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The Determinant of Capital Structure. Evidence from Pakistani Cement Industry

Wissenschaftlicher Aufsatz 2015 17 Seiten

BWL - Investition und Finanzierung




1. Introduction

2. Literature Review

3. Discussion on Variables and hypothesis
3.1 Financial Leverage
3.2 Profitability
3.4 Growth
3.5 Size
3.6 Liquidity
3.7 Tax

4. Methodology
4.1 Data Source
4.2 Sample
4.3 Variables and Measurement
4.4 Data Analysis Method

5. Empirical Analysis
5.1 Descriptive analysis
5.2 Correlation Matrix

6. Conclusion



This paper is an attempt to determine the capital structure of listed firms of cement industry in Pakistan stock exchange (KSE). This study covers the 17 cement industry as sample that listed in Karachi Stock Exchange (KSE) and the period selected for analysis from 2009 to 2013 and analyzed the data by using regression analysis. Sources of study, the data obtained from the annual financial report of official website of selected cement industries firms and from the State Bank of Pakistan (SBP) published reports. The main objectives of this empirical study to forecast the relationship of dependent variable (financial leverage) with independent variables (size, tangibility, profitability, liquidity, tax rate and growth rate). The study showed a positive and significant association of firm size, tangibility and tax rate with financial leverage of the firm but in contrast to this, profitability, liquidity and growth rate showed a negative relationship with financial leverage.

Keywords: capital structure, cement industry, leverage, size, profitability, liquidity, tax rate, growth rate, tangibility, KSE.

1. Introduction

Finance is the life blood of the business operation so Financial decisions have a great importance in the business operation. Capital Structure can be well-defined as in term of Financial Management that how Business (company) generates its Financial needs (inside and outside) to grow its value and face the competition. Capital Structure is that Finance, that is the combination of the two things own Capital (Equity) and Debt (outside). If we look at Equity, Equity is also a combination of two main things. Internal Equity and other one is the External Equity, Internal Equity Include Common stock, paid up capital, Retained Earnings, and Treasury Stock (Pulled Back). External Equity can be generate to full fill the Business (Company) obligation in the form to issue Share and sold to Investors who willing to Invest their money. Debt is the other Capital Structure element come from creditor and corporate issuance. Debt is also categories in two form Long term Debt and short term Debt. Firstly long term Debt, Major portion of long term Debt come from bounds issued by the Business (company) and sold to the investor in the Capital market, Debenture and long term note payable. Secondly Short term Debt can be generated in form short term bank loan and short term note payable.

Capital Structure Decision must be most authentic and all the capital structure decision must be in proper way for implementation, inaccurate and unstable decision related to capital structure may create the financial distress and bankruptcy. To increase and stable value of the firm, management of that firm must be taken and set Capital Structure decision in appropriate way. It is depend upon the management that what is the financial leverage method is selected to achieve an optimum capital structure. Pervious Study indicates that there is no specific rule for the Capital Structure that helps the financial manager to adopt an optimum debt level. This paper tries to give the answer related to Capital Structure decision of Pakistan Cement Industries firm Listed in KSE. Number of studies was conducted in cement and other listed manufacturing firm in KSE. Most studies were conducted on the textile sector. This study belongs to observe capital structure decision in Cement Industry in Pakistan. Pakistan Credit Rating Agency Limited (Feb 2014), Pakistan is ranked among top 10 Cement Exporting Countries. FY 2013 Pakistan Cement Industry production stood 33mln (3% increase as previous year). Cement sector of the Pakistan contribute 1.2% of the global Cement production. This present study tries to evaluate the specific Capital Structure decision in cement industry of the Pakistan. Another purpose of study to give remarkable results that helps to managers, researchers, investor and financial analyst to take safe and sound decision in this changing world economy.

Objectivity of the Study

- Conclude firm specific factors effect on the Capital Structure decision (Leverage) in Cement Industry of Pakistan.
- Find out the most important factors that relate to take decision of Capital Structure in Cement Industry in Pakistan.

2. Literature Review

Dr. Aurangzeb & Anwar ul Haq (2012) studied the capital structure decision in textile industry of Pakistan, Data period 2004 to 2009.Multiple regression method was used to analyze the relationship between depend variable (leverage) and independent variable (firm size, profitability, tangibility of the assets and sale growth). The result conclude that leverage is positively relate with firm size, tangibility of the assets and profitability, the firm easily acquire the debt for operation that have higher profitability and firm size is also greater and tangible assets of the firm in high proportion. Sale growth shows negative association with Leverage. Studysuggested strategy maker focus on above relationship between depended and independent to sort decision regarding capital structure.

