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Determinants of Capital Structure

An Empirical Study from UK Firms


Lujie Chen


A dissertation presented in part consideration for the degree of MA Finance and Investment


I would like to extend my appreciation and greatest gratitude to my supervisor Mr. Mark Billings for his support and guidance throughout my dissertation period. This dissertation cannot be completed without him.

I thank all lecturers and staffs of Nottingham University Business School for their help and effort.

I also would like to thank my parents for always being so supportive. Their enduring love inspires me throughout my studies in the United Kingdom.

Finally, I thank all friends I have met in Nottingham for giving me such a memorable year. I especially appreciate the support from Xiao Zang, who has always accompanied me throughout my hard time.


Capital structure has been one of the most controversial issues in the ground of finance during past years. There are a number of existing theories and empirical studies observing patterns involved in choosing a capital structure, however until now, there is no universal one. With the objective to provide an insight into determinants influence a firm’s level of debt, we apply ANOVA and multiple regression analysis of secondary data on 80 UK public companies operating in 10 industries. In addition, the study on the impacts of revised IAS 19 on pension deficit makes this dissertation differentiated from existing ones. We divide the time span into pre-pension scheme period 2001-2004 and post-pension scheme 2005-2006 to examine how the adjustment at balance sheet affects firms’ capital structure. The study demonstrates a disparity between empirical results and theoretical predictions. Overall, the model has a relatively low explanatory power and most of variables themselves show a conflicting sings and levels of significance in terms of long-term and short-term debt ratios. Growth rate, firm size, tax shields and asset compositions are significantly correlated to particular type of debt in different time period. In addition, firms do adjust their leverage ratios facing the disclosure of pension fund as a part of longterm liability. This research provides analysis tools for financial managers when looking to raise capital and assists managers with indications of what the market is anticipating. However, unavoidable research limitations suggest further studies.

## Key words: Capital Structure Leverage, Liability Pension Scheme


CHAPTER 1: INTRODUCTION......................................................................................8 1.1 Capital Structure.......................................................................................................8 1.2 Research Objectives ................................................................................................9 1.3 The Structure of the Research .................................................................................10 CHAPTER 2: LITERTATURE REVIEW ........................................................................7 2.1 Theories and Empirical Studies Review...................................................................12 2.1.1 M&M Theory without Taxes ...........................................................................12 2.1.2 M&M Theory Correction................................................................................19 2.1.3 M&M Theory with Corporate and Personal Taxes ........................................22 2.1.4 Static Trade-off Theory..................................................................................25 Cost of Bankruptcy and Financial Distress……………………………..25 Financial Distress and Taxes Saving…………………………………...27 2.1.5 Pecking Order Theory……………………………………………………………30 2.1.6 Pecking Order Theory VS. Static Trade-off Theory………………………..…32 2.2 Overview of Pension Scheme and Accounting Standards…………………………..34 2.3 Worldwide Capital Structure Patterns.....................................................................35 CHAPTER 3: METHODOLOGY........................………….............................................37 3.1 Dependent Variables...............................................................................................37 . 3.2 Independent Variables and their Expected Signs....................................................39 3.3 The Impact of Pension Fund……………………………............................................47 3.4 Data Description……………………………………....................................................48

3.5 Research Model……………………………………………………………………..…...49


........71 APPENDIX ..............5....63 4......2 Cross-sectional Research on Long-term Debt................64 4......................2 Impacts on Short-term Debt..........................4..……65 CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS................................................................................................................................................................................5..................................4.....................................79 Appendix One: Firms Financial Information Appendix Two: Tables of Coefficients Appendix Three: R2 Summary Appendix Four: Correlations between Independent Variables Appendix Five: Descriptive Figures from ANOVA Test 5 .........57 4..............................................................................50 3.....62 4..........3...........................58 4......................2 Multiple Regression Analysis………………………………………………50 CHAPTER 4: RESULTS ANALYSIS…………………...1 Effects of Industry Classification..........60 4..............6 Research Limitations…………………………………………………………….....................................................................................53 4................................................5 The Summary of Statistical Results.............................................54 4.............................................3 Cross-sectional Research on Short-term Debt..................1 One-way Analysis of Variance (ANOVA)............1 Impacts on Long-term Debt......................68 REFERENCES..............................4 Effects of Pension Scheme...

