You are on page 1of 24

FALL 2011

CORPORATE FINANCETERM REPORT


FACTOR INFLUENCING THE CAPITAL STRUCTURE OF TOBACCO SECTOR COMPANIES IN PAKISTAN

SUBMITTED TO: SIR JAMAL ZUBERI SUBMITTED FROM: FARAZ HALEEM SYED MUHAMMAD ALI FARAZ ILLAHI SECTION: A

10226 10320 10245

ACKNOWLEDGEMENT
We would like to thank Almighty Allah without whose blessings we would not had this opportunity to work on this report. We are indebted to quite a few people who had helped us from the beginning to the completion of this research report. Their timely and unconditional support has been a source of inspiration for the whole group which has made possible to complete our research report.

In the end, we would like to thank our teacher, Mr. H. Jamal Zubairi, Associate Professor and Head of Department of Accounting and Finance at our Institute of Business Management for his guidance throughout the project and has been acting as a facilitator and a mentor during this time and his unconditional support has been the source of motivation to perform at our best. Thank you Sir.

LETTER OF TRANSMITTAL
December 28th, 2011

REPORT ON FACTOR INFLUENCING THE CAPITAL STRUCTURE OF TOBACCO SECTOR COMPANIES IN PAKISTAN

Dear Readers: Our team has completed the report on Factor Influencing the Capital Structure of Tobacco Sector Companies in Pakistan, which is enclosed herewith. This report is a summary of our research findings from the work that we completed during the December 2011. We completed the report on schedule and try our level best to cover the highlights of the topic. This report provides information regarding the concept of Capital Structure in Pakistani Tobacco Companies, what are the structures of different companies, there related Policies, Corporate Strategies and their effectiveness with a brief survey conducted. We hope that this report will give you a broad understanding about the topic.

Yours sincerely,
NAMES Faraz Haleem Syed Muhammad Ali Faraz Illahi ID 10226 10320 10245 CONTACT NUMBER 0333-7441212 0346-2211459 0332-3516339

TABLE OF CONTENT
Contents
Static Trade off Theory: ................................................................................................................................ 9 Pecking Order Theory: .................................................................................................................................. 9 Signaling theory: ........................................................................................................................................... 9 RESEARCH REVIEW ...................................................................................................................................... 11 Capital structure: ........................................................................................................................................ 12 Growth Rate: ........................................................................................................................................... 12 Market Conditions: ................................................................................................................................. 12 DEPENDANT VARIABLES:............................................................................................................................. 14 INDEPENDANT VARIABLES: ......................................................................................................................... 14 Pooled Regression Analysis ......................................................................................................................... 16 Linear regression ..................................................................................................................................... 16 PEARSON CORRELATION: HYPOTHESIS AND METHODOLOGY ................................................................... 17 The Regression Model ................................................................................................................................ 18 Table-1: Descriptive Statistics (3-year summary) ....................................................................................... 19 Regression Analysis Results ........................................................................................................................ 20 Table-3.1: Regression Model Summary .................................................................................................. 20 Table-3.1: Regression Model Summary ........................................................................................... 20 Table-3.2: ANOVA (b) .............................................................................................................................. 20 Table-3.3: Regression Coefficients & their significance .......................................................................... 21

ABSTRACT
Signifying the optimal capital structure is a critical decision for any organization. This result is important to maximize returns and to find the impact of such a decision on organizations ability. Still a well managed capital structure is extremely important to a firms profitability, performance as well as liquidity needs and helps to create good prosperity of the firm. This report investigates the factors influencing the capital structure of tobacco sector companies in Pakistan. This study analyzed two firms in the tobacco sector, listed at the Karachi Stock Exchange for the period 2009-2011 quarterly using pooled regression in a panel data analysis. The results show that these six independent variables explain 98% of variation in the dependent variables, only two variables which are tangibility of the assets and size of the firm, were found to be highly significant. The objective of this research study is to determine the influence of profitability: Return on Assets (ROA) and Return on Equity (ROE), Size of the Firm (SZ), Growth (GT), Liquidity (Quick Ratio), Tangibility of Assets (TG) and Non-debt tax shield (NDTS) on the capital structure of tobacco sector companies in Pakistan and this was to be tested for consistency of the results over the range of data. The research holds importance for researchers, investors, analysts and managers. Similar research has been done by Jasir Ilyas in 2005 on combined non-financial sector of Pakistan. The variation of Tobacco sector in Jasir Ilyass research was 99%. Jasir Ilyas used same statistical tool that we are using.

