02 Nov 2017
Capital structure is regarded as one of the important components in corporate finance at which capital structure is a combination of debt and equity. The association between capital structure and firm value has been the subject of considerable debate. Throughout the literature, debate has centered on whether there is an optimal capital structure for an individual firm or whether the proportion of debt usage is irrelevant to the individual firm’s value (Joshua Abor, (2005). An optimal capital structure is gained when a firm maximizing it total value while at the same time minimizing the cost of financing (Parrino and Kidwell, 2009). A best mixture of financing should be practiced and achieved for every firm as the proportion between debt and equity varies as well dependent on many factors, firms’ characteristics, availability of sources, market timing, and macroeconomic variables. It should be noted that the capital structure adopted for every firm will change over time as the company growing due to the external changes such as regulatory framework and capital market (Mahmud, 1998).
Theory of capital structure and its relationship towards the firm’s performance started after the seminal work carried out by Modigliani and Miller (1958), and becomes a debating issue in corporate finance and accounting literature. Modigliani and Miller (1958) concluded to the broadly known theory of "capital structure irrelevance" where financial leverage is irrelevance to the firm’s value. However this theory was based on the assumptions that do not hold in the real world. These assumptions include perfect capital markets, homogenous expectations, no taxes, and no transaction costs. On the other hand, prior to the MM theory, companies believed that their values can be increased by using financial leverage with the assumption on the presence of an optimal capital structure that minimizes cost of capital (Megginson, Smart & Graham, 2010).
After the controversial situations, Modigliani and Miller (1963) eased the conditions and showed that, under capital market imperfection where interest expenses are tax deductible, firm value will increase with higher financial leverage. The impact of tax is modeled and shows that profitable companies have more debts in order to cope with the tax management in the corporation’s profit. However, increasing debt results in an increased probability of bankruptcy. Hence, the optimal capital structure represents a level of leverage that balances bankruptcy costs and benefits of debt finance.
2.2.1 Agency Cost Theory
The agency cost is one of the crucial concepts as the pioneers of this theory, Jensen and Meckling (1976) argue that the ownership structure is invariant in regard to the probability of cash flow. Besides, agency cost theory also defines the agency relationship in term of a contract between agents, managers and principals (shareholders). The managers are authorized to make decision and perform some services on behalf of the shareholders. This lead to a substantial conflict between principal and agent when managers fail to act according to shareholders’ interests. In general, two types of conflict arise in the agency problem: (i) between managers and shareholders, and (ii) between shareholders and debt holders (Megginson, Smart & Graham, 2010).
Conflict between managers and shareholders is observed especially among firms with free cash flow in which the excess cash is used to finance the positive net present value (NPV) projects. Instead, the shareholders fail to capture the entire gain from the earnings while having to bear the cost from those activities. On the other hand, the excess cash is often misuse by the managers to fund negative NPV projects such as inefficient activities within the organization, or for their own personal benefit. Therefore, debt is introduced as a device to discipline the managers (Harris & Raviv, 1991). In addition, Jensen (1986) also argues that the excess cash problem is solved through debt financing in which managers are obliged to creditors through several requirements. If the managers fail to fulfil the creditors’ requirements, eventually the firm is exposed to bankruptcy risk.
According to Jensen and Meckling (1976), the second type of conflict is due to inequality in the debt contract. In other words, the shareholders will enjoy the profits on a successful project while the loss has to be faced by the debt holders if the project fails which leads to overinvestment (risk shifting) or underinvestment (asset substitution) problems. The over investment occurs when the stockholders tend to exploit bondholders once the debt is issued as managers tend to accept negative NPV projects (which is risky) which will increase the amount of debt if the project fails.. Underinvestment issue is related to the managers’ attitudes that avoided projects which is NPV. Therefore, firms are willing to proceed with unattractive projects at the expense of shareholders.
In addition, the stage of maturity affects the firm’s policy in choosing projects and debts as older firms tend to choose safe projects and adopt longer debt repayments while younger tend to undertake risky projects (Diamond, 1989). However, Hirshleifer et al. (1992) suggested that firms might face higher level of debt in pursuing the safe project as firm’s reputation is one of the factors to obtain a safe project.
Based on agency cost theory, few studies have highlighted different capital structure models. One of the models estimates that firms which have higher market value tend to experience a high liquidation values and lower investigation costs which will end up with a greater probability of default and more debt (Harris and Raviv, 1991). Therefore, this model manages to discover a positive relationship between leverage and firm value. Alternatively, Stulz (1990) argued that by balancing the benefit of debt and avoiding the decreased value of a projects, the optimal target debt is achieved. This results in a trade-off between reduced free cash flow and underinvestment that occur when a firm is expected to have more debt during takeover. Meanwhile, firms with higher investment opportunities will have a lower level of debt.
2.2.2 Trade-Off Theory
One of the dominant theories of capital structure, trade-off theory which proposed by Miller (1977), determines the capital structure by balancing the different benefits such as tax shields (saving) and costs associated with debt financing. According to trade-off theory, if firms are more profitable, they prefer debt financing to equity financing as a means of further improving their profits (Ibrahim, 2009). This theory also argues that the firm’s performance can be improved by mitigating conflicts between shareholders and managers concerning the free cash flow (Jensen, 1986), optimal investment strategy (Myers, 1977), the amount of risk to be undertake (Jensen and Meckling, 1976).