..............................................................56 Figure 10: Mean of Leverage Ratio by Industry for Post-pension Scheme Period....................... Deviation of Leverage by Industry for Post-pension Scheme Period…..........16 Figure 2: Expected Yield on Common Stock and Debt Ratio........28 Figure 8: Mean of Leverage Ratio by Industry.............................18 Figure 4: Cost of Capital and Debt Ratio………………..............…...............................56 Figure 9: Standard Deviation of Leverage Ratio by Industry..........21 Figure 5: Summary of M&M Propositions with Taxes................................LIST OF FIGURES Figure 1: Average Cost of Capital and Debt Ratio………………………………………...............23 Figure 7: Optimal Debt Ratio……………………………………………………………...........………………………………………………….22 Figure 6: Bond Market Equilibrium.................................17 Figure 3: Summary of M&M Propositions without Taxes.................61 Figure 11: Std...........62 6 ....

........................................................................LIST OF TABLES Table 1: Capital Structure of America’s Most Admired Companies......47 Table 6: Sample of Targeted Industries and Companies ……………………......…………..57 Table 11: Regression Results of Short-term Debt…………………………………...………….....…………….............................27 Table 3: Worldwide Capital Structure Patterns............59 Table 12: Comparison of Leverage between Pre-pension Scheme Period and Postpension Scheme Period………………………………………………..……60 Table 13: Comparison of Long-term Regression Results between pre-pension Scheme Period and Post-pension Scheme Period…………………………........……..........36 Table 4: Industry Classification and Leverage...... Table 9: Results from ANOVA………………………………………………………………54 Table 10: Regression Results of Long-term Debt………………………….....9 Table 2: Cost of Financial Distress and Bankruptcy..46 Table 5: Summary of Variable Indicators and Predicted Signs..52 Table 8: Signs and Significance of Independent Variables………………………………53..........................................................64 7 .........................49 Table 7: Summary of Collinearity Statistics ……………………………………………….............……………63 Table 14: Comparison of Short-term Regression Results between pre-pension Scheme Period and Post-pension Scheme Period……………………………...

There are various forms of debt and equities. They argue that in the existence of perfect financial market. capital is the proportion of firm value financed with debt.Chapter One: Introduction 1. In simple terms. hereafter M&M). Since then. we are next trying to provide an overview of existing theories on capital structure.1 Capital Structure Securities issued by corporations may be classified roughly as equity and debt. debt or hybrid securities. it is believed that companies should also adjust their target debt ratio. capital structure is irrelevant to firms’ value. The new policy requires the company to make an estimate of pension obligation at balance sheet and to recognize a defined benefit liability. The distinction between debt and equity is the basis for modern theory in finance area and practical issues of corporate capital structure. they attempt to find the particular combination that maximizes the overall market value of the firm. The aspect of long-term and shortterm debt is becoming especially important under the revised accounting policy. capital structure is not just ‘debt versus equity’. such as long-term debt. However. the leverage ratio (Emery et al. 2004). Capital structure refers to the way a corporation finance itself through some combination of equity. In the real complex world. Capital structure has been one of the most controversial issues in the theory of finance during past 40 years and now still there is no universal theory of the debt-equity choice. common shares and preferred shares. 2001). DeAngelo and Masulis (1980). especially the long-term debt. Kim (1986) and Modigliani (1982) further reconcile Miller’s equilibrium 1 IAS 19 refers to International Accounting Standard 19. Employee Benefits 8 . When firms are looking to raise capital. From 2005. The modern theory of capital structure began with the celebrated paper of Modigliani and Miller (1958.IAS 191. many economists have followed the path they mapped. short-term debt. since the total amount of liabilities appears to increase. Under the emphasis of transparency. The factor involved with choosing a capital structure are complex and the impact of each determinant on the value of firm are not always obvious. Some years later. and no reason to expect one (Myers. firms started to disclose pension fund as an individual item of long-term liability.

