The Determinants of Capital Structure
Xuefeng Li 1,a
1 School of Economic and Management, Zhengzhou University of Light Industry,
Zhengzhou, Henan, China
a lxf@zzuli.edu
Keywords: Capital structure; panel data; fixed effects model
Abstract. In this paper, we u new samples of Shanghai 180 index of China to investigate the determinants of capital structure. With the panel data of 102 listed companies over the span from 2004 to 2006, we analyze the factors which influence the capital structure of the companies. As in other countries, collateral value of ast, firm size, and reputation have positive and significant effects on leverage, profitability, liquidity, non-debt tax shields have negative and significant effects on leverage. Different from tho in other countries, leverage in Chine firms increas with growth opportunity. We also find that Chine listed firms tend to depend on short-term debt financing.
1. Introduction
Since the minal works of Modigliani and Miller (1958, 1963) , there have been studies on capital structure of firns in such ctors as manufacturing, electriutility, non-profit hospital and agriculture firns. Modigliani and Miller (1958) argue on the basis of the very restrictive assumptions, such as, perfect capital markets, homogenous expectations, no taxes and no transaction costs, that, they draw a conclusion that capital structure is irrelevant to the value of a firm. The literature on capital structure has been expanded by many theoretical and empirical contributions. Much emphasis has been placed on releasing the assumptions made by Modigliani and Miller, in particular by taking into account corporate taxes (Modigliani and Miller, 1963), personal taxes (Miller, 1977), bankruptcy costs, agency costs (Jenn and Meckling, 1976; Myers,1977), and information asymmetries (Myers, 1984).
Despite decades of intensive theoretical and empirical rearch after MM theory, there is a surprising lack of connsus as to what factors determine capital structure. The reason is that the capital structure is not only the company's own decision-making, but cloly related to a country's cultural differences, the stage of economic development, the financial system and corporate governance mechanism (Rajan and Zingales (1995) and Wald (1999)).
China is a developing country and the development of market economy is far from sufficient. As Chin
e listed companies and the enterpris of mature market economies are at different levels of political, social and economic environment, facing different market structure, whether the choice of the capital structure of Chine listed companies would be differences. The objective of this article is to carry out empirical testing, using panel data methodology, to investigate the determinants of the capital structure of Chine listed companies.
The paper is organized as follows. In Section 2, we provide literature review on the determinants of the capital structure and hypothesis. The method and data are prented in Section 3, while our results are discusd in Section 4. Finally, Section 5 contains some concluding remarks.
2. Literature review and hypothesis
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The famous minal paper by Modigliani and Miller (1958) t the stage for numerous propositions t
hat have been developed to provide the theoretical underpinnings of this crucial concept. The linkage between capital structure and firm value has engaged the attention of both academics and practitioners. Bradley (1984), Rajan and Zingales (1995), Wald (1999), De Miguel and Pindado (2001) and others show that profitability, firm size, collateral value of asts, growth opportunities, non-debt tax shields an so on affect capital structure.
2.1 Profitability
Although much theoretiacal work has been done since Modigliani and Miller (1958), no consistent predictions have been reached of the relationship between profitability and leverage. Pecking order theory suggests firms will u retained earnings first as investment funds and then move to bonds and new equity only if necessary. In this ca, profitable firms tend to have less debt. Rajan and Zindales (1995), Wald (1999) show that leverage is negatively related to profitability. Agency-bad models also give the same predictions. However, Long and Maltiz (1985) argue leverage would be positively related to profitability, but the relationship is not statistically significant. In this study, profitability will be defined as earnings before interest and tax (EBIT) scaled by equity (variable: ROE).
陪伴的近义词2.2 Liquidity
The liquidity of the firm also has important effect on the leverage. According to the pecking order theory, firms with high liquidity will borrow less. The firm with more liquidity shows that it can generate abundant funds which can then u to finance its operating and investment activities. Therefore, the property fluidity can have the negative influence to the debt. In this paper, we proxy the liquidity of the firm considering its current ratio which is equal to current asts divided by current liabilities (variable: LIQU).
2.3 Collateral value of asts
On the relationship between collateral value of asts and leverage, theories generally state that collateral value of asts is positively related to capital structure. Trade-off theory suggests that companies u tangible asts as collateral to provide lenders with curity in the event of financial distress. If an firm’s tangible asts occupy greater proportion of total asts, the asts can be ud as collateral, so firm may more be debt financing. On the contrary, if an enterpri’s intangible asts are high, liabilities ratio will be smaller. Myers (1984), Rajan and Zindales (1995) make sure that collateral is positively correlated with leverage. This paper defines collateral value of asts as the ratio of inventory plus fixed asts to total asts (variable: CVOA).