On the other hand, debt costs include direct and indirect bankruptcy costs. Therefore, through debt financing, a firm is more committed to manage it future cash out flows in terms of periodic interest and the principal borrowed which will lead to an increase in the likelihood of firm’s financial default and bankruptcy. However, several studies suggest that bankruptcy costs do exist but they are reasonably small relative to tax saving associated with debt (Miller, 1977; Warner, 1977). Therefore, the trade-off theory concludes that firms that have a higher income to shield are more profitable and should incur debt to take tax advantages (i.e. operate with higher leverage). Consequently, a positive relationship could be expected between debt level and firm’s performance such as profitability like return on assets (ROA), return on equity (ROE), and earning before tax and interest (Ibrahim, 2009).
Although agency cost theory is able to solve conflicts by the introduction of debt, Stulz (1990) believes that debts payment decreases the availability of cash flows available for managers which will reduce the opportunities of profitable investing. Thus, companies with less debt have more opportunities for investment and in comparison with other active firms in the industry, have more liquidity. Additional costs of debt include agency costs in regard to the monitoring made by bondholders as well as potential bankruptcy costs. Costs and benefits of alternate financial sources are "traded off" until the marginal cost of equity equals the marginal cost of debt, yielding the optimal capital structure, and maximizing the value of the firm (Ibrahim, 2009).
2.2.3 Pecking Order Theory
Another theory of capital structure discussed by Myers (1984), Myers and Majluf (1984) and Fama & French (2002), is called pecking order theory. In this theory, firms with positive net present value (NPV) investments will prefer financing new investments by internal sources (i.e. retained earnings) first, if this source is not enough then managers seeks for external sources from debt as second and equity as last if there is no other alternative. However, this practice leads to a conflict between benefits of shareholders and creditors as the creditors likely to increase the interest rate. Besides, an addition supervision costs is required to manage this conflict (Megginson, Smart & Graham, 2010).
Overall, larger firms that are more diversified acquire stable cash flow and less asymmetric information problems should tend to have more equity than debt and thus have lower leverage as well as small probability of bankruptcy. Findings of Titman and Wessels (1988), Harris and Raviv (1991) and Rajan and Zingales (1995) confirmed the results of Mayers (1984) which believed increase of leverage will decrease profitability (see Ibrahim, 2009). On the other hand, Wald (1999) believed that the link between profitability which is measured through various shape such as earnings before interest and tax (EBITTA) and debt-asset ratio is positive and significant. In conclusion, the perking order theory mainly points out the conflicts between managers and investors due to information asymmetry about the firm’s investment opportunities. This conflict demonstrates that high leverage leads to poor performance.
The single-country analysis or panel data is widely used by most of the studies involving different countries determinants of capital structure using either a single-country analysis or panel data while some studies compare the capital structure between countries and regions. For example, Deesomsak, Paudyal and Pescetto (2004), who conduct a study in the Asia-Pacific region, conclude that a firm’s decision on capital structure is affected by the environment. According to Brigham and Ehrhardt (2005), the frims capital structure is influence by business risk, tax position, financial flexibility, managerial aggressiveness and growth opportunities. However, as mention in Harris and Raviv (1991), there also exist problems of finding, defining and measuring the determinants of capital structure and the motives and circumstances that could determine capital structure choices seem nearly uncountable.
In this study, the the most commonly used explanatory variables are used as determinant factors. According to Harris and Raviv (1991), the consensus is that "leverage increase with fixed assets, non-debt tax shields, investment opportunities, and firm size, and decreases with volatility, advertising expenditure, the probability of bankruptcy, profitability, and uniqueness of the product." Titman and Wessels (1988) state that asset structure, non-debt tax shields, growth, uniqueness, industry classification, size, earnings volatility, and profitability are factors that may affect leverage according to different theories of capital structure. Furthermore, other authors provide another set of potential determinants of capital structure. This clearly shows that even if there is a consensus among researchers what factor may constitute a minimum set of attributes, there is still plenty of room for arguing in favor of determinant factors that influence capital structure decision. In this study, the most commonly used explanatory variables are used as determinant factors which are firm size, tangibility of assets, profitability and liquidity to further analyze the effects of firm structure on leverage.
(i) Profitability
Most of the past studies conclude that a negative link is obtained between leverage and profitability. (Titman and Wessels, 1989; Harris and Raviv, 1991; Wiwattanakantang, 1999; Booth et al., 2001; Mitton, 2006; Zou and Xiao, 2006). However, according to Mittoo and Zhang (2008) argue that profitability is positively related so short-term debt and negatively to long-term debt.
In Malaysia case, highly profitable firms tend to utilize small fraction of debt as being concluded by some studies including Booth et al. (2001), Deesomsak et al. (2004), Fraser et al. (2006) and de Jong et al. (2008). In addition, Pandey (2001) and Pandey and Chotigeat (2004) documented that profitability has a significant inverse relationship with all types of book and market value debt ratios. However, a negative link between total debt ratio and profitability is observed by Baharuddin et al. (2011) especially in the construction sector in Malaysia. In contrast, Mohamad (1995) found a positive relationship between profitable firms and leverage.
(ii) Size
Large firms with a higher leverage tend to experience lower level of bankruptcy risk as predicted by trade-off theory (Ibrahim, 2009). The decision on the optimal capital structure must include the bankruptcy cost really as this cost represent a smaller proportion of the total value for larger firms and a larger proportion for smaller firms as according to Bates (1971) small firms tend to be more self-financing. Small firms relied more on bank financing and trade credits as well as rarely issued stock. Likewise, Titman and Wessels (1988) argued that small firms tend to reduce short-term debt as they grow larger. In contrast, large UK firms rely more on long term debt due to better access to credit markets as found out by Marsh (1982). Therefore, one of the determinant of capital structure is the firm size. This factor is important as firm size represents a proxy for differences in capital accessibility (Leary et al., 2009).
Malaysia has different context as observed by Pandey (2001), Fraser et al. (2006), and de Jong et al. (2008) which emphasized that the debt ratio is positively related to the firm size. Pandey and Chotigeat (2004) argued that larger firms are more diversified which leads to lower bankruptcy risk while small firms use relatively more external financing than firms in the US (Beck et al., 2008). Besides that, Suto (2003) claimed that corporate size is one of the determinants to leverage. For example, large construction firms tend to rely heavily on debt financing compared to other sector (Baharuddin et al., 2011). However, Irene and Hooi (2011) found that firm size was significant to both GLCs and Non-GLCs but GLCs in negative relationship while Non-GLCs are in positive relationship to debt ratio.
In contrast, Mooi (1993), Mahmud (1998) and Wan Mahmood et. al. (2011) argued that there is no significant difference between capital structure and firm size across industries in Malaysia despite they discovered that a significant differences between capital structure and industries.
(iii) Tangibility
Corresponding to both the trade-off theory and agency cost theory, firms with larger tangible assets compared to intangible assets have greater leverage capacity, which reduces the possibility of mispricing in the event of liquidation. Thus, in the event of financial distress, lenders feel more secures which ultimately reduces the agency cost of debt (Jensen and Meckling, 1976). Tangibility is positively related to leverage as firms are able to obtain more fixed assests to secure against debt and the creditors are more willingness to give credit which help to solve operation monitoring cost (Shah and Khan, 2007). Besides, the tangibility relationship on leverage is demonstrated across past literature (e.g. Harris and Raviv, 1991; Zou and Xiao, 2006; Antoniou et al., 2008; de Jong etal., 2008; Mittoo and Zhang, 2008). In addition, Frank and Goyal (2009) further emphasized that tangibility is one of the core factors for market leverage. For instance, Turkey’s industrial firms increase their long-term debt and reduce the total debt as their tangibility increases (Gonenc, 2003).
In regards to the Malaysia firms, various finding regarding relationship between tangibility and debt ratio or leverage was found by several studies. For example, negative link is significant between tangibility and total debt across Malaysia sectors (Booth et al. 2001). In addition, studies carried out by Pandey (2001) using a fixed effect model and Pandey and Chotigeat (2004) with a pooled OLS model, found that tangibility is negatively correlated with short-term and total debt while long-term debt shows insignificant values. However, studies made by Fraser et al. (2006) and de Jong et al. (2008) stated that tangibility is positively link to leverage and recently, Baharuddin et al. (2011) discovered that asset tangibility has the largest influence on total debt across construction firms in Malaysia in which they argued that as the firm owns a greater amount of tangibility, the demand for debt in financing the assets increases. Irene and Hooi (2011) also found a positive relationship between tangibility and total debt for both GLCs and Non-GLCs.
(vii) Liquidity
Firms with high liquid tend to incur a high debt ratio to meet the short-term obligation based on the trade-off theory as concluded by Scott (1977). In addition, the liquidity is specifically related to long-term debt in a positive correlation while negative to within construction firms in Europe (Feidakis and Rovolis, 2007). However, the firms are not required to raise their debt if they have a satisfactory level of liquidity as emphasized by the pecking order theory. This is due to the fact that the firms are able to finance their future investments with the accumulated internal funds when they possess more current assets. Meanwhile, for developed countries, a negative link is observed between debt and liquidity with insignificant relationship is obtained for developing countries such as Malaysia (Jong et al. 2008).
Across developing countries, some studies found out that a highly liquid firm still depends on equity financing while avoiding debt financing (Ullah and Nishat, 2008). Besides, Deesomsak et al. (2004) also found a similar relationship between liquidity and leverage across Malaysia listed firms. In contrast, some countries do show inverse link as Mazur (2007) found a negative relationship between liquidity and leverage across Polish firms and Sbeiti (2010) found a similar relationship across Gulf Cooperation Council (GCC) countries.
Based on the MM theory, many other alternative theories have been developed such as the trade-off theory, pecking order theory, and agency cost theory which are basically based on theoretical models that utilize empirical studies to determine the determinants of capital structure typically in developed countries and some developing countries. These theories show that capital structure theory is not universal to be applied to every country and business as each factor differs according to the theories proposed (Myers, 2003).
As a whole, the literature provides some insights and indicates that sector analysis is under explored, particularly within developing countries. In addition, capital structure decision making may differ across sectors or industries due to its unique behavior, and these differences may affect the leverage decisions via the capital structure determinants. Thus, the power of capital structure determinants may varies across sectors as each determinant could be important in some sectors, yet unimportant to other sectors within a particular nation. Moreover, the substance of each factor may change due to circumstances that occur within the sector, the nation or even globally.
This chapter explains out the result of the study. Further discussions and analysis were based on the objectives of the study which is to examine the relationship of firms level determinant factors on capital structure of the public listed firms in Malaysia. Moreover, this chapter deliberates further discussion on the difference of determinant factors of capital structure between sectors of public listed firms in Malaysia from various sectors of the year 2002 to 2011. Its involved five selected sectors which are property, consumer product, industry product, trading and services, and plantation. Hence, this chapter discusses the impact of sectoral behavior on the relationship between leverage and capital structure determinants, focusing on firm-level determinants across selected sectors in Malaysia. The first section begins by laying out a detailed descriptive statistics summary, trend analysis of leverage and correlation matrix analysis. Subsequently, the following section focuses either on the pooled OLS, random effect or fixed effect model of the determinant factors across the selected sectors. Breauch-Pagan test and Hausman test is used to select the appropriateness of econometric technique for model selection either Pooled OLS, Random Effect or Fixed Effed model.
Recent empirical evidence highlights the role of sector or industry in explaining the pattern of a firm’s financing, particularly in the developing countries. According to L’Here et al. (2002) and Wang et al. (2003), the sectors role evolution started in the late 1990s, especially after the financial crisis in 1997-1998. Several studies (Ferri and Jones, 1979; Aggarwal, 1981; Aggarwal, 1990; Annuar and Shamsher, 1993; Mohamad, 1995; Correa et al., 2007) have revealed that industry classification plays a significant role in determining a firm's capital structure. However, these studies fail to consider the differential effect of each sector on the capital structure decision-making. In general, there are variations of behavior across sectors that may influence the relationship between capital structure determinants and leverage.
Table 4.1 provides a summary of the descriptive statistics for the dependent and independent variables for the sample of firms. Based on the overall sectors, the results show that the Total Debt Ratio (DEBT) has an average value of 0.364 with a standard deviation of 0.846. The highest value for DEBT is 18.729 and while the lowest is -5.557. The average value for Long Term Debt Ratio (LTDR) is 0.146 with the range of value is from -0.003 to 1.369 and standard deviation is 0.163. For Short Term Debt Ratio (STDR) has an average value of 0.219 ranging from -5.554 to 18.062 and a standard deviation of 0.828. Based on this result, it signifies that 36.4% of investment capital is financed by total debt, 21.9% generated from short-term debt and 14.6% generated from long-term debt. This situation is possible in Malaysia as the commercial banks supply more short-term debt, rather than long-term debt for a longer term investments. Meanwhile, the standard deviation indicates
that the total debt ratio has the highest volatility, followed by the short-term debt ratio. Nevertheless, the long-term debt ratio has the lowest dispersion level. This strengthen the argument of variation in the leverage utilization, particularly in usage of short-term debt across firms in Malaysia. This could be attributed to several factors such as firm size, the level of accessibility in the capital market, the nature of the firm in a particular sector, and other factors that are directly or indirectly related to a specific firm. Most firms financed their business by equity followed by short-term debt, and finally from long-term debt as a last choice for financing. This result supports the finding by Chen (2004), which found a different pecking order across developing countries when raising finances. Managers perceived internal funds to be the fastest and easiest source of financing, followed by issuing of new equity and bank borrowings, and the issuing of new debt becomes the last choice for financing.
In terms of tangibility (TANG) for overall sectors, on average, fixed assets represent about 41.1% (0.411) of total assets with standard deviation of 0.206. The average mean value for liquidity is 1.963 with the range from 0.038 to 34.879. The standard deviation is 1.830. On overall, the result shows that, the firms have a good financial health and liquid. On the other hand, the average mean of profitability for return on assets (ROA) is 3.702 with standard deviation of 10.358 and return on equity (ROE) is 0.168 with standard deviation of 47.941. The highest ROA is 162.647 and the lowest ROA is -43.659. The range for ROE is from -463.185 to 215.761. However, based on the mean value, the result shows us the firms’ profitability is showing positive value for the overall sample. For size (SIZE), measured by natural log of total sales, the mean reported is 4.984 and the range is 2.131for the lowest and 7.713 for the highest. The standard deviation for SIZE is 0.812.
As the firms are classified by sectors, a high volatility in the total debt ratio is observed, specifically, industrial products and plantation firms. In conrast, the level of dispersion in short-term debt ratio is greater compared to long-term debt, probably due to different levels of short-term consumption across firm size. Most of the sectors employ a relatively high amount of short-term debt except for the property firms as these firms utilized more long term debt (17.9%) rather than short term debt (12.6%). The property sector has the lowest debt financing which is 30.5% for total debt compares with other sectors. On the other hand, the industrial products sector has the highest debt financing with the mean 0.432 for DEBT, 0.113 for LTDR and 0.319 for STDR.
In terms of profitability for return on assets(ROA) and return on equity (ROE), each sector consists of a mixture of performing and underperforming firms. The average value of profitability is similar across sectors, in which consumer product firms have highest mean value for ROA and ROE which are 6.075 and 3.399 respectively. The level of dispersion in ROA is high within the industrial product sector while in ROE, the level of dispersion is high within trading and services sector. On the other hand, the tangibility (TANG) and firm size (SIZE) are similar across the sectors. In regards to the liquidity ratio (LIQUID) the property sector shows the mean value of 2.428. On the other hand, the other sectors show similar result for liquidity ratio (LIQUID).
Table 4.2 provides a correlation matrix based on 100 Malaysia listed firms for the data set for the year 2002 to 2011. For all sectors, tangibility(TANG) is negatively correlated
and significantly related to liquidity (LIQUID), profitability (ROA and ROE) and firm size (SIZE). Liquidity is significantly positive correlated to return on assets(ROA) and return on equity(ROE), and negatively correlated to firm size(SIZE) and tangibility(TANG). Other than that, ROA and ROE are positively correlated to firm size. In comparison across sector, tangibility(TANG) is negatively correlated to liquidity(LIQUID), ROA, ROE and size for all sectors except in property sector, where tangibility is significantly correlated positively to ROA and ROE, but no significant correlation to firm size(SIZE). At 1% level of significant, and liquidity(LIQUID) is correlated positively to ROA for all sectors. However, liquidity has significant correlation and positively correlated to ROE in industrial and consumer product sector. ROA and ROE has positive correlation significantly across all sectors. No significant correlation between ROA and size for property, consumer product and plantation sectors. ROE is significantly correlated positively to size for all sectors except in consumer product and plantation sectors. Based on correlation matrix on Table 4.2, the correlation between these variables varies across sectors due to each sector’s characteristics. These results provide some indications of the variation of firm-level determinants across sectors.
In this study, static panel data regression analysis was used. Recently, it has become more popular to estimate panel data regression models in economic research, and so also in empirical corporate finance. One reason for this is maybe due to increased availability of panel data, and also an increased awareness of the advantages of panel data over cross-section or time-series data (Baltagi, 2002). As mentioned in Chapter 4, the following equation assesses the association between the firm-level determinants and leverage using both the pooled OLS and random-fixed effect analysis based on the balanced panel.
Where DEBT, LTDR and STDR is the debt ratio for firm in year t, with the determinant factors as tangibility (TANG ), liquidity (LIQUID), return on assets (ROA), return on equity (ROE) and firm size (SIZE). The disturbance term is denoted as ɛijt that and is assumed to be serially uncorrelated with mean zero.
The result on overall samples are shown in Table 4.3. Based on Breauch Pagan Test and Hausman Test for the total debt ratio (DEBT) and long term debt ratio (LTDR), the test accepts Fixed Effect model while the short term debt ratio (STDR) accept Random Effect model. From the Table 4.3, the results show different model selection across type of debt ratio and sectors. The estimates show the liquidity(LIQUID), return on assets (ROA) and return on equity (ROE) are significantly negative relationship to total debt and short term debt. Tangibility and firm size are significant and positive relationship to long term debt and ROE maintain negative relationship significantly to all types of leverage. These result indicates profitability (measured by ROA and ROE) have a negative relationship and is significant at the 1% level with leverage or debt ratio. This result is in support of the pecking order theory which emphasizes that the profitable firms utilize their profits (internal funding) to finance their investments and use less debt or other external funds.
This result is consistent with the findings of Harris and Raviv (1991), Wiwattanakantang (1999), Booth et al.(2001), Deesomsak et al. (2004), Chen (2004), Mitton (2006), Correa et al.(2007), Shah and Khan (2007), Fraser et al. (2006), de Jong et al. (2008), and Baharuddin et al. (2011). Although,the result is not consistent with the findings of Mohamad (1995) and Zuraidah, A et al. (2012) which concludes that the profitability has inverse relationship with long term debt and total debt but this study’s result are consistent with the pecking order theory. Nagano (2003) emphasized that firms across East Asian countries are highly dependent on internal funds compared to the industrialized countries due to significant differences between the external and internal cost of financing.
The liquidity (LIQUID) variable shows a negative relationship and is significant to total debt and short term debt, which is consistent with the results of Deesomsak et al. (2004), Mazur (2007) and Ullah and Nishat (2008) that support the pecking order theory. They argue that firms do not need to raise debt when they have a sufficient level of liquidity to finance their investment and, hence, have a lower leverage. This result is also consistent with and Sbeiti (2010) which shows a negative relationship between liquidity and leverage, and argued that firms tend to finance their investments based on pecking order. However, this result is not consistent with the agency cost theory and trade-off theory, which is meant highly liquid firms have relatively high debt ratios in order to meet their short-term obligations.
Therefore this study in relation to the trade-off theory, tangibility (TANG) is associated positively at the 1% level of significant to long-term debt, and that is consistent with several previous studies (e.g., Harris and Raviv, 1991; Fraser et al., 2006; Shah and Khan, 2007; de Jong et al., 2008; Antoniou et al., 2008; Mittoo and Zhang, 2008; Kayo and Kimura, 2011). Firms with larger tangible assets have greater leverage capacity and provide lenders with security in the event of financial distress. Based on the agency cost theory, high tangibility reduces the conflict between stockholders and creditors. Eventually, this protects the lenders from moral hazard problems caused by them (Jensen and Meckling, 1976). However, these result is contradict with the finding by Booth et al. (2001), Pandey (2001), Pandey and Chotigeat (2004), and Baharuddin et al. (2011), found that tangibility is negatively correlated with short-term and total debt while long-term debt shows insignificant values.
In tandom with tangibility, firm size (SIZE) maintained a similar association with long-term debt. Larger firms have higher amounts of long-term debt compared to smaller firms (Booth et al., 2001). In line with the findings of Mittoo and Zhang (2008), the utilization of short-term debt decreases as the firms become larger. The result is also in line with the trade-off theory, where large firms have a larger capacity for leverage due to lower bankruptcy risk and agency cost of debt with stable cash flows compared to smaller firms.
As the firms are classified by sectors, as shown in Table 4.3, the determinant factors toward total debt, long term debt and short term debt are varies across all sectors. Profitability (ROE) plays an important role in determining total debt across sectors and it negatively related to total debt for all sectors except in property sector where the result shows negative relationship significantly. Long-term debt also maintains a similar relationship and is significantly related to profitability across industrial product, consumer product, and trading and services sectors. ROE has positive relationship to total debt ratio (DEBT) in property sector. Moreover, insignificant relationship was observed between ROE and long term debt in plantation sector. In term of profitability by ROA, the result shows a significant negative relationship to total debt and short term debt in property, industrial product, and trading and services sector. Furthermore, the result also shows a significant negative association between ROA and long term debt in property sector. In addition, there is a significant positive relationship for ROA and long term debt in consumer product sector. Besides, ROA has no significant relationship to long term debt in plantation, industrial product, and trading and services sector. ROA also has no significant relationship to total debt and short term debt in consumer product and plantation sector.
As a whole, the mechanism between profitability and leverage confirms the applicability of the pecking order theory across sectors in Malaysia. This finding is in agreement with Booth et al. (2001) who concluded that highly profitable firms in Malaysia use low amounts of debt compared with the less profitable firms. Besides, profitable firms could retain their earnings and managers perceived retained earnings to be the fastest and most effortless source of financing (Delcoure, 2007). In the case of Malaysia, since banks provide greater amounts of short-term debt compared to long-term debt, firms tend to raise their finance from the equity market. This indirectly alters the financing chronology of the pecking order theory. Instead of using retained earnings, followed by debt and finally equity, these firms adopted a modified pecking order. They utilize the retained earnings as the main source of financing, followed by equity, short-term debt and, finally, long-term debt would be the last option. This is consistent with other developing countries (Chen, 2004).
Similar to the overall sectors result, tangibility seems to be one of the most important variables that influences long term debt utilization across sectors, except in the plantation sector. A significant positive association to long term debt, give us indication that firms tend to increase long-term debt as their tangibility capacity increases. This is applicable across sectors particularly among the property, consumer product, industrial product , and trade and services sector. These empirical results confirm the existence of the trade-off theory across sectors in Malaysia. Remarkably, the associations between tangibility and total debt and short term debt are inconsistent across sectors. The results in Table 4.3 also show that, tangibility is significantly and positively related to total debt in construction and property, consumer product, and trading and services sector but it is no significant relationship between tangibility and total debt in industrial product and plantation sector. These results are in support of Ovtchinnikov (2010) who found that the association between these variables differs across industries. Sectoral variations do not only take place within a country but also occur across countries. As a result, this variable supports the trade-off theory where tangibility has a positive relationship to long-term debt and total debt, which is applicable to all sectors except in the plantation sector. Similar positive outcomes are noticeable in recent studies such as Shah and Khan, (2007), Feidakis and Rovolis (2007), de Jong et al. (2008), Antoniou et al. (2008), Mittoo and Zhang (2008) and Kayo and Kimura (2011).
Parallel to tangibility, firm size (SIZE) also has relationship in a different direction to the types of leverage across sectors. This is feasible as Booth et al. (2001) found different relationships between types of leverage and size across developing countries. A similar scenario could take place between sectors within a developing country such as Malaysia. The construction and property sectors increase total debt as their firm’s size became larger, which is in line with the findings of Harris and Raviv (1990), Suto (2003), Pandey and Chotigeat (2004), Feidakis and Rovolis (2007), Ullah and Nishat (2008), and Kayo and Kimura (2011). This is possible since larger firms have better access to the equity market due to its reputation and the attraction of the capital gain in the secondary market (Chen, 2004). The result also observes a different relationship pattern between firm size and short-term debt. The positive relationship is observed in the property and plantation sector significantly, while the firm size is negatively related to short term debt in the consumer product and trading and services sector. The positive relationship between firm size and long-term debt which supports the trade-off theory is in the property, and industrial product sector which is consistent with the findings of Mittoo and Zhang (2008).
The liquidity (LIQUID) variable has a similar negative relationship and is significant with total debt and short term debt, which is consistent with the results of Deesomsak et al. (2004) and Ullah and Nishat (2008) that support the pecking order theory. The association between liquidity and leverage or debt ratio is consistent with the pecking order theory across sectors except for long term debt in industrial product sector. Consistent with the overall sectors, comparable results are discernible between liquidity and leverage although short-term debt is insignificant across the industrial product and plantation sector. Furthermore, this variable remains significantly negative to the long-term debt in trading and services sector. Generally, we can say that liquidity is an important determinant factor to total debt and short term debt in construction and property, consumer product, and trading and services sector. On the other hand, liquidity is not an important factor in determining long term debt for all sectors except for industrial product and trading and services firms. Consequently, the overall results confirm the applicability of the pecking order theory across sectors in Malaysia, and the outcomes are consistent with prior studies, for instance, Deesomsak et al. (2004), de Jong et al. (2008) and Ullah and Nishat (2008).
Results on Table 4.3 also report that, all determinant factors are not significant to the leverage or debt ratio in plantation sector except for ROE. All independent variables are not significant to long term debt in plantation sector in which the capital structure in the plantation sector is determined by other factor. As a conclusion, a number of issues are noticeable in the panel data regression analysis. First, the relationship between types of leverage or debt ratio and firm-level determinants (i.e., ROA, ROE, tangibility, liquidity and firm size) differ across sectors. Secondly, discrepancy exists in the coefficient magnitude of explanatory variables across sectors though the variables are statistically significant either at 1%, 5% or 10% level of significant.. The applicability of the capital structure theories, such as, the trade-off theory, agency theory and pecking order theory, diverge across sectors in Malaysia.
The main finding of this study show that capital structure determinants vary across sectors due to the nature or behavior of each sector. Although the proportion of debt financing is similar, each sector adopts different financing patterns. The impact of sector characteristics on capital structure determinants can be observed through the changes of sign and magnitude of the explanatory variables’ coefficients across sectors. Based on the panel data regression analysis, some interesting finding are visible from the overall sectors. First, leverage or debt ratio is highly dependent on profitability (ROA and ROE) and liquidity whereas, the long term debt highly dependent on tangibility, ROE and firm size. These variables seem to be the most important determinant factors relating to leverage or debt ratio. Secondly, profitability maintains a negative relationship with debt ratio, which is consistent with the pecking order theory.
From the sectoral perspective, the result shows that the relationships between types of debt ratio and determinant factors, such as, tangibility, liquidity, ROA and firm size, differ across sectors. Secondly, the coefficient size of the explanatory variables across sectors are varies, although the variables are statistically significant either at 1%, 5% or 10% level. This reflects the degree of importance of each variable in the process of leverage or debt determination. The applicability of the capital structure theories diverge across sectors in Malaysia. In general, the significant relationship between firm-level capital structure determinants, and all types of leverage across sectors, provides evidence that the nature of each sector tends to influence the mechanism between leverage and capital structure determinants. It also shows that, the size of magnitude of each significant variable varies across sectors, and this reflects the impact of each variable in the process of leverage determination are also varies. In other words, the different sizes of coefficients imply the different degrees of economic significance of each determinant on capital structure decisions. Since total debt is largely relied on short-term debt, variables such as liquidity (LIQUID), return on assets (ROA), return on equity (ROE) and firm size (SIZE) react similarly to debt ratio.
In conclusion, this study has proved that overall public listed companies capital structure behaved in support to the pecking order theory and agency cost theory, instead of trade-off theory.
This chapter presents the overall summary of the study by highlighting the main findings of the hypothesis based on the research questions. Subsequently, the second section explains the contributions of this study towards the theory development and policy implications. This is followed by a discussion on the limitations of the study that leads to future research.
The main purpose of this study is to examine the relationship of determinant factors on capital structure of the public listed firms in Malaysia. Furthermore, the purpose of this study is to identify the different of determinant factors on capital structure across sectors of public listed firms in Malaysia. The sample for this study involves 100 listed companies for the period of ten years from 2002 to 2011 and focusing on five selected sectors which are property, industrial product, consumer product, trading and services, and plantation sector.
This study found that capital structure determinants vary across sectors due to the nature or the behavior of each sector. The results show most Malaysia firms employ a larger amount of short-term debt compare to long-term debt except in the property sector which utilized long term debt more than short term debt. Overall, the total debt financing is highly controlled by the short-term debt. Liquidity, ROA and ROE are significantly and negatively associated to total debt and short term debt. For tangibility and firm size, that are significant and has positive relationship to long term debt and ROE maintain negative relationship significantly to all types of debt ratio or leverage. This result is in support the pecking order theory which emphasizes that the profitable firms utilize their profits (internal funding) to finance their investments and use less debt or other external funds.
The impact of sector characteristics on capital structure determinants can be observed through the changes of sign and magnitude of the explanatory variable’s coefficients across sectors. The association between leverage and the explanatory variables also varies across sectors. Based on the overall sectors, leverage or debt is highly dependent on profitability (ROA and ROE), liquidity and tangibility. The profitability by ROE plays an important factor in determining total debt across sectors and it is significantly and negatively related to total debt for all sectors except in property sector where the result shows negative relationship significantly. Similar relationship is observed between ROE and long term debt across industrial product, consumer product, and trading and services sectors. For the tangibility, the variable it seems to be one of the most important variable that influences long term debt utilization across sectors, except in the plantation sector. A significant positive association to long term debt, give us indication that the firms tend to increase long-term debt as their tangibility capacity increases.
In this study, firm size (SIZE) also reacted in a different direction to the types of leverage across sectors The result shows that a different relationship pattern between firm size and short-term debt. The positive relationship is observed in the construction and property, and plantation sector significantly. While the firm size is negatively related to short term debt in the consumer product and trading and services sector. The finding of this study gives us indication that the behavior of each sector is unique and diverse across sectors. This diversity affects the relationship between leverage and capital structure determinants, particularly the firm-level determinants. In addition, the degree of significance and magnitude of coefficients further shows the effect of a unique sector rather than sectors or industries as a whole.
Overall, the finding of this study gives us evidence that the applicability of capital structure theories (the trade-off theory, agency theory and pecking order theory) diverge across sectors in Malaysia. In conclusion, the evidence suggests that profitability (ROA and ROE), tangibility, liquidity, and firm size are the main factors determining a firm's capital structure in Malaysia. However, the determinant factors are differ to the type of debt ratio or leverage and the sectors concerned.
The outcomes of this study contributes several contributions to the literature on capital structure theories and empirical evidence, particularly within developing countries. But, as the behavior of sectors is unique, generalizing the outcomes based on the overall sample might not reflect the actual behavior of each sector of a particular country. It is undeniable that the firm-level determinants consistently maintained their position as the primary determinants of a firm’s debt policy. Hence, this study fills the gap in the body of the literature pertinent to the capital structure determinants, and its importance to the capital structure decision-making by capturing the indirect impact of sectoral behavior across sectors among public listed companies in Malaysia.
Secondly, this study also fills the gap of empirical evidence in the context of developing markets. Most of the sector or industry-related studies were concentrated within the developed markets, while the developing markets are still under-explored due to data limitations. Furthermore, the divergence of capital market development across the emerging markets affects the capital structure decision-making across sectors. These findings become the main contribution towards emerging market evidence.
Thirdly, this study further extends the applicability of capital structure theories that are highly dependent on the types of leverage despite sector behavioral issues. The series of literature concludes there is a greater utilization of short-term debt across developing countries relative to developed countries. However, the evolution of leverage differs significantly across the emerging markets although the consumption of short-term debt is greater than long-term debt. Most of the relationships between total debt and capital structure determinants are highly influenced by the larger proportion of short-term debt. Therefore, similar relationships are observable between the total debt and short-term debt. These findings have huge implications on the capital structure theories as the application of these theories should be based on the types of leverage rather than the total leverage.
Fourthly, this study may provide some guideline for management to consider the appropriate determinants of sector-specific capital structure in their capital structure decision-making. Effective and efficient decision-making leads to cost reductions and, thus, maximizes the wealth of the shareholders.
Finally, the outcomes of this study could be beneficial for the banking institutions in Malaysia. The corporate lending procedures and evaluations could take into consideration the underlying determinants that are sector or industry-specific rather than depending on the general determinants. The differential types of leverage across sectors demonstrate different debt financing patterns across sectors and, hence, provide a good benchmark for firms within each sector in Malaysia.
There are several limitations that may represent possibilities for future research. Firstly, this study only limit the data on 100 listed companies on Bursa Malaysia as a sample due to limited time to conduct the study. Data limitations seem to be the primary problem as the study focuses on Malaysia, one of the emerging markets. First, the study excludes the information on market values due to the limited data that only caters for a shorter period of observations. In order to maintain a larger sample size over a longer period, the market values are excluded from this study. Therefore, this study is mainly restricted to book values of debt, namely, total debt, long-term debt and short-term debt, as the dependent variables.
Thirdly, as it is difficult to obtain data for each firm on specific variables during different time periods, firms with missing data were excluded from the study. The numbers of firms could be increased if the numbers of variables or the sample period of the study were reduced. In relation to the country-level determinants, the study adopts the ratio of liquid liabilities to GDP to proxy the debt market development, instead of using the ratio of bond market capitalization to GDP data. This is because the sample period of this study covers from 1996 until 2007, while the data is only available after 2001. Despite the data limitations, this study imposed some boundaries within the context of the capital structure literature, as the model excludes ownership structure variables that are highly consistent with the agency theory. Likewise, this study did not address the influence of Islamic financing on the capital structure decision-making, as the Islamic bond market is progressing successfully and contributes towards the development of the capital market of Malaysia.
Based on the result of the study, a few recommendations that can be applied for future research. Extension of the sample size, sample periods, and variables of the study may provide a better understanding of an additional sub-period as the country experiences the world credit crunch crisis in early 2008. Other than that, the future study could address the impact of Islamic financing on firms’ capital structure across sectors. A comparative analysis between the conventional and Islamic financing could be undertaken within each sector or industry.
This study highlights the sensitivity of capital structure determinants in each sector within the groups of Malaysia listed companies. Based on the panel data regression analysis, the findings of this study reveal that the relationship between capital structure determinants and leverage vary across sectors due to the nature or characteristics of each sector. This study also demonstrates that overall sample results do not provide the actual mechanism between leverage and capital structure determinants. As the scope becomes narrower, the indirect impact of sectoral behavior on capital structure determinants can be observed through the changes of sign and magnitude of the explanatory variables’ coefficients across seven sectors.
Nevertheless, the overall analyses reveal that the orientation between firm-level determinants and leverage is greatly influenced by each sector’s characteristics that control the direction of relationships and the degree of significance. The artificial nested testing procedure provides the preferred model which is customized according to each sector. This model selection is strongly dependent on types of leverage and sectors. Finally, the results are broadly consistent with the prominent capital structure theories, and the applicability of these theories is highly dependent on the uniqueness of each sector in Malaysia.
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