However. It is not appropriate to conclude that one theory is superior to another. % (Book Value) 46 12 193 8 0 8 0 35 31 50 Debt-to-Equity Ratio. which is as a result of asymmetric information.2 Research Objectives The empirical evidence shows consistent attributes of leverage ratios. which is to copy each other. In contract. as though there are definite reasons for following certain patterns. The pecking order theory stems from Donaldson (1961) and the key idea is that mangers raise new finance in a particular sequence. The main proponent of this theory more recently has been Myers (1984) and the implication is that there is no optimal capital structure because capital structure is simply the accumulation of past shortages of internal cash flow. and author’s calculation The above table illustrates that these companies take different approaches when looking to raise capital. 2005).with the existence of optimal capital structure and they generate a result that the firm’s optimal capital structure will involve the static trade-off between the tax advantage of debt and various leverage-related costs. Each type of model is particular good for certain explanations and has been argued by conflicting empirical studies. there is another leading theory called pecking-order theory. % (Market Value) 9 8 56 1 0 1 0 10 15 10 Source From: “America’s Most Admired Companies” Fortune (March 7. Some argue that firms are simply following the Behaviour Principal of Finance. The study of capital structure attempts to explain the mix of securities 9 . 1. we believe this is too simplistic. Table One: Capital Structure of America’s Most Admired Companies Companies Wal-Mart Berkshire Hathaway General Electric Dell Microsoft Johnson &Johnson Starbucks FedEx Southwest Airlines IBM Debt-to-Equity Ratio.

the treatment of pension scheme is a significant concern in our studies. the research questions are as following: What are the determinants of firms’ leverage in terms of both short-term and longterm borrowing? How does these determinants influence firms’ capital structure? How does the treatment of pension fund affect firms’ borrowing decision? 1. One-way Analysis of Variance (ANOVA) and Multiple Regression will be employed to observe the proposed determinants. the revised IAS 19 and the adjusted treatment of pension deficit at balance sheet will be introduced. Also. Bradley et al 1984. Different from previous studies. we will provide a detailed literature review on capital structure. we will distinguish long-term and short-term debt in order to observe different borrowing behaviour. 10 . In addition.3 The Structure of the Research This dissertation is organized into six chapters. Finally. data description and the research model will be presented in the later part of this chapter. As an extension of Bennett & Donnelly (1993). Most of previous researches focus on testing a single theory or testing the explanatory power of capital structure models on (Buser and Hess 1983. Chapter five is the conclusion to a summary of our study. Ozkan 2001). our research is aimed to help you to understand why some firms use a great deal of debt. while other firms use very little. To summary. In the next chapter (chapter 2). More importantly. We will in addition test on how this adjustment influences companies’ borrowing behaviour by dividing the time length into pre-pension scheme period 2001-2004 and post-pension scheme period 2005-2006. Chapter three is the research methodology which discusses the proposed determinants proxies and gearing measurement. we will look at 80 UK listed non-financial firms operating in 10 industries from 2001-2006. Titman and Wessels 1988.used to finance investment. By generating a cross-sectional data set. In chapter four. some implications and practical guidelines will be suggested. It contains both studies on existing theories of capital structure and empirical research on firms’ borrowing behaviour. we interpret our statistical results and some further issues regarding the validity of our research are discussed. Tizcinka and Kamma 1983.