INTRODUCTION
In every business organization, capital is the main element to establish and run its business activities smoothly. Capital can be collected by using two sources which are debt capital and equity capital. Debt capital is collected by issuing debentures; bonds etc and this Debt Capital are related with fixed cost of capital. Equity capital can be collected issuing different shares like common stock, preferred stock etc. Therefore maintaining the balance of this capital is known as corporate capital structure. Capital structure of a company is a mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debts are in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also measured to be part of the capital structure. A company's proportion of short and long-term debt is considered when analyzing capital structure. When people refer to capital structure they are most likely referring to a firm's debt-toequity ratio, which provides insight into how risky a company is. Usually a company more heavily financed by debt poses greater risk, as this firm is relatively highly levered. It is not possible to have an ideal capital structure, however, the management should target capital structure and initial capital structure should be framed with subsequent changes in initial capital structure to have it like target capital structure. Some companies do not plan capital structure but they are still achieving a good prosperity. There are significant variations in the capital structures of different industries and different companies. There are many factors that affect capital structure. Following are the basic factors which should be kept in view while determining the capital structure:Growth and stability of sales of firms that are growing rapidly generally need larger amount of external capital. The floatation costs associated with debt are generally less than those for common stock, so rapidly growing firms tend to use more debt. At the same time, however, rapidly growing firms often face greater uncertainty which tends to reduce their willingness to use debt. Firms whose sales are relatively stable can use more debt and incur higher fixed charges than a company with unstable sales Competitive structure or stability of profit margin of the firms with high rate of return on investment uses relatively little debt. Their high rate of return enables them to do most of their financing with retained earnings. If profit margin is constant more debt is used. The selection of capital structure is also influenced by the capacity of the business to generate cash inflows, stability, and certainty of such inflows. Regularity of cash inflows is much more important than

the average cash inflows. A company with unstable and unpredictable cash inflows can no longer afford to depend on debts. Cost of capital if the cost of capital is too high, borrowing is costly. So at that situation equity capital is preferable. As compared with other securities, the equity shares are more economical because they have least cost of capital. In the processing of trading, no more floatation costs, brokerage costs etc are incurred. The consideration of retaining "Control" is also very important. The ordinary shareholder can elect the directors of the company. If company sells the common stock, it will bring new voting investors into the firm, making the control difficult. To maintain control within the hand of limited members, a firm has to use more amount of debt or preferred stock because they have no management and voting right. If the firm wants to more equity shares the management right will be diversified. Marketability or lender's attitude refers to the readiness of investors to purchase a security in a give n period of time. The capital markets keep changing continuously. The capital structure will have to be customized to the attitudes of investors prevailing at the time of issue of capital. If investors demand preference shares, firm must have issue of preference share capital. Due to the changing market sentiments, the company has to decide whether to raise funds with a common shares issue or with a debt issue. Size of the company is another factor. The availability of funds is greatly influenced by the size of the enterprises. A small company finds it difficult to raise debt capital. The terms of debentures are less favorable to small companies so they have to rely on equity share and retain earning for funding business. Large companies are generally considered to be less risky by the investors and, thus, they can issue common shares, preference shares and debentures to the public. Floatation costs take place only when the funds are externally raised. Floatation costs consist of some or all of the following expenses; printing of prospectus, advertisement, underwriting and brokerage etc. Generally, the cost of floating a debt is less than the cost of floating an equity issue. This may lure the company to issue debt than common shares. The company will save in terms of floatation cost if it raises funds through large issue of securities but the company should raise only that much of funds which can be employed profitably. In large companies flotation cost is not a significant consideration. Development of capital market is an important factor in capital structure. It refers to the extent which the capital market is developed (i.e. equity or debt market). More developed equity market means more equity used and less developed equity means less equity used. Similarly, more developed debt market means more debt used and vice versa.