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2.4 Non-debt tax shields
The tax deduction for depreciation and investment tax credits is called non-debt tax shields (NDTS). DeAngelo and Masulis (1980) maintain that depreciation and investment tax credits are substitutes for the tax benefits of debt financing. Thus, firms with large non-debt tax shields will be expected to issue less debt. Chaplinsky and Niehaus (1993) also find that leverage is negatively correlated with NDTS. While Bradley et al. (1984) find leverage is positively related with NDTS. In this study, we u depreciation scaled by total asts to measure non-debt tax shields (variable: NDTS).
2.5 Firm size
Many studies suggest there is a positive relation between leverage and size. Wald (1999) finds that large firms more often choo long-term debt, while small firms choo short-term debt.. Larger firms may be able to take advantage of economies of scale in issuing long-term debt, and may even have bargaining power over creditors. In the same circumstances, the possibility of bankruptcy for large firms is smaller than small ones, so the larger firms have a stronger capacity of debt and higher debt ratio. Rajan and Zingales (1995) generally find that larger firms are likely to u more debt. This study us the natural logarithm of sales as a proxy for firm size (variable: SIZE).
2.6 Growth opportunity
Theoretical studies generally suggest growth opportunities are negatively related with leverage. On th one hand, if management pursues growth objectives, management and shareholder interests tend to coincide foe firms with strong investment opportunities. On the other hand, debt also has its own agency cost. According to the trade-off theory, firms holding future growth opportunity tend to borrow less than firms holding more tangible asts becau growth opportunity cannot ver as collateral. Furthermore, according to the pecking order theory, firms expecting high future growth opportunity should u greater equity financing. Myers (1984) considers that high-growth firms may hold more real options for future investment than low-growth firms, so firms with high-growth opportunity may not issue debt in the first place and leverage is expected to be negatively related with growth opportunity. Berens and Cuny (1995) also find that growth opportunity implies significant equity financing and low leverage. Empirical studies such as Rajan and Zingales (1995), and Wald (1999) predominately support the trade-off theory. However, Ferdinand (1999) argues that when companies have relatively high growth opportunity, the need for capital is more and therefore companies are more inclined to take a higher debt ratio. In this paper, we proxy our growth opportunity measurement as total asts growth rate (variable: GROWTH).
2.7 The reputation of a firm
The reputation of a firm may affect its leverage capability, becau it reduces the conflicts between the company and its lenders. The longer the firm's history of repaying its debt, the better is its reputation, and the lower is its borrowing cost. The company’s reputation is a symbol of strength, if the company has good reputation, the company would occupy more debt. Jenn (1976) concludes that, by fulfilling its payment obligations, a company enjoys a good reputation, which may be sufficient to eliminate conflicts with its creditors. As Myers (1984) points out, the companies that are most concerned about having a reputation for being honest are tho that expect to remain in the market for a long time. For them, honesty is the best policy. This study us the natural logarithm of number of years since listed as a proxy for reputation (variable: REPU)
Taking into account the review of the literature, the hypothes that we propo about the possible determinants of the debt level of Chine listed companies are as follows:
H1. The stronger a company’s profitability, the less its tendency to resort to debt.
H2. The higher the liquidity of a firm, the lower its debt level.
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H3. The larger the collateral values of ast, the lower the need to resort to external financing.
H4. The greater the non-debt tax shields of a company, the lower its tendency to resort to debt.
H5. The larger the size of a company, the more possibilities there are of obtaining debt financing.
H6. The greater a firm’s growth opportunity, the lower its tendency to need external resources.
H7. The better the reputation of a firm, the higher its debt level.
3. Data and measurement of variables
In this paper, a new sample we u is Shanghai 180 index shares. Shanghai 180 index shares were launched in 2002. Becau of their strong reprentation, good income, low risk and high liquidity, they are increasingly becoming the capital market focus.
We investigate the determinants of capital structure of Shanghai 180 index for the period from 2004 to 2006. All the companies included in the sample fulfill the following two criteria: they were all listed in the market before 2004 and none of them was expelled from Shanghai 180 index during the period 2004-2006. We form our variables using data derived from China Center for Economic Rearch (CCER) databa. The final sample, after considering two criteria, consists of 102 listed firms.
The different variables that allow us to test the stated hypothes are: profitability, liquidity, collateral
value of asts, non-debt tax shields, firm size, growth opportunity, and firm reputation. The dependent variable in the regression model is the ratio of leverage, defined as:
asts Total debt
Total DAR =
(1)
The evolution of the leverage ratio for all the sample firms and its decomposition into short-term and long-term leverage are shown in Table 1. Table 1 Descriptive statistics
Year Leverage ratio （%） Short-term leverage （%）Long-term leverage （%）
2004 43.56 33.55 10.01 2005 44.37 34.78 9.59 2006 45.48 36.51 8.97 From Table 1, we can e that the leverage ratio is gradually incread, from 43.56 percent in 2004 to 45.48 percent in 2006, and short-term leverage is also gradually incread, form 33.55 percent to 36.51 percent during the period from 2004 to 2006, but long-term leverage rate is gradually reduced, from 10.01 percent in 2004 to 8.97 percent in 2006. From 2004 to 2006, the proportion of short-term leverage accounts for 77 percent, 78 percent and 80 percent of total debt respectively. Short-term leverage rate is much hi
gher than long-term debt rate, showing the Chine listed companies mainly depend on short-term debt financing. This suggests that Chine listed companies are mainly equity capital financed. The possible reason is that the bond market in china is very small and quite undeveloped. So, China should accelerate the development of the bond market in order to expand the financing channels of listed firms.