MM’s theory is Strictly under the assumption of perfect capital market and real-world mangers do not follow MM by treating debt and equity indifferently. Contrast to the static trade-off theory. empirical studies of capital structure will be discussed as the guideline of proposed determinants. Finally. there is another view of how financing decision are made. Therefore. the summary of worldwide capital structure pattern will 11 . because there is a cost of financial distress. there is no universal theory of the debt-equity choice and no reason to expect one. This is “Pecking Order Theory”. almost any company has its own target debt-to-equity ratio to adhere. In 1963. The Modigliani-Miller results (1958) indicate that mangers cannot change the value of a firm by restructuring the firm’s securities. Based on these theories. MM proves that the increase in the cost of equity exactly offsets the higher proportion of the firm financed by low-cost debt. Nevertheless. introduced corporate tax into the model. 1963). Since the ground work by Modigliani and Miller (1958. which stems from Donaldson’s study (1961) and the key idea of pecking order theory is that mangers raise new finance in a particular sequence. In fact. numerous empirical studies observed how theories influence firm’s financing. Myers (1984) asserts that a firm’s optimal debt ratio is usually viewed as determined by a trade-off of the cost and benefits of borrowing. both the value of the firm and the firm’s overall cost of capital are invariant to leverage (Ross. Because of this. and obtained the revised conclusion. Myers (2001) argued that until now. numbers of theoretical and empirical studies have provided various predictions and explanation on corporation’s leverage behaviour. trade-off theory and pecking order theory. even though debt appears to be cheaper than equity. The reason for this is that as the firm increases its debt level. They argue that the increase of debt level can increase the value of the firm. They argue that the firm’s overall cost of capital cannot be affected as debt is substituted for equity. In this chapter. Modigliani and Miller relaxed those restraints. However. holding the firm’s assets and investment plans constant. Moreover.Chapter Two: Literature Review The study of capital structure attempts to explain the mixture of securities and capital sources used by companies to finance investment. the equity will become more risky and the cost of equity rises as a result. including MM theory. we will provide a theoretical literature review. such as corporate taxes. 2005). firm in real world are rarely 100% leveraged. many economists (including MM themselves) started to count other factors into their consideration.

be represented. Investors and firms can borrow and lend on the same terms. an idealization but one which is common in financial analysis. Competitive markets: many perfect substitutes for all securities and all market participants are price takers. This assumption can be counted within that of frictionless markets. Neutral or no personal taxes. No information and bankruptcy costs. In particular. of course.g. some investors (equity holders) may themselves be other firms (e. 12 . Taxes are neutral in the sense that the tax rate is the same across tax-payers. It is the fact that some investors do replicate the borrowing and lending strategies of firms. and financial assets are divisible. 2004) Costless capital markets: no transaction costs or barriers to transactions. it is obviously reasonable to say that terms on which investors can borrow or lend are the same with corporations do so. Under this case. They assume the existence of perfect capital market without taxes: (Bailey.1 M&M Theory Without Taxes Modigliani and Miller (1958) is a classic paper in the are of capital structure. the tax system is non-discriminatory. The assumption is. It is listed separately here in order to highlight the possibility that the assumption might not hold. which is sometimes referred to as ‘home made leverage’.e. This is the standard assumption required to give the arbitrage principle its predictive force. 2.1. and for all income sources i. financial intermediaries). The claim can be accepted in the aspect that MM-theorems do not require that every investor can undertake the same financial transactions as firm but only that a sufficient number can do so.1 Theories and Empirical Studies Review 2.

the earnings of the firm exceed its debt obligations in every possible outcome. In these ‘equivalent return’ classes. the return of equity in any firm is significantly correlated with ones in other firms. A risk class is defined as a set of firms. Propositions I-No Tax Consider any company and let X stands as the expected return on the assets owned by the company. This assumption plays a strategic role in the rest of the analysis. VU=PV(X)=X/kU (1) Where KU is the expected rate of return for shareholders of the unlevered firm 13 . Assume a company which has no debt in its capital structure. However. it is now generally accepted that the existence of risk classes is an inessential requirement and modern treatments tend to dispense with the assumption and rely on more abstract ways of applying the arbitrage principle. (Assume this must all be paid out as dividends). Value Additivity Principle is the central idea supported their analysis. Using the assumption of perfect capital market and the Value Additivity Principle. which says that if cash flow stream is split into a set of component streams then the present value of the original stream must equal the sum of the present values of the component streams. Existence of risk classes. Market value of the debt and the market value of common share are denoted by D and S respectively.In other word. M&M state that the value of the firm is unaffected by its choice of capital structure. which has an identical pattern of earnings and payoffs. The assumption that firms belong to risk class allows the arbitrage principle by enabling the payoffs of one firm’s equity and bonds to be replicated with another. With the satisfaction of perfect market. M&M derived the following two basic proportions and the extensions with respect to the valuation of securities in companies with different capital structures. with a constant perpetual net cash flow X.