The growth opportunities of business can be either tremendous or very low. Depending upon the growth opportunities the debt ratio fluctuates. Higher growth opportunities exist then higher debt is used otherwise vice versa. Agency costs are another factor in determining the capital structure. While determining capital structure, having least agency cost is preferred but if there is agency problem than debt is used largely for funding the business. Other sources of tax shield In order to take the advantage of low tax, borrowing is preferable for a firm because interest is considered as deductible expenditure according to the income tax law. But dividends are not considered deductible expenses and they are paid out of profits after tax. Level of economic development is high then more debt is required. Level of economic development plays significant role in capital structure. Wherever economic development is taking place investors will be looking to invest there E.g. - In countries like China and India where economic conditions are very suitable for business, investors from all over the world are willing to invest in such countries.

THEORETICAL FRAMEWORK
Static Trade off Theory:
Myers (1984) divides the contemporary thinking on capital structure into two theoretical currents. The first one is the Static Tradeoff Theory (STT), which explains that a firm follows a target debt-equity ratio and then behaves accordingly. The benefits and costs associated with the debt option sets this target ratio. These include taxes, cost of financial distress and agency cost. (1) As the interest payments are a tax-deductible expense, they decrease the tax liability thus providing cash savings. Therefore Firms will use a higher lever of debt to take the advantage of tax benefits if the tax rates are higher. If the firms incur losses, this tax benefit will fade away. So if the operating earnings are enough to meet the interest expense then firms will get the benefit of tax deductibility of interest expenses.
(2) As the level of debt increases the chance that a company default increases so there must be an optimal level of debt. If the firm goes ahead of this optimal point it will default on the repayment of the loan due to which the control of the firm will be shifted from shareholders to bondholders who will try to recover their investments by liquidating the firm. A firm may face two types of bankruptcy costs due to this, direct and indirect costs. Direct costs include the administrative costs of the bankruptcy process, if the firm is large in size; these costs constitute only a small percentage for the firm. The indirect costs occur because of change in investment policies of the firm in case the firm foresees possible financial distress. In order to avoid bankruptcy, the firm will cut down expenditures on research and development, training and education of employees, advertisements etc.

Pecking Order Theory:


The Pecking Order Theory (POT) put forward by Myers (1984) and Myers and Majluf (1984), states that firms follow a chain of command of financial decisions when establishing its capital structure. Initially, firms prefer to finance their projects through internal financing i.e. retained earnings but if they need external financing, they first they apply for a bank loan then for public debt and as a last resort, the firm will issue equity to finance its project. Pecking Order Theory has a more important effect on capital structures for firms that are managed in the interests of equity holders, rather than the combined interests of debt and equity holders. However, when financial distress costs are high, equity-maximizing and value-maximizing firms make similar capital structure choices.

Signaling theory:
This approach, originally developed by Ross (1977), explains that debt is considered as a way to highlight investors trust in the company, that is if a company issues the debt it provides a signal to the markets that the firm is expecting positive cash flows in the future, as the principal and interest payments on debt are a fixed contractual obligation which a firm has to pay out of its cash flows. Thus the higher level of debt shows the managers confidence in future cash flows. Another impact of the signaling factor is the problem of the under pricing of equity. If a firm issues equity instead of debt for financing its new projects, investors will interpret the signal negatively. Furthermore, acting as an agent to shareholders, the manager tries to appropriate wealth from bondholders to shareholders by incurring more debt and investing in risky projects.

