Abstract
To have an ideal mix of debt and equity in a balance sheet of an entity is till to date a very complicated issue for managers as there is no such rule to predict an optimal capital structure. An in-depth understanding is required for the corporate culture, the degree of the development of the capital market and the economy in which the firms operate. This study seeks to investigate the leverage composition of Pakistani corporations through their determinants. Fixed effect regression is used to show the relationship of determinants of capital structure on leverage corporations listed on Karachi Stock Exchange (KSE) for the period of 2006 to 2013. The results suggest that agency cost, growth, age, and size are significantly and negatively associated with the capital structure of Pakistan firms, however, collateral value of asset is significantly but positively associated with the capital structure of the firm. On the other hand, free cash flows, non debt tax shield, profitability, business risk and bankruptcy cost are not significantly associated with leverage composition of the firms and are against the signaling theory and peaking order theory. The key importance of this study is that no prior research was done for determinants like agency cost, free cash flows, bankruptcy cost and age as determinants of capital structure for Pakistani firms among other determinants. Further, this study does not confine to a particular sector rather it covers all companies listed by Karachi Stock Exchange.
Highlights
Capital structure irrelevance theory was introduced by Modigliani and Miller (1958) and since arguments have progressed for the leverage decision of the firm
Even though this theory is based on unrealistic assumptions, there are a number of variables that narrate the value to the firm and often identify as determinants of the capital structure e.g. agency cost, collateral value of asset, growth, free cash flows, and age of the firm, business risk, bankruptcy risk, profitability and non debt tax shield
The key importance of this study is that no prior research was done for determinants like agency cost, collateral value of assets, free cash flows, bankruptcy cost and age as determinants of capital structure for Pakistani firms
Summary
Capital structure irrelevance theory was introduced by Modigliani and Miller (1958) and since arguments have progressed for the leverage decision of the firm. MM theory suggests that the value of the firm is independent of its capital structure under certain assumptions. Even though this theory is based on unrealistic assumptions, there are a number of variables that narrate the value to the firm and often identify as determinants of the capital structure e.g. agency cost, collateral value of asset, growth, free cash flows, and age of the firm, business risk, bankruptcy risk, profitability and non debt tax shield. The capital structure decisions directly influence the market value of the firms and the cost of the firm
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