issuing debt causes the required return on the remaining equity to rise. Proposition II. This process can be demonstrated as following: We know that VL=X/KL Where KL is the average cost of capital of the levered firm Therefore. (4) This is to say. KU=KL That is. shareholders of levered firms demanding higher returns than shareholders in all-equity companies.Now assume the company is partly financed by perpetual riskless debt. 14 . then we have VL=PV(X-ID) + PV (ID) (2) VL=PV(X)-PV(ID)+PV(ID)=PV(X) (3) Compare equation (3) and equation (1). If the value of the firm and the coupon rate are denoted as VL and I. the average cost of capital to any firm is completely independent of its capital structure and is equal to the capitalization rate of a pure equity stream of its class. which is the ratio of its expected return to the market value of all its securities. the market value of any firm is independent of its capital tructure and is given by capitalizing its expected rate of return at the k This proposition can be stated in an equivalent way in term of the firm’s average cost of capital K. with nominal value D. we have VU=VL. Base on the core financial principle that investors expect compensation for risk.NO Tax M&M’s second important insight is that even though debt is less costly to issue than equity.

(2) recognizing 15 . the required rate of return on equity for a geared company is equal to that for an ungeared company. we finally derived: KL=KU+(D/SL)*(KU-I) (12) In proportion II. M&M derived the above proportion concerning the rate of return on common stock in companies whose capital structure include some debt: the expected rate of return or yield KL. plus a premium for financial risk. we can obtain that KLSL= KU (SL+D)-ID (11) Divided by SL.VL=SL+D=(X-ID)/kL+ID/I (7) Where SL is the value of equity in leveraged company and we multiply both sides by KL to get: KLVL=X +KLD -ID (8) We know that X=KU(SL+D) (Remember that VL=VU) Then equation (8) becomes: KLVL= KU(SL+D) +KLD –ID And this equation can be reformulated as: KL (VL-D)=KU (SL+D)-ID (10) (9) According to equation (7). In words. on the stock of any company is the function of leverage. Some extensions of the Proportion I and II: M&M have extended those two propositions in a number of useful directions: (1) allowing for a corporate profits tax under which interest payment are deductible.

certain interpretation must be changed. and (3) acknowledging the presence of market imperfections which might interfere with the process of arbitrage. * * In their extension. the relation between common stock yields and leverage will no longer be the strictly linear one given by the original. the after-tax capitalization rate KL can be no longer identified with the ‘average cost of capital’ which is KL=X/VL. it can be shown that the market value of firm in each risk class must be proportional in equilibrium to their expected return net of taxes. ( Modigliani and Miller.the extension of a multiplicity of bonds and interest rates. Although the form of propositions is unaffected. proposition I remains unaffected as long as the yield curve is the same for all borrowers. In particular. It has been stated that the difference between KL and the true average cost of capital is a matter of some relevance in connection with investment planning within the firm. corporation finance and the theory of investment’. 1958) By the same type of proof used for the original version of proportion I. 16 . (Figure 1) Figure One: Average Cost of Capital and Debt Ratio Source Adopted From: M&M (1958) ‘ The cost of Capital.

which is shown as LK in figure 2. the yield curves of proposition II are a consequence of the more fundamental proposition I. the lower yield of the shares being thus offset by the higher return on bonds. the relation would be consistent with the line of MN. By contrast. The later would find it profitable to own a pro-rata share of the firm as a whole by holding its stock and bonds. This demand would be reinforced by the action of arbitrage operators. After all. 1958) A summary of the main M&M theory results without taxes can be presented as following: 17 . if the interest rate (I) increase with leverage. Beyond some high level of leverage. (M&M. Should the demand by the risk-lovers prove insufficient to keep the market to the peculiar yield curve MD.According to proposition I. other than lotteries buyers. would purchase stocks in this range. Figure Two: Expected Yield on Common Stock and Debt Ratio Source Adopted From: M&M (1958) ‘ The cost of Capital. corporation finance and the theory of investment’ Also. yet at a decreasing rate. the yield may even start to fall. the expected return on common stock (KL) still tend to rise as D/S increase. with a constant rate of interest. M&M explain the downward sloping part of the curve MD using some examples as why investors. The correlation between KL and D/S should go with the curve MD in figure 2.