TOBACCO SECTOR OF PAKISTAN


There are two firms in this sector and this research study includes all of them.. Variation is related to the values of independent variable. Profitability of the firm is negatively related to the firms leverage. Size of the firm in this sector is a significant variable according to the both regression techniques, showing negative relationship with the firms debt ratio. Thus the study accepts the null hypothesis of the study which states that with the increase in the size of the firm the debt financing decreases. The study accepts the hypothesis which states that with the increase in the Tangibility of the firm, debt to equity ratio also increases, as found in slope of the tangibility in both analysis techniques. This variable is found to be significant in both the analysis techniques. With the increase in the growth opportunity of the firm, the debt ratio of the firm also increases. The study found that the growth as independent variable is not significant in any of the regression techniques. For Non Debt Tax Shield as an independent variable the study rejects the null hypothesis as the study found that the slope of NDTS variable is directing towards the negative relationship of NDTS and firms leverage. However, both the tests were significant for the growth variable. The study rejects the null hypothesis regarding the Tax Rate and accepts the alternative statement of the study which states that with an increase in the tax rate the firms debt also increases.

LITERATURE REVIEW
RESEARCH REVIEW
Modigliani & Miller (1958) forms the basis for modern thinking on capital structure. The basic theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed. It does not matter if the firms capital is raised by issuing stock or selling debt. It does not matter what the firms dividend policy is. Jenson and Meckling (1976) developed agency cost hypothesis and identifying the two types of conflicts i.e. between shareholders and managers and debt holder and equity holders. Agency cost hypothesis suggests that firms managers are mainly interested to maximize their own benefits than to maximize shareholders wealth. Therefore, the stockholders of the firm try to discourage these interests by means of monitoring and control actions which also prospects cost i.e. agency cost. Myers and Majluf (1984) and Myers (1984) made a valuable addition in capital structure literature by providing Pecking Order and Static Trade-off Hypothesis respectively. According to the Pecking Order Hypothesis, the firm should follow specific hierarchy for financing its assets. Initially, the firm utilize internally generated fund i.e. retained earnings then debt and If more funds are required then assets are financed by equity capital. Trade-off hypothesis proposed that firm should have optimal capital structure based on balancing between the benefits of debt and costs of debt. In other words, firm sets target debt-equity ratio according to the nature and requirements of business and then gradually moves to achieve it. A study by Miao (2005) provides a competitive equilibrium model of capital structure and industry dynamics. In the model, firms make financing, investment, entry, and exit decisions subject to idiosyncratic technology shocks. The capital structure choice reflects the tradeoff between the tax benefits of debt and associated bankruptcy and agency costs. The interaction between financing and production decisions influences the stationary distribution of firms and their survival probabilities. The analysis demonstrates that the equilibrium output price has an important feedback effect. This effect has a number of testable implications. For example it implies that high growth industries have relatively lower leverage and turnover rates. Filbeck and Krueger (2005) highlighted the importance of efficient working capital management by analyzing the working capital management policies of 32 non-financial industries in the US. Their findings reveal that significant differences exist among industries in working capital practices over time.

IMPORTANT TERMS
Capital structure: The capital structure shows the way a corporation finances itself through
combination of equity sales, equity options, bonds, and loans. Optimal capital structure refers to the combination that minimizes the cost of capital in order to maximize maximizing the stock price. Factors that Influence a Company's Capital-Structure Decision:Business Risk: Business risk of a company is the basic risk that company faces due to its operations. The larger the business risk, the minor the optimal debt ratio of the company. Company's Tax Exposure: all the debt payments of a company are tax deductible. If a company's tax rate is high, using debt to finance a project is attractive because the tax deductibility of the debt payments protects income from taxes. Financial Flexibility: Financial flexibility is essentially the firm's ability to raise capital in bad times. Companies should make an effort to be careful when raising capital in the good times without expanding its capabilities too far. A company is more financially flexible when it has lower debt level. Management Style: when management's approach is more conservative, it is less inclined to use debt to increase profits. An aggressive management may try to grow quickly and can use large amounts of debt to speed up the growth of the company's earnings per share (EPS).

