Determinants of capitalstructure

1. 1

2. Abdullah Shahzad Roll. No. 203 BBA 7 th (M) GC U niversity Fsd.

3. Determinants of Capital Structure: Evidence From China Samuel G.H Huang And frank M. Song

4. Introduction (These Slides concepts are According to the Article)

5. Capital Structure The question of capital structure has received a lot of attention from economists for quite sometime. The publication by Modigliani and Miller (1958) is believed to have triggered the beginning of corporate finance as a discipline. Jensen and Meckling (1976), Miller (1977), Myers (1984), Jensen (1986), Titman and Wessels (1988), Harris and Raviv (1991), among others .

6. Capital Structure Financing overall operations and growth  using different sources of funds “Proportion of debt instruments and preferred and common stock on a company’s balance sheet”

7. Abstract This paper employs a new database It contains the market and accounting data from more than 1000 Chinese listed companies up to the year 2000 To document the characteristics of these firms in terms of capital structure. As in other countries: leverage in Chinese firms increases with firm size, non-debt tax shields and fixed assets. Decreases with profitability and correlates with industries

8. Hypothesis: Relationship Between Financial Leverage and Determinants Of Capital Structure

9. Capital Structure Theories: Trade off Pecking order Agency cost Leverage: Ratio of total loans and net total assets

10. Trade off Theory Proportion of debt and equity finance to balance cost and benefits Corporate and personal taxes Bankruptcy cost debt  tax liability  after tax cash flow debt  Risk of default  cost of debt Tradeoff - Optimum capital structure Max value of firm

11. Trade off Theory

12. Pecking Theory Inverse relationship between profitability and debt ratios Follows Law of Least Effort Firms prefer internal financing Adopt target dividend payout ratios External Financing Debt like convertible bonds Equity Issue costs Internal funds : Least Debt : Low Equity: Highest

13. Factors affecting leverage Profitability Size of the firm Non debt tax shield Growth Opportunities Tangibility Dividend Risk Intangibility

14. Profitability Trade off theory Positive correlation Increased capacity to bear interest costs Bankruptcy cost of large firm is less More the profit, greater the need for tax shield Pecking-order theory Negative correlation Greater profits  greater retained earnings  internal funding  reduced leverage

15. Size of the firm Trade off theory Size of firm & bankruptcy cost – Inverse relation Positive correlation – size and leverage Pecking order theory Less information asymmetry for large firm Negative correlation

16. Non-debt tax shield If there are other non debt options available for tax shields  low leverage Negative correlation

17. Growth Opportunities Trade off theory Strong incentive to avoid under investment Equity can be issued at higher market price Negative correlation Pecking order Growing firm will not have internal reserves in abundance Positive correlation Growth in sales

18. Tangibility Trade off Theory Proportion of debt increases with increased fixed assets Collateralization – Improved guarantee of repayment Positive correlation Pecking order Firms with few tangible assets are more sensitive to informational asymmetries Negative correlation Tangibility : Ratio of Book value of fixed assets and Total assets of the firm

19. Risk Standard deviation of Returns the larger the variations you can expect to see in returns. Increased information asymmetry Shareholders reluctant to invest Resort to debt Positive Correlation

20. Dividend Dividend paid / BV of equity Less internal funds Better potential to repay debt External Funding – Debt Positive correlation

21. Intangibility Ratio: Intangible assets and total assets Increased information asymmetry Shareholders reluctant to invest Resort to debt Positive correlation

22. Literature Review In 1958, First Scientific Research by Modigliani and Miller (MM) proved irrelevance of capital structure on firms value assuming no taxes. In 1963, MM proved tax shield benefit of leverage leading to increase in value of firm . In 1977, Scot proposed Tradeoff theory. In 1984, Myers and Majluf proposed Pecking order theory

23. Literature Review In 1995, Rajan & Zingles found positive correlation of tangibility and sales with leverage and negative correlation of market to book ratio and profitability. In 2003, Drobetz & Fix took six determinants-tangibility, size, market to book ratio, profitability, volatility, uniqueness of products and non-debt tax shield. They found tangibility and size positively correlated and profitability and growth negatively correlated with leverage .

24. Literature Review In 2004, Shah & Hijazi studied non-financial firms listed on KSE and took tangibility, size, profitability and growth as determinants. They found positive impact of tangibility and size and negative impact of profitability and growth In 2007, Shah & Khan studied the no-financial firms listed on KSE and took six variables-size, profitability, volatility, growth, tangibility and non debt tax shield. They found the only one significant result, negative relationship between profitability and leverage

25. Research Design Sample: For 1000 Chinese Listed Companies Population : China Stock Exchange Time: Up To The Year 2000.

26. Research Design Data Source: School Of Economics And Finance Center For China Financial Research (CCFR). The University Of Hong Kong Huang’s Email: [email protected] Tel: [phone] Song’s Email: [email protected] Tel: [phone] Model: Regression Model Tell What is Regression Model

27. Technique: Qualitative Data: Secondary Data (Tell What is Qualitative Data and Secondary Data)

28. Findings Variable Correlation with Leverage Profitability Negative Volatility in Return Positive Size of Firm Positive Tangibility Positive Growth Positive Non Debt Tax Shield Negative Intangibility Positive Dividend Positive

29. Conclusion Companies with greater profit use internal reserves or raise equity for funding Investors are less interested for investing in companies with high return volatility Large firms are favored by creditors due to their less bankruptcy cost Firms with huge fixed assets can attract more lending due to collaterals

30. Conclusion Cont… Companies with high growth perspective find it easy to raise fund through borrowings Companies with other modes of tax exemption/benefit are less interested in tax benefit on interest paid on debt Investors are highly sensitive to information asymmetry High dividend paying firms show more potential to repay debt

31. THANK YOU