retained earnings. This is especially true in the case of common stock financing. and only if KL##≥KL. That is. and common stock issues. this dose not mean that the owners or managers have no reasons for preferring one financial plan to another. To establish this result. moreover. In summary. They have shown. it will create an investment opportunity if and only if the rate of return on the investment (KL##) is as large as or larger than KL. managers who operate business in imperfect market know how to choose one capital structure over another. M&M derive a simple rule for optimal investment policy. an investment is worth undertaking if.Figure Three: Summary of M&M Propositions Without Taxes Summary of Modigliani-Miller Propositions Without Taxes: Assumption: The existence of perfect market Results: Proposition I: VL=VU Proposition II: KL=KU+(D/SL)*(KU-I) Intuition: Proposition I: The market value of a company is independent of its capital structure. or that there are no other policy or technical issues in finance at the level of the firm. the cut-off point for investment in the firm will in all cases be KL and will be completely unaffected by the type of securities used to finance the investment. Proposition I implies M&M’s irrelevant theory and asserts that that is not worth concerning the issue of the optimal capital structure for a firm. They are bonds. Proposition II: The required rate of return on equity for a geared company is equal to that for an ungeared company. In each case. However. M&M propositions are important in modern finance because by understanding why capital structure has no value impact in ‘perfect market’. M&M consider three major financing alternatives open to the firm. how the theory of firm value can lead to an 18 . plus a premium for financial risk. If a firm in class risk k is acting in the best interest of stockholders for any financial decisions. Proposition III− No Tax: On the basis of their propositions with respect to cost of capital and financial structure.

To this extent. Their modified work illustrates that even though one firm may have an expected return after taxes twice that of another firm in the same class.PV(ID) (16) Based on equation (14) VU=PV(1-T)X and PV(ID)=D. More importantly. tax rate as well as leverage level.2 M&M Theory Correction Modigliani and Miller (1963) ‘Corporate Income Taxes and the Cost of Capital’ made a correction on their previous paper regarding the effects of the present method of taxing corporations on the valuations of firms.1. On an after tax basis: VU=PV {(1-T)X } VL=PV{(1-T)(X-ID) }+ PV (ID) (14) (15) Note that interest is deducted before tax is calculated. 2. the result is restricted by a number of assumptions and is not suggested for practical guidelines. if the two firms have different degree of leverage. However. They also assert that within any class. the quantitative difference between the valuations implied by their propositions and by the traditional view is narrowed. we finally get VL=VU+TD (17) 19 . it will not be the case that the actual expected return after taxes of the first firm will always be twice that of the second. arbitrage will make values a function of expected after-tax returns. they state that the tax advantages of debt are somewhat greater than what have been originally suggested. The introduction of a corporation tax system makes a difference to the traditional proposal that capital structure is irrelevant. the equation 11 becomes: VL=PV(1-T)X -PV(ID)+T∗PV(ID)+PV(ID)=PV(1-T)X+T. therefore.operational definition of the cost and how that concept can be used as a basis for rational investment decision-making within the firm.

the presence of debt increases the value of the firm and under the consideration of corporate taxes. firms are not financed by 100% debt in the real world due to the cost of financial distress. the value of the firm is increased.Obviously. we obtain: KLSL=KUSL+KUD(1-T) -ID(1-T) Finally. every more debt the firm raises. we get KLSL=(X-ID)(1-T)=X(1-T)-ID(1-T) It can be re-written as: KLSL =KU(VL-TD)-ID(1-T) (20) (19) Because we know that VL=SL+D Equation (20) can be expressed as : KLSL =KU(SL+D)-KUTD-ID(1-T) (21) Re-arange this equation. Similarly. However. the cost of equity in the geared up firm consequently changes. firms physically should use as much debt finance as possible. Start from VL=SL+D. which can be rewritten as: VL=(X-ID)(1-T)/KL + D (18) Take D from both sides and multiply KL. In other words. we have KL=KU+D(1-T)(KU-I)/SL (23) (22) The weighted average cost of capital under a tax system can also be derived as: 20 .