Growth Rate: Firms that are in the growth stage borrowing money to grow faster through debt financing but high debt load is not appropriate. More stable and mature firms typically need less debt to finance growth as its revenues are stable.

Market Conditions: Market conditions influence company's capital-structure condition. If the investors are limiting companies' access to capital because of market concerns, the interest rate to borrow may be higher than a company would want to pay. In that situation, it may be prudent for a company to wait until market conditions return to a more normal state before the company tries to access funds for the plant.

SAMPLE SIZE AND SOURCE OF DATA


Our study is about the Tobacco sector of Pakistan. The study used in the financial data of these firms is over the years of 2009-2011 Quarterly. The data is obtained from balance sheet, income statement and cash flow statements of these companies quarterly reports. The sample size for the report is 2 companies and they are: 1. Pakistan Tobacco 2. Phillip Morris

DEPENDANT & INDEPENDENT VARIABLES DESCRIPTION


We used total of eight variables in our study and they are as follows: Leverage (CS), Tangibility of Assets (TG), Firm Size (SZ), Growth (GT), Return on Assets (ROA), and Return on Equity (ROE), Quick Ratio (QR) and Non-debt tax shield (NDTS). These variables were used to identify positive or negative impact on the capital structure of tobacco sector companies in Pakistan and are explained in detail below.

DEPENDANT VARIABLES: A. Leverage: CS = Total Debt / Total Assets


Leverage refers to the percentage of assets financed by debt and it is calculated by taking the total debt as a percentage of total assets. It shows the level to which an investor utilizes borrowed money. Highly leveraged companies may be at risk of bankruptcy if they are unable to make payments on their debt. Leverage can increase the shareholders return on their investment and often has tax advantages

INDEPENDANT VARIABLES: B. Tangibility of assets: TG = Fixed Assets / Total Assets


Its a measure of the extent to which fixed assets are financed with owners equity. High ratio indicates an inefficient use of working capital which reduces the companys ability to carry accounts receivable and maintain inventory and usually means a low cash reserve. This will often limit the ability to respond to increased demand for products or services. Tangibility of assets should be calculated as the ratio of fixed assets to total assets.

C. Firm Size: SZ = Log (sales)


Size of the firm should be measured by taking the natural log of the sales to smoothen the variation over the periods considered. The size of a firm plays an important role in determining the kind of relationship the firm enjoys within and outside its operating environment. The size of a firm has a significant impact on the capital structure. The larger the firm, the greater the influence it has on its stockholders as the larger size firms have enough resources.

D. = Increase in asset value this year over last year / last year value
This shows the percentage increase in Total Assets over the period of years.

E. Return on Total Assets (ROA): ROA = (Net Income / Total Assets) x 100
It indicates how profitable a company is relative to its total assets and how efficiently a company manages its assets in order to generate income. It tells you what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry that is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or the ROA of a similar company.

F. Return on Equity (ROE): ROE = (Net Income / Shareholders Equity) x 100


ROE measures the rate of return on the ownership interest (shareholders' Equity) of the common stock owners. It is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is equal to a fiscal year's net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares).

G. Quick Ratio: QR = (Current Assets Inventory) / Current Liabilities


QR is an indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. It is also known as the "acid-test ratio" or the "quick assets ratio". The basics and use of this ratio is similar to the current ratio in that it gives users an idea of the ability of a company to meet its short-term liabilities with its short-term assets. If the current ratio is significantly higher, it is a clear indication that the company's current assets are dependent on inventory.

H. Non-Debt Tax Shield: NDTS = Annual depreciation charges / Total Assets


A reduction in taxable income for an individual or corporation achieved through claiming allowable deductions of depreciation and annual investment tax credits. These deductions reduce taxpayers' taxable income for a given year or defer income taxes into future years. It is calculated by dividing annual depreciation charges by the Total Assets of the company.

