# Capital structure and Leverage

**Topics:**Corporate finance, Regression analysis, Debt

**Pages:**24 (5686 words)

**Published:**September 16, 2014

Influence of Capital Structure on Leverage of Cement Sector in Pakistan

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ACKNOWLEDGEMENT

First of all we would like to thank Allah Almighty for granting us the capability and courage to work on this report with my best efforts, and for the patience and perseverance endowed by Him. We would also like to thank Mr. H. JAMAL ZUBAIRI for giving us the chance to work on this report and for his guidance, advice and examples during regular sessions which made this report possible. We would also like to extend our gratitude to the senior students who gave guidance and helped us in this report. We genuinely hope that this report meets the designated standards and you have a pleasant time going through it. Thank you.

Abstract

This paper attempts to determine the capital structure of firms in the cement industry of Pakistan. The study finds that a specific industry’s capital structure exhibits unique attributes which are usually not apparent in the combined analysis of many sectors. The study took 5 firms in the cement sector, listed at the Karachi Stock Exchange for the period 1997 to date and analyzed the data by using pooled regression in a panel data analysis. Following the model developed, it has chosen six independent variables i.e. firm size (measured by natural log of sales), tangibility of assets, profitability, growth, quick ratio and non-debt tax-shield and further analyzed their effects on leverage. The results, except for firm size, were found to be highly significant.

Introduction

The firm can choose a mix of financing options to finance its assets so that its overall value can be maximized and this is known as the capital structure of the firm. The market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends. A firm can choose between three methods of financing: issuing shares, borrowing or spending profits (as opposed to dispersing them to shareholders as dividends). The theorem gets much more complicated, but the basic idea is that under certain assumptions, it makes no difference whether a firm finances itself with debt or equity. Although this theory is based on many unrealistic assumptions, it provides the basic theoretical background for further research. After MM a lot of research has been done on optimal capital structure and determinants of capital structure. During this period, among others, three main theories emerged which explain the behavior of the firm in choosing its capital structure. These are Static Tradeoff Theory, Pecking Order Theory and the Signaling Theory. This study focuses on firms of the cement industry of Pakistan and the purpose is two fold. One is to see whether the determinants identified provide an explanation for the choice of capital structure of firms in the Pakistani cement sector. Second, we attempt and to see whether each industry exhibits some unique attributes which are not apparent in the combined analysis of firms from different industries. Also, we have chosen the cement industry because it is a capital-intensive industry and requires a much bigger commitment of funds to setup a new business and to expand its capacity further. The remainder of this paper is divided into sections. Section 1 presents the theoretical basis for the analysis presented in this paper. Section 2 then provides a detailed description of the methodology, operational definitions of the variables and model used. Section 3 then details the results of this analysis, comparing the results with the past findings. Finally, section 4 summarizes and concludes.

THEORETICAL FRAMEWORK:

Static Trade off Theory

Myers (1984) divides the contemporary thinking on capital structure into two theoretical currents. The first one is the Static Tradeoff Theory (STT), which explains that a firm follows...

Bibliography: Shah, Atta, and Hijazi S., 2005, “The Determinants of Capital Structure in Pakistani Listed Non-Financial Firms”, presented at 20th AGM & Conference of Pak Society of Development Economics (Jan. 11, 2005).

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