However. the cost of equity increases as a result of increasing financial distress. when firms gear up. A summary of the main M&M theory results with taxes can be presented as following: 21 .WACC=KLSL/VL+I (1-T)D/VL (24) The equation can be expressed by the following figure Figure Four: Cost of Capital and Debt Ratio # Note that Ki in the figure refers to our ‘KL’ and the rest indicators are the same with our analysis Source Adapted From: M&M (1963) ‘Corporate Income Taxes and the Cost of Capital: A correction As we increase the amount of debt in the capital structure the WACC falls and tends to towards at i. the rise is not at such a rate as to outweigh the tax shield on debt. which is the extreme gearing level. Moreover.

3 M&M Theory with Corporate and Personal Taxes M&M theories suggest that managers either should not worry about the capital structure decision or should borrow as much as possible to minimize taxes.Figure Five: Summary of M&M Propositions with Taxes Summary of Modigliani-Miller Propositions With Taxes: Assumption: Corporations are taxed at the rate of T on earning after interest. This will drive market price to an equilibrium implying leverage irrelevance to any given firm. Miller (1977) offers an explanation for the puzzle. corporation leverage lower tax payments. Individual and corporation borrow at the same rate. Suppose that: T is corporate tax rate TS is marginal personal tax rate for shareholders Td is marginal personal tax rate for debt holders The value of unlevered firm now becomes: VU=PV X(1-T)(1-TS)  (18) And the value of the levered firm is: VL=PV (X-ID) (1-T) (1-TS)  + PVID (1-Td)  =VU+D 1-(1-T) (1-TS)/ (1-Td)  (19) 22 . tax shield can be devalued by the marginal personal tax disadvantage of debt and supply side adjustments. No transaction cost. He points out that in a world with differential personal taxes. Proposition II: The cost of equity rises with leverage. because the risk to equity rises with leverage 2.1. Results: Proposition I: VL=VU+TD Proposition II: KL=KU+D(1-T)(KU-I)/SL Intuition: Proposition I: Since corporation can deduct interest payments but not dividend payment.

the before-tax cost of capital on debt must be higher than cost of equity if investors are to hold debt. only if TS=Td. The upward-sloping line represents the demand curve for debt. Leveraged corporation have the advantages of deducting their interest payments to bondholders in computing their corporate income tax. This line intersects the Y-axis at which the interest rate on corporate debt exactly offsets debt’s corporate tax advantage. In this case. This relationship can be presented in the following figure. At this point. However this advantage of deductibility may not always be the case. and indicates that bonds must offer higher rates to attract investors from higher tax brackets. the formula can be reduced to VU+TD. the only investors holding corporate bonds are tax-exempt investors and taxable investors facing a personal tax rate on 23 .According to the above equation. as the interest rate on corporate debt is taxed as income for the holder of corporate debt. The interest paid on corporate debt must be high enough so that the after-tax income from holding corporate bonds is more than the income from equity. Equilibrium occurs at B#. Figure Six: Bond Market Equilibrium Source From: Miller(1977) “Debt and Taxes” The horizontal line in this figure represents the supply curve of corporate debt.

interest income less than or equal to the corporate tax rate. Investors with personal tax rates above the corporate tax rate would choose to hold municipal bonds rather than taxable corporate bonds. B# is the aggregate level of debt in the economy, but for any particular company, there is no net advantage to using debt or equity. (Megginson et al, 2007)