Zeeshan Fareed et al,(2014) investigates the capital structure decision in cement industry in Pakistan using 19 firms listed in Karachi stock exchange as a sample data period 2001 to 2012. Least square method and correlation method was used to investigates the relationship between depend variable (leverage) and independent variable (tangibility, firm size, firm growth and profitability). The result suggested that the firm have greater size and growth easily fiancé its project through debt financing as compared to equity financing and profitability shows the negative relationship with leverage mean that profitability not acquire the debt financing usually use own resource (internal finance). Tangibility shows positive relationship with leverage but not significant, show those firms acquire more debt.

Richard Kofi Akotoand Dadson Awunyo-Vitor, (2013), was conducted their study to find out the determinants of capital structure of listed manufacturing business in Ghana. For this purpose seven listed manufacturing firms was selected and data was taken from 2000 to 2009. Study includes dependent variable as debt ratio and independent variables as size, profitability, growth opportunities and fixed assets to total assets ratio. To analyze the data, Panel regression method was used to find results, in Ghana long term financing is mostly used instead of short term financing, total debt and assets structure found a positive and significant relationship among them but there was positive and insignificant relationship found among total debt and liquidity and they was also concluded that size and profitability was positivelysignificant with total debts. It was recommended by them that the government of Ghana should focus to develop the capital market of country for long term loan to business.

Muhammad Zuhaib et al, (2013), started the research to know the relationship among dependent variable as leverage and independent variables as performance, tangibility, working capital, and size. For this objective the i6 cement firms which listed at KSE was taken as sample of study, from the period 2009 to 2013, trade off theory and packing order theory was followed by them to to find out the relationships. Panel data technique was applied to analyze. After analysis they concluded that size of the firm and leverage negatively related, performance was also negatively related to leverage but it was found a positive relation among tangibility and leverage.

Sayilgan et al (2007) conducted a study with a purpose to show the impact of factors that determine “Capital Structuring” in Turkish Manufacturing Firms. Work was done on 123 Turkish firms listed at (‘’TSE”) by using the PANEL DATA MODEL. Analysis of independent variables showed very significant results on Corporate Capital Structuring in Turkey. They showed that the SIZE and the Growth Opportunity of firm’s assets impact positively, the trade-off model; bigger firms are estimated to have a greater debt capacity and are able to be more highly geared. Growth opportunities are capital assets that add value to a firm. And all the other factors impact negatively, inverse relationship between non-debt tax shields and debt, tangible assets are likely to have an impact on the borrowing decisions of firms of TURKEY Manufacturing listed at Istanbul Stock Exchange.

Bambang Sudiyantno and Septavia Mustika Sari (2013) worked on a sample of 114 Indonesian manufacturing firms listed at Indonesian stock exchange (ISE) in order to analyze the impact of specific determinants on the debt policy of firms. Sources of funding may come from within the company or outside the company. The proportion between the amount of funds from within and outside is so-called capital structure in financial management. Using the purposive sampling Methodology the independent variables were analyzed. “Multiple Regression Equation MODEL” was used. It showed that non-debt tax shield and profitability had negatively significant over debt policy but tax didn’t count more as higher the profitability the lower will be the use of debt .On the other hand tangibility and Firm’s Size have positive impact on debt –policy of Indonesian firms as higher the assets and size of the firm the higher will be the use of debt.

Talat afza and Amer Hussain (2011) conducted a study to examine the specific attributes that determine capital structuring on three sectors (Automobile, Engineering and Cable) in Pakistan. For this purpose “Pooled data Regression Model” was being used under Regression and Correlation Methodology .Results showed that two main theories effect the capital structuring of firms either positively or negatively. The results are consistent with liquidity and non-debt tax shield concluding that the firms with great liquidity and large depreciation use retained earnings to finance and then use equity finance if further funding is required .On the other hand business with no good asset’s investment should use debt-financing as last option. First is preferred by Automobile firms and second option is usually practiced by other two .All these results supported the packing order theory.

Karabacak and Sayilan (2006) demonstrated that the impact of firm specific characteristics on the corporate capital structure decisions of Turkish firms by using dynamic panel data methodology on 123 Turkish manufacturing firms listed on the Istanbul Stock Exchange (ISE) using data period from 1993 to 2002. This study indicates that the empirical evidence on all the independent variables is significantly determinants for the capital structure of Turkish firms. Empirical evidence on the capital structure decisions of Turkish firms reveals that profitability, growth opportunities in plant, property and equipment, non-debt tax and tangibility have an inverse relation with debt level, however, size and growth opportunity in total assets reveal a positive association with a leverage ratio.

Cortez and Susanto (2012) illustrated that the determinants of corporate capital structure evidence from the Japanese manufacturing companies by using panel data and multiple regression to analyze the relationship between the dependent variables for 10 years (2001 to 2010). In this study we find that size, growth in total assets and growth in fixed assets are not significant. Variable of tangibility, profitability, non-debt tax shield are statistically significant. Profitability and non-debt tax have negative relate with debt level while tangibility has a positive relation with debt level.

3. Discussion on Variables and hypothesis

Dependent variables

3.1 Financial Leverage

Several studies used several methods to find out the leverage (Rajan and Zingales 1995 and Titman and Wessels 1988,). Some studies market value and some use book value of debt and assets respectively. Former studies measures leverage by dividing (book value of debt by book value of debt plus market value of equity), some studies found out the leverage by dividing (book value of debt by book value of debt plus book value of equity). In this study, use book value to find out the leverage (book of total debt / book value of assets)

Independent Variables

3.2 Profitability

Profitability relationship with leverage can be explained in two opposite point of view. Packing order theory assume the relationship of profitability with leverage is negatively, packing order theory explain that, high profitable firms first use their internal resources(earning) and then goes for external resource. Using more internal finance the profitable firms reduce the level of the leverage.Packing order theory assumes the negative relationship between the profitability and leverage (Myers 1984).

Hypothesis 1: There is negative relationship between profitability and Leverage

3.3 Tangibility

Firms have large volume of fixed assets can easily borrow debt at low interest providing the fixed assets as collateral. Firms with high percentage of the fixed assets easily get the debt as compared to those firms that have low percentage of the fixed assets.

We measure tangibility ratio by dividing the fixed with total assets. In tangibility of assets ratio formula we use gross fixed assets rather than net value in nominator, net value is calculated by minus depreciate. We not use net fixed assets in two major ways (i) different firm use different method of depreciation, (ii) firms can be pledge its assets as market value even it has fully depreciated. So we use total gross fixed to calculate the tangibility the assets ratios. Chakraborty (2010), Titman and Wessel (1988) and Feri and Jones (1979) empirically proved that tangible assets is positively relate with the leverage. Study conducted in Pakistan using Pakistan firm’s data as by Walliulah and Nishat (2008), Rafiq et al (2008), Shah and Khan (2007), Hijazi and Tariq (2006), Shah (2007) and Shah and Hijazi (2004) empirically proved positively relationship between Tangibility of assets and Leverage.

Hypothesis 2: Firms that has high percentage of the assets will have higher leverage ratio

3.4 Growth

According to packing order theory hypothesis, there is positive relationship between growth and leverage, firm’s first use their internally generated funds to full fill the financial needs. Internally generated funds insufficient to full fill the requirementsof different project for growth, firms usually focus on the external funds (debt) in case of insufficient internal funds, external funds increase the level of leverage, its assumption of the packing order theory higher leverage higher will be the growth. Drobez and Fix (2003) and Marsh (1982), empirically proved, firm high growth opportunity will have more access to leverage.

Hypothesis 3: Firms with higher growth rate will have low leverage

3.5 Size

Packing order theory assume that, firm size is negative relate with leverage. Usually large size firms disclosed more information to externalas related to small size firms. Large firms face problems to get the external finance due to less asymmetry information (one party have large information and other is low), due to this large firms prefer to issue the equity rather to get debt.

Hypothesis 4: Firm size is positively relate with leverage

3.6 Liquidity

Trade of Theory (TOT) assume that most liquid firms use more external finance, due to their pay back ability is high as compared to low liquid firms, and usually more debt give the benefits to firms against low tax deduction, due to payment of interest. Ahmed et al (2011) empirically proved negative relationship between liquidity and leverage.

Hypothesis 5: Liquidity Negative relate with leverage



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determinant capital structure evidence pakistani cement industry




Titel: The Determinant of Capital Structure. Evidence from Pakistani Cement Industry