STATISTICAL TOOLS
The software we are using to develop hypothesis and analyze the data is SPSS (Statistical Package for Social Sciences) which is a computer program for statistical analysis. The statistical tools used for analyzing the data are:-

Pooled Regression Analysis


Linear regression is an approach to modeling the relationship between a scalar variable y
and one or more variables denoted X. In linear regression, data are modeled using linear functions, and unknown model parameters are estimated from the data. Such models are called linear models. Most commonly, linear regression refers to a model in which the conditional mean of y given the value of X is an affine function of X. Less commonly, linear regression could refer to a model in which the median, or some other quartile of the conditional distribution of y given X is expressed as a linear function of X. Like all forms of regression analysis, linear regression focuses on the conditional probability distribution of y given X, rather than on the joint probability distribution of y and X, which is the domain of multivariate analysis.

HYPOTHESIS
PEARSON CORRELATION: HYPOTHESIS AND METHODOLOGY
The object of the study is to see the linkage of financial indicators to Capital Structure which is the Leverage (CS) of tobacco industry. In order to achieve this objective we tested the following hypotheses: Ho: Tangibility of Assets (TG) is not directly related to Leverage (CS) of the firm. H1: Tangibility of Assets (TG) is directly related to Leverage (CS) of the firm. Ho: Firm (SZ) is not directly related to Leverage (CS) of the firm. H1: Firm (SZ) is directly related to Leverage (CS) of the firm. Ho: Growth (GT) is not directly related to Leverage (CS) of the firm. H1: Growth (GT) is directly related to Leverage (CS) of the firm. Ho: ROA is not directly related to Leverage (CS) of the firm. H1: ROA is directly related to Leverage (CS) of the firm. Ho: ROE is not directly related to Leverage (CS) of the firm. H1: ROE is directly related to Leverage (CS) of the firm. Ho: Quick Ratio (QR) is not directly related to Leverage (CS) of the firm. H1: Quick Ratio (QR) is directly related to Leverage (CS) of the firm. Ho: Non-debt tax shield (NDTS) is not directly related to Leverage (CS) of the firm. H1: Non-debt tax shield (NDTS) is directly related to Leverage (CS) of the firm.

EMPIRICAL RESULTS & ANALYSIS OF THE FINDINGS


The Regression Model
This study uses panel regression analysis. Panel data analysis facilitates analysis of crosssectional and time series data. We use the pooled regression type of panel data analysis. The pooled regression, also called the Constant Coefficients model, is one where both intercepts and slopes are assumed constant. The cross section company data and time series data are pooled together in a single column assuming that there is no significant cross section or inter temporal effects.

Therefore the equation for our regression model will be: CS = 0 + 1 (TG) + 2 (SZ) + 3 (GT) + 4 (ROA) + 5 (ROE) + 6 (QR) + 7 (NDTS)

Where CS = Leverage TG = Tangibility of assets SZ = Firm Size measure by Log of sales GT = Growth ROA = Return On Assets ROE = Return On Equity QR = Quick Ratio NDTS = Non-debt text shield

Analysis & Results


This section contains the results of the descriptive and regression analysis. Table 1 shows the summary of descriptive statistics for the variable values in the sample (11 quarters over a period of 3 years, for each company).

Table-1: Descriptive Statistics (3-year summary)

Variable CS TG SZ ROA ROE QR NDTS GT

Mean 0.4758 0.4296 14.47 0.0669 0.1378 0.4645 0.0135 0.0547

StDev Minimum 0.1831 0.1556 0.0711 0.3395 1.299 11.61 0.0381 0.0932 0.4510 0.0024 0.1512 -0.0054 -0.0191 0.0672 0.0100 -0.1746

Maximum 0.7157 0.5754 15.68 0.1704 0.3919 1.7729 0.0190 0.3520

Theoretically, total debt/total assets ratio should be less than one or one at maximum. Theoretically speaking, fixed assets/total assets too should be lower than one. However, we use gross fixed assets/ total assets ratio as a measure of tangibility. According to output, our variables are lying between -1 and +1, same as in Jasir Ilyas.