The equilibrium demonstrated in Miller (1977) illustrates that as the supply of debt from all corporations expand, investors with higher tax brackets have to be enticed to hold corporate debt. As a result, investors receive more of their income in the form of interest rather than capital gains. However, actual tax rates do no appear to support this equilibrium. Graham et al (2000) estimates that the tax rate paid by marginal investors in corporate debt is about 30 percent, which is well below the top bracket. He also observes the tax rate on equity income which is at 12 percent. In this case, the extra tax paid by investors cannot offset the corporate interest tax shield. Nevertheless, interest tax shields are still believed to be extremely valuable. Rubinstien (1973) merges the CAPM model with the original M&M framework on capital structure. This was reasonable because the M&M framework and the CAPM model share the same assumption facing the existence of perfect capital markets. Meanwhile, the most important assumption of M&M’s model that firms belonging to the same risk class were replaced by the assumption that firms have the same beta (β) risk of CAPM. Rubinstien’s studies re-construct the basic proposition of the M&M theorems with a number of assumptions. Although Rubinstien’s model represents an important progress and it provides the grounded work to prove the basic M&M irrelevance theorem using a mean-variance approach, his work has a number of limitations and is not extremely valuable. The study is constructed only from theoretical perspectives and not been empirically tested. Hsia (1981) generalizes the remaining propositions and this pregerss was also contingent on another independent discovery in the field of option pricing which was provided by Black and Scholes (1973). He applies the fact that the value of equity in a leveraged firm is identical to the value of a call option written on the firm, and that the


value of risky debt in a levered firm can be viewed as the value of risk-free debt plus a “shock” put option on the value of the firm. Both option are European type and have an exercise pricing equal to the future value of the risk-free debt. The maturity time of options equals to the maturity of the risk-free debt.

Rubinstien’s and Hsia’s studies are considered as the most general work so far. Other proofs behind the M&M proportions have considerably complicated from a mathematical point of view. 2.1.4 Static Trade-off Theory Under the M&M theory, capital structure is irrelevant to firm’s value. Corporate income taxes, viewed in isolation, give firms a strong incentive to use leverage. Under M&M’s model, firms should theoretically borrow as much as they can to maximize tax advantages. However, in the real world we do not se firms financed by 100% debt. Sometimes must be missing from their model and this is the cost of financial distress. Cost of Bankruptcy and Financial Distress:
Financial distress is defined as a condition where obligations are not met or are met with difficulty. A major disadvantage for a firm relaying heavily on debt is that it increases the risk of financial distress, and ultimately liquidation. This may become harmful for both equity and debt holders. 2 The risk of incurring the costs of financial distress has a negative effect on a firm’s value which offsets the value of tax advantages on borrowing. The most common example of a cost of financial distress is bankruptcy costs. Corporate bankruptcies occur when shareholders exercise their right to default. There are two forms of bankruptcy costs: direct and indirect (Megginson et al, 2007). Direct costs of bankruptcy are out-of-pocket cash expenses directly related to bankruptcy filling and administration. Document printing and filing expenses, as well as professional fees paid to lawyers, accountants, investment bankers, and court personnel are all direct bankruptcy costs. Indirect costs of bankruptcy are expenses that result from bankruptcy but are not cash expenses sent on the process itself. These costs include the diversion




of management’s time, lost sales during and after bankruptcy, constrained capital investment and R&D spending, and the loss of key employees. Although indirect bankruptcy costs are difficult to measure, researchers have shown that they are significant. Many empirical studies indicates that relative to the pre-bankruptcy market value of large firms, direct costs are too small, comparing indirect costs, to provide an effective threat to the use of debt. Warner (1977) is the representative work for his argument. His study involved 11 railroads and is the first step in setting out a methodology for measuring an devaluating bankruptcy-related costs. He cautions that the costs are not small enough to be neglected completely in discussion of capital structure policy. But it would be reasonable to conclude that for firms of the size under consideration, ‘the expected direct costs of bankruptcy are unambiguously lower than the tax saving on debt to be expected at present tax rates in standard valuation models’ (p.345). Warner’s work was criticized by Altman (1984) in the aspect that his results are based on a narrowly defined bankruptcy cost definition (lack of indirect bankruptcy costs) and the small sample size could not provide a whole picture. Altman investigated the empirical evidence with respect to both the direct and indirect cost of bankruptcy. Based on regression models, his results show very strong evidence that costs are not trivial. In many cases they exceed 20% of the value of the firm measured just prior to bankruