The Capital Structure: Is Debt just a Policy or Requerement?

Abstract

1. Introduction The presence of debt started when Luca Pacioli introduced his accounting equation in interpretation that firms are obtaining their assets by using liabilities and equities. After years, debt always show up in most of firm's financial reports and generally attracting the investors in capital market. The existence of debt inflicting some questions in context of capital structure, such as is debt a requirement for most of firms in term to finance their investment activities in objective to achieve the target profit? or is debt just a policy for other intentions?. These issues about capital structure of the firms are still in debate around academicians especially in context of trade off theory and pecking order theory since debt has playing its own role which makes the capital structure still a puzzle (Myers, 1984; Nechaev and Antipina, 2016; Thalassinos et al., 2010; Vovchenko et al., 2017; Fetai, 2015). Myers (2001) proposes two conditional theories of capital structure for explaining why firms obtaining debt, which are trade off and pecking order. According to Myers (2001), in perspective of trade off, firms as tax payers generally shall look for optimum debt in term to get tax shield, while in perspective of pecking order, firms shall avoid debts if their internal fund such as retained earnings sufficient for financing their expenditures or investments (Boldeanu and Tache, 2016). In contrast, the findings by Baker and Wurgler (2002), Klein, O'Brien, and Peters (2002), Hovakimian, Hovakimian, and Tehranian (2004), Alti (2006), Elliott, Kant, and Warr (2008), Thalassinos et al. (2015), Allegret et al. (2016), Duguleana and Duguleana (2016) and Brendea (2012) show that the market timing hypothesis can become an alternative explanation about capital structures of the firms, where the valuations by investors for share prices in capital market shall trigger the effects of pecking order or trade off in flexible. As developing country, the Indonesia has many firms with various debt. Limited to the samples, based on data from Indonesia Stock Exchange (www.idx.co.id) the trends of average total debts to total assets ratio are 52.33% for year of 2011, 48.06% for year of 2012, 49.88% for year of 2013, 48.99% for year of 2014, and 50.25% for year of 2015. The trends show that the average of debt to asset ratios for firms in period of 2011 to 2015 are fluctuate in range of almost or even half by their total assets which means most assets of these firms are financed by debts. The study proceeds the next sections as follows, section 2 reviews the relevant literatures and hypothesis development. Section 3 presents the samples, variable definitions and the regression models. Section 4 presents the result and discuss the findings, and finally section 5 concludes the findings. 2. Literature Review 2.1. Trade off theory and pecking order theory Similar to Myers (2001), Elliott, Kant, and Warr (2008) propose that, the model of capital structure can be viewed in perspectives of two main theories which are trade off theory and pecking order theory. Moreover, Elliott, Kant, and Warr (2008) explain that, in perspective of pecking order theory, the firms shall choose the equities with lower cost of capital which implies that the firms shall finance their investments by use their internal funds then by external funds, while in perspective of static trade off theory, the firms in periodically shall adjust their capital structure until it reach the optimum portion. Sunder and Myers (1999) prove empirically that, the mature firms tend to adopt pecking order model in term to determine their capital structure rather than trade off model. Sunder and Myers (1999) also explain that, although debts shall give tax benefit to firms but the over debts shall make the firms bear the financial distress costs. According to Cheng and Shiu (2007), in view of pecking order theory, the existence of asymmetry information between insiders and outsiders makes firms use their internal fund rather than debts in term for financing the investments, and that why pecking order assumes the firms tend to decrease their debts when they get profit. …