomic and firm specific differences. Practical Implication: Estimated results show that GDP growth has significant positive association with the leverage. However, liquidity, profitability, tangibility, sales growth, inflation, interest rates, and stock market development reveal inverse relation with leverage. Finally the results suggest that that both trade-off and pecking order theories can explain financing decisions of listed pharmaceutical firms in Bangladesh.

Highlights

In spite of extensive research over the last four decades, the theory of the determination of optimal capital structure remains one of the most debatable issues in modern corporate finance and Myers’ eighteen years old question “How do firms choose their capital structure?
The present study attempted to lay some groundwork to explore the determinants of capital structure of pharmaceutical firms listed on the Dhaka Stock Exchange (DSEX) over the period 2008 - 2012
The study applied a number of advanced econometric techniques, e.g. error component model estimation, fixed effect model, and panel-corrected standard errors (PCSE) to identify the determinants of capital structure

Summary

Introduction

In spite of extensive research over the last four decades, the theory of the determination of optimal capital structure remains one of the most debatable issues in modern corporate finance and Myers’ eighteen years old question “How do firms choose their capital structure?. Determining optimal capital structure has got special attention since the emergence of capital structure theory formulated by Modigliani and Miller (1958; hereafter MM) They showed that under some restrictive set of assumptions (e.g., no corporate and personnel taxes, no transaction costs, symmetric information, complete contracting, complete markets), in the perfect capital market, capital structure decision is irrelevant to firm value. When these assumptions are relaxed the choice of the proportion between debt and equity becomes meaningful. All these theories emerge because of the divergence in the market structure, operation, size, and nature of the firms worldwide and are not accepted universally

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