Regression Analysis Results


The following tables present the results of pooled regression analysis.

Table-3.1: Regression Model Summary

Table-3.1: Regression Model Summary


Model R 1 .986 Adjusted R R Square Square .973 .959 Std. Error of the Estimate .036821

a. Predictors: (Constant), Growth, Non-Debt Tax Shield, Return on Equity, Quick Ratio, Tangibility of Assets, Size of the firm, Return on Assets b. Dependent Variable: Leverage

Table-3.2: ANOVA (b)


Model
1

Sum of Squares Regression Residual Total 0.685 0.018 0.704

df 7 14 21

Mean Square 0.097 .001

F 72.247

Sig. .000a

a. Predictors: (Constant), Growth, Non-Debt Tax Shield, Return on Equity, Quick Ratio, Tangibility of Assets, Size of the firm, Return on Assets b. Dependent Variable: Leverage

Table-3.3: Regression Coefficients & their significance


Unstandardized Coefficients Model
1

B (Constant) Tangibility Firm Size Growth ROA ROE Quick Ratio NonDebt TaxShield -0.381 1.379 0.048 0.137 -4.302 1.411 -0.094 -0.229

Std. Error 0.128 0.512 0.012 0.085 0.902 0.422 0.030 0.105

t Stat -2.979 2.694 3.922 1.611 -4.768 3.339 -3.064 -2.168

p - value 0.009 0.017 0.001 0.129 0.0003 0.004 0.008 0.047

Regression Equation
CS = - 0.381 + 1.379 TG + 0.048 SZ + 0.154 GT 4.302 ROA + 1.411 ROE 0.094 QR 0.229 NDTS

The above tables show the results of the regression analysis. The value of R-square (R2=0.973: Table 3.1) shows that the four variables i.e. growth, size, profitability and tangibility, non debt tax shield and quick ratio explain nearly 98% of variation in the response variable leverage. This means that the choice of capital structure is mainly defined by these six variables in the tobacco sector. The Adjusted R-square is slightly below the R2.

Expected & Observed Relationships:

Determinant Tangibility Firm Size Growth Profitabilty: ROA Profitability: ROE Quick Ratio Non Debt Tax Shield

Measure Fixed Assets/Total Assets Log Of Sales percentage of increase in total assets ROA ROE Net current assets/current liabilities Annual Depriciation/current liabilities

Expected Relationship Direct Inverse Direct Inverse Inverse Inverse Inverse

Observed Relationship Direct Direct Direct Inverse Direct Inverse Inverse

Conclusion
In this study we analyzed a sample of 2 firms in the tobacco sector by using a pooled regression model to measure the determinants of capital structure of the firms in the Pakistan tobacco industry. The results were found to be as expected, besides firm size and ROE. Firm size is positively correlated with leverage thus suggesting that the bigger the firm size the more debt they will use. Thus the results comply with the Static Tradeoff Theory, which expects a positive relationship between firm size and leverage.

Bibliography
Journal of Managerial sciences volume 2 by Jasir Ilyas o www. philipmorrispakistan.com.pk/ www.ptc.com.pk Fama, E., 1980, Agency Problems and Theory of the Firm, Journal of Political Economy, Vol. 88, No. 2

Frank, M.Z. and Goyal, V.K., 2003a, Testing the pecking order theory of Capital structure. Journal of Financial Economics, Vol. 67

Harris, M. and A. Raviv, 1990, Capital structure and the informational role Of debt, Journal of Finance 45, 321-349.

Modigliani, F. and Miller, M.H., 1958, The Cost of Capital, Corporation Finance and the Theory of Investment, the American Economic Review, Vol. 48, No. 3

Modigliani, F. and Miller, M.H., 1963, Corporate Income Taxes and the Cost of Capital: A Correction, the American Economic Review, Vol. 48, No. 3

You might also like