Determinants of Capital Structure: An Empirical Study of Selected Indian Manufacturing Companies

Abstract

(1) Research Problem: To re-examine the issue of non-linearity in capital structure choices of firms through the application of the hitherto un-applied technique of ‘panel data unconditional quantile regression’ with a view to indirectly ascertain the applicability of Trade-off Theory, Agency Cost theory and Pecking Order Theory through the analysis of the predictions of these theories on the firm-specific determinants of capital structure of Indian manufacturing firms.

[ Porter (2015, p. 343) reiterates “ the growing consensus in the literature is that many researchers have inadvertently misused conditional quantile regression for many years, by interpreting the results as if they came from an unconditional quantile regression model. In other words, they have interpreted their coefficients as if they were the effect on the quantile of y, rather than quantiles of y defined within groups based on their set of covariates”. ]

(2) Research Objectives: (A) To choose the appropriate panel data model from three mutually exclusive panel data models ( Pooled Ordinary Least Squares Model, Fixed Effects Model and Random Effects Model ) for analysing the impact of firm-specific determinants of capital structure on the mean of the variable measuring capital structure ( say, “V”) in respect of Indian manufacturing companies listed on the Bombay Stock Exchange (BSE), with a view to indirectly assess the applicability of Trade-Off Theory (TOT), Agency Cost Theory (ACT) and Pecking Order Theory (POT) for an average company with mean (average) level of leverage. (B) To apply ‘unconditional quantile regression technique’ on the chosen panel data model for analysing the differential impact ( that is, non-linear behaviour) of the firm-specific determinants of capital structure over the entire unconditional distribution of the variable “V” in respect of Indian manufacturing companies listed on the Bombay Stock Exchange ( BSE ), with a view to assess indirectly the applicability of Trade-Offff Theory (TOT) , Agency Cost Theory (ACT) and Pecking Order Theory (POT) at different quantiles of the unconditional distribution of V, that is, for representative companies having varying (for example, ‘very low’, ‘low’, ‘moderate’, ‘high’ or ‘very high’) levels of leverage.

[A representative company at a particular quantile of leverage represents a company with the corresponding level of leverage, for instance, a representative company at the 50th quantile represents a company with median (or moderate) level of leverage, or a representative company at the 10th quantile may be said to represent a company with very low level of leverage.]

( 3 ) Formulation of Variables :-
( a ) Dependent Variable : Total Debt to Capital Ratio in terms of market value and book value { that is Market Leverage Ratio ( MLEV ) and Book Leverage Ratio ( BLEV ) } ;
( b ) Explanatory Variables : Firm-specific determinants of capital structure, represented by : ( i ) firm size ( SIZE ) , ( ii ) tangibility ( TANG ) , ( iii ) non-debt tax shield ( NDTS ) , ( iv ) profitability ( PROF ) , ( v ) growth opportunities ( GROW ) , ( vi ) bankruptcy risk ( distance from bankruptcy ) { DFB }, and ( vii ) liquidity ( LIQ ) ;
after controlling for the unobserved industry effects and the unobserved macro-economic and institutional factors through the inclusion of Industry Dummy Variables and Time Dummy Variables .

( 4 ) Sample : The final sample include a balanced panel data of 601 Indian manufacturing companies listed on the Bombay Stock Exchange ( BSE ) , comprising all the eleven broad industrial divisions ( as classified in the Prowess IQ database ) , over a period of 18 years from 1997-98 to 2014-15.

( 5 ) Econometric Models : The study seeks to apply Unconditional Quantile Regression ( UQR ) methodology to the sample data. However , as the basic structure of the data for this study is that of a panel data-type, the baseline econometric model will be a Panel Data -Least Squares ( LS ) regression model which will be chosen from the Pooled Ordinary LS model, Fixed Effects model and Random Effects model after performing the appropriate tests. Unconditional Quantile Regression , based on Recentered Influence Function ( RIF ) will then be applied to the chosen panel data model.

( 6 ) Research Hypotheses :
The generalized Null Hypotheses ( H0 s ) to be tested in this study are stated as follows :
( A ) Panel Data Least Squares ( LS ) Regression :-
H0 : There is no statistically significant impact of firm - specific determinant ‘X’, industry division dummy variables ( IND2 , IND3 ,…, IND11 ) , and time period dummy variables ( D2 , D3, …, D18 ) on market leverage ratio ( MLEV ) or book leverage ratio ( BLEV ) in respect of the average Indian manufacturing company { that is , company with mean ( average ) level of leverage } listed on the Bombay Stock Exchange , where X = SIZE , TANG , NDTS, PROF , GROW , DFB and LIQ , and statistical significance refers to 1% , 5% and 10% levels of significance.

( B ) Panel Data Unconditional Quantile Regression [ or Panel Data Recentered Influence Function - Least Squares ( RIF- LS ) Regression ] :-
H0 : There is no statistically significant impact of firm - specific determinant ‘X’, industry division dummy variables ( IND2 , IND3 ,…, IND11 ), and time period dummy variables ( D2 , D3, …, D18 ) on market leverage ratio ( MLEV ) or book leverage ratio ( BLEV ) in respect of the representative Indian manufacturing company listed on the Bombay Stock Exchange at the th unconditional quantile of MLEV and BLEV { that is , company with th quantile level of leverage } , where X = SIZE , TANG , NDTS PROF , GROW , DFB and LIQ ;  = 10 , 25 , 40 , 50 , 60 , 75 and 90 ; and statistical significance refers to 1% , 5% and 10% levels of significance.

( 7 ) Findings of the Study :
( A ) Fixed Effects Regression : Firm size , tangibility , non-debt tax shield , profitability , growth opportunities , bankruptcy risk and liquidity appear to be the significant determinants of capital structure and no particular theory of capital structure but a mix of TOT , ACT and POT may be said to be applicable for the average manufacturing firm ( with mean level of leverage ) listed on the Bombay Stock Exchange ( BSE ).

( B ) Fixed Effects Unconditional Quantile Regression :
The differential impacts of the explanatory variables on MLEV and BLEV over the unconditional quantiles of MLEV and BLEV present a holistic view of the relationships between the firm-specific determinants of capital structure and the leverage ratio and may be said to affirm the existence of non-linearity in the behaviour of such determinants in respect of Indian manufacturing companies listed on the Bombay Stock Exchange ( BSE ) . Moreover, the applicability of Trade - Off Theory , Agency Cost Theory and Pecking Order Theory at various unconditional quantiles of MLEV and BLEV suggest that capital structure decisions of Indian manufacturing corporate firms listed on the BSE are not determined by any one particular theory of capital structure but by a mix of various theories over the entire unconditional distribution of the leverage ratio .

Keywords: Capital Structure, Panel Data, Unconditional Quantile Regression, Non-linearity

JEL Classification: G32, C21, C23