The Determinants of Capital Structure: Evidence from Indonesia

Abstract

Purpose: This paper aims to examine the determinants of capital structure. Theoretical framework: There is an essential gap in modern finance theory on the issue of corporate debt policy, where contemporary theory cannot explain the company’s choice of capital structure composition (Myers, 1977). Myers (1984) claimed that we have a limited understanding of capital structure. We have no idea how corporations determine whether debt, equity, or hybrid securities to issue. Furthermore, Thies & Klock (1992) claimed that capital structure is one of the most divisive topics in finance. Design/methodology/approach: A hundred and three companies were observed 618 times, applying multiple regression to find out the determinants of capital structure in manufacturing companies in Indonesia from 2011 to 2017. Findings: This study disclosed that five capital structure determinants (firm size, profitability, debt tax shield, growth, and liquidity) significantly affected capital structure. Firm size, debt tax shield, and growth positively correlated with capital structure, while profitability and liquidity negatively correlated with capital structure. Firm size was inequivalent with expectations, indicating that managers take advantage of firm size to increase their debt. Likewise, growth was not analogous with expectations, indicating that the company was taking advantage of its growth opportunities to increase debt. On the other hand, profitability, debt tax shield, and liquidity had the desired direction of the relationship. Furthermore, the other two variables, firm age and business risk, had no significant effect on capital structure, alluding that they were improper variables to explain variations in the sample companies’ capital structure. Research, Practical & Social implications: The study focused on manufacturing companies listed on the Indonesia Stock Exchange, consisting of various industrial sectors and sub-sectors or heterogeneous. Thus, recruiting homogenous samples is recommended to generalize Indonesians’ sub-sector companies. In addition, the findings suggested that the management needed to pay attention to firm size, profitability, debt tax shield, growth, and liquidity to determine the composition of its capital structure. Originality/value: Manufacturing companies listed on the Indonesia Stock Exchange were recruited as the sample of the study. However, the controversies and inconsistencies of the results are still debatable.