Table 2 prents the exogenous variables for the level of debt.
Table 2 Summary of determinants of capital structure
Variable Sign Definition
Profitability ROE EBIT/equity
Liquidity LIQU current asts/current liability
Collateral CVOA (inventory plus fixed asts)/total asts
Non-debt tax shields NDTS depreciation/total asts
Firm size SIZE LN (sales)
Growth opportunities GROWTH total asts growth rate
Reputation REP LN (number of years since listed)
4. Methodology and empirical evidence咸蛋南瓜
The described methodology is applied in our study with the purpo of estimating, by means of a balanced panel, the determinant factors of the leverage ratio, using as exogenous variables: profitability, liquidity, collateral value of asts, non-debt tax shields, firm size, growth opportunities, and reputation. We estimate the following model:
t
字宝宝i t i t i t i t i t i t i t i i t i REP GROWTH SIZE NDTS CVOA LIQU ROE DAR ,,7,6,5,4,3,2,1,εβββββββα++++++++= (2) The descriptive statistics of the variables of the model are summarized in Table 3.
Table 3 Descriptive statistics of leverage and independent variables
Variable Minimum Maximum Mean Std.Dev. DAR 0.023 0.871 0.446 0.173 ROE -0.371 0.516 0.139
0.118 LIQU 0.189 7.801 1.483 1.025 CVOA 0.125 0.926 0.583 0.195 NDTS 0.001 1.253 0.195 0.185 SIZE 19.561 27.675 22.160 1.316 GROW 0.684 9.193 1.642 0.845 REP 0.000 2.773 1.789 0.607
In order to estimate the effect of the independent variables on the dependent and to improve our results, we consider the two different econometric approaches—fixed effects model and random effects model.
魔芋膳食纤维The Hausman specification test is employed to test the fixed effects model versus the random effects model. Using Hausman specification test, we obtain the2χStatistic test value of 24.6, with an associated probability of 0 percent. This test result indicates that the fixed effects model fits better to
our specific t of variables and thus prevails over the random effects model.
The regression results using the fixed effects model are prented in Table 4.
The results regarding our various hypothes about leverage are as follows.
H1 analys the relationship between profitability and the dependent variable. We measure profitability as earning before interest and tax divided by equity. This variable is significant and negatively related to the endogenous variable. The negative and significant result is consistent with
the predictions of the pecking order theory, showing that firms prefer to u internal sources of funding when profits are high.
Table 4 Regression results using the fixed effects model
t-Statistic Prob.
Variable Coefficient
-3.032 0.003
C -0.198
-3.481 0.001 ROE -0.032
-15.801 0.000 LIQU -0.040
16.841 0.000
CVOA 0.151
-15.269 0.000 NDTS -0.282
11.311 0.000
高中满分作文大全SIZE 0.028
GROWTH 0.059 23.875 0.000
3.837 0.000
REP 0.012
R2 0.893
Adjusted R2 0.890
F-statistic 299.993
Prob.(F-statistic) 0.000
H2 address the relationship between liquidity and the leverage. We consider the liquidity of the
firms using the current ratio which is equal to current asts divided by current liabilities. The estimat
ed regression coefficient is negative and statistically significant. The result is consistent with pecking order theory, proving that firms with high liquidity tend to borrow less.
H3 relates to the collateral value of corporate asts, which is measured as inventory plus fixed asts divided by total asts. The coefficient of this variable is significant and positively related to leverage. This result is accordant with Myers (1977), Titman and Wesls (1988), Rajan and Zindales(1995), which shows that tangible asts as debt collateral can decrea lender’s risk and the
firms with more tangible asts can require more debt.
H4 considers the effect of non-debt tax shields on its leverage level. We define non-debt tax shields as depreciation divided by total asts. This variable is significant and inverly related to the leverage. The result confirms the findings of previous studies such as DeAngelo and Masulis (1980)
and Chaplinsky and Niehaus (1993) which testifies that firms with high non-debt tax shields tend to require less debt.
H5 address the influence of firm size and the level of debt, where size is defined as the natural log
敛衽arithm of sales. Firm size has a positive and significant impact on leverage. This finding is consistent with Marsh (1982), Rajan and Zingales (1995), and Wald (1999), attesting that the size of
the firms is a symbol of strength, the larger corporations have the greater debt cured capacity and
the less risks of bankruptcy, leading to a stronger ability in obtaining external financing.
H6 analys the relationship between growth opportunity and the dependent variable. We measure growth opportunity as total asts growth rate. A somewhat puzzling result is the positive relation between leverage and growth opportunity. The finding contradicts the previous prediction.
