Research Project

Determinants of capital structure: a study of cement sector in

Pakistan

Lahore school of accountancy & finance

To be submitted to : Sir Amir Iqbal

Submitted by: Sher Mutamir MS ( A&F) Muhammad Khurram MS ( A&F)

The decisions relating to the capital structure have been one of the most important decisions that has to be taken by the financial managers in any organization.

This study investigates the effect of profitability, tangibility, size and liquidity on capital structure decisions of the listed companies in Karachi stock exchange of cement sector in Pakistan.

This research study provides the information that would help the management of cement industry to make better decisions related to the capital structure.

Abstract

The main purpose of this research study is to examine the determinants of the capital structure of the five selected cement companies listed in Karachi stock exchange (K.S.E),for the period of 10 years, from 2004 to 2013.

The capital structure is one of the most important part of any organization. It’s the financial engine of the company. It has a direct impact on the company as a whole

Capital structure is basically a combination of a company’s long term debt, specific short-term debt, and equity.

Introduction

capital structure is affected by many external and internal factors, such as tax, political, social, management, and macro economical indicators.

Cont….

In present, the problem faced by the cement sector of Pakistan is making the right decision while considering the capital structure.

Many cement companies in Pakistan are not following up an optimal capital structure. Their leverage is not optimal.

Low firm value of different cement companies.

Problem statement

To what extent profitability, tangibility, size and liquidity affect the capital structure decisions of the cement sector of Pakistan?

Research Question

The study analyzes the effect of profitability, tangibility, size and liquidity of capital structure decisions on cement sector of Pakistan.

Research Objective

The study has its significant for the financial experts mainly related to the cement sector. By studying this research study, they can make better decisions related to the capital structure, which will alternatively increase their firm’s value.

The students and researcher’s will also find this study helpful for carrying on their research.

Significance of the study

  There have been many theories related to the capital structure decisions, depending upon the sector and time scale. Most of the studies find that the capital structure does have a significant effect on the organization as a whole.

One of the most famous study has been of Modigliani and Miller, according to their study Tax benefits on debt financing has been the most important determinant of capital structure, while ignoring the dividend. (Modigliani and Miller, 1963).

Literature Review

There are strong evidences of sizeable and costs of distress in relation to changes in leverage and the associated cost and the benefits of the leverage of the firm (Sibilkov2009).

There are results that debt financing has been changing as per the market trends of debt issues (Doukas, Guo & Zhou 2011).

Bauer and Bubak (2003) also test for the existence of optimal capital structure and for relevance of signaling theory in the case of Czech listed firms.

We delimit this study to cement sector of Pakistan listed in K.S.E .

Delimitation

  This study make’s a set of hypothesis. H1: There is a significant positive relation between leverage and firm size of cement industry of Pakistan.  H2: There is a significant negative relationship between leverage and firm size of cement industry of Pakistan.  H3: There is a significant positive relationship between leverage and profitability of cement industry of Pakistan. H4: There is a significant negative relationship between leverage and profitability of cement industry of Pakistan.

Hypothesis

H5: There is a significant positive relation relationship between leverage and tangibility of cement industry of Pakistan.

  H6: There is a significant negative relationship between leverage and tangibility of cement industry of Pakistan.

  H7: There is a significant positive relationship between leverage and liquidity of cement industry of Pakistan.

  H8: There is a significant negative relationship between leverage and liquidity of cement industry of Pakistan

In this research investigation of relationship between the different variables of capital structure, such as profitability, tangibility, size and liquidity are studied of the cement sector made for a period of 10 years, from 2004 to 2013, of 5 cement companies listed in KSE.

The variables and firms included in this research study will also be discussed; the distribution patterns of data and the other statistical techniques in investigating the relationship between these variables will be studied.

Research Methodology

In Karachi stock exchange there are total 17 cement companies listed. Our population size is 17.

Population

Out of 17 listed companies of cement sector, we selected a sample of 5 companies. In the study our sample size is 5.

Sample

The research will carry the SPSS software to conduct research. The statistical tools which will be used are Pearson correlation and linear regression.

Instrumentation

The data collected for this research was taken from annual reports of the selected cement companies. The data has been taken from year 2005 to 2013.

Data Collection

Independent variables Dependent variable

 

Theoretical framework

Firms size of cement firms

Profitability of cement firms

Tangibility of cement firms

Leverage of cement firms

Liquidity of cement firms

Dependent Variable Leverage (Debt/equity ratio): A measure of a company's financial leverage, calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets.

Variables

Independent Variables Firm size (log of sales): Firm size represents the overall size of the firm. There are various methods to calculate the size of firm. We have chosen Net sales, as a medium of firm size, by according to the previous research study by Patrick Bauer Empirical Evidence from the Czech Republic (2004). Here Log of net sales has been taken.

Profitability (ROTA): The independent variable profitability is calculated using the financial ratio, Return of total assets (ROTA). Its calculated by EBIT divided by Net assets. The ratio is used as an indicator of how effectively a company is using its assets to generate earnings.

Liquidity (current ratio ): A liquidity ratio that measures a company's ability to pay short-term obligations. It is calculated by current assets divided by current liabilities.

Tangibility ( Fixed assets to total net assets)

The variable tangibility is measured by the financial ratio, fixed asset to total asset ratio. A measure of the extent to which fixed assets are financed with respect to total assets. A higher return indicates that the fixed assets are used efficiently with respect to total assets.

LVRG it= β0 + β1 (Fms it) + β2 ( PB it) + β3 (TNG it) + β4 (LQTY it) + e

Model Specification

Data Analysis

The correlation shows relationship between the variables. We can see that the firm size is positive correlated with leverage, 1 % increase in leverage will tend to increase .626% of firm size.

On the other hand, there is a significant negative correlation between leverage and profitability. If there is 1 % increase in leverage it will decrease -1.56 % of profitability.

Moreover tangibility is also negatively correlated with leverage. An increase of 1 in leverage affects the tangibility to move at a significant negative direction at 1.76.Similarly liquidity is also negative correlated with leverage, as an increase of 1 % in leverage will tend to decline liquidity negatively at .290.

It’s clear that only firm size is positively correlated with leverage.

As for the previous research studies on capital structure decision, this phenomenon of capital structure is the same for mainly the countries belonging to the developing world.

Explanation:

The value of F-statistic is significant thus it shows reliability of the model. Adjusted R2 shows that the independent variables explain the 0.489 of the leverage. R2 shows

Overall model perfectness, it explains that almost .53% of the variation in the leverage is due to changes in

the explanatory variables. The remaining 47% variation is owing to the unknown variables.

Durbin-Watson stat is .722, that shows the positive correlation and predicts that there is no multi collinearly and auto correlation in the model due to errors.

Explanation The results are based upon the regression model. The information to pay

attention to here is the probability shown as “Sig.” in the table. If this probability is below 0.05(alpha level), we conclude that the significance level is large enough so that we can reject the hypothesis that none of the explanatory variables help explain variation in Y.

As for the firm size, its unstandardized co efficient B is 1.46, which indicates that if there is an increase of 1 unit of dependent variable the firm size will move to the positive direction at 1.146.

Moroever its level of significance is less than 0.05 alpha level, so its significant to the dependent variable.

Similarly the liquidity’s coeffient is negative -1.084, this means that 1 unit increase in dependent variable will cause liquidity to decline by -1.084. While its level of significance is less than the alpha level .001 < 0.05, it indicates its significant.

On the other hand, Profitability is positive at 0.35 while tangibility is negative at -0.16, but both of these variables have significance level greater than alpha level , .678 > 0.05 and .950 > .05. This shows that both of the variables are not significance.

On the basis of research investigation, we accept the following hypothesis:

   H1: There is a significant positive relation between leverage and firm size of cement industry of Pakistan.

  H8: There is a significant negative relationship between leverage and liquidity of cement industry of Pakistan.

 

Hypothesis Summary

The research study taken had significant results, and it is thereby concluded that the way in which capital structure is managed it has significant impact on the overall organization, specifically the cement sector.

There is a significant positive relation between leverage and firm size, we accept H1. On the other hand, liquidity has a significant negative relation with the leverage. Moreover tangibility and profitability are insignificant.

Conclusion

  Modigliani, Merton H. Miller (1963), Corporate Income Taxes and the Cost of Capital: A Correction, The American Economic Review.

Myers & majluf (1984) Corporate Financing and investment decision when firms have information that investors do not have.

  Czech Journal of Economics and Finance, 54, 2004, ã. 1-2

Determinants of Capital Structure Empirical Evidence from the Czech Republic Patrik BAUER (2004).

Bibliography

Williamson (1988), Asset liquidity and capital structure

Mahvish Sabir, Qaisar Ali (2012) Determinants of capital structure: A study of oil and gas sector of Pakistan

Amarjit Gill, Nahum Bigger, Neil Mathur (2011), The Effect of Capital Structure on Profitability: Evidence

from the United States, International Journal of Management Vol. 28 No. 4 Part 1Approach, Journal of Finance, 47, 1343-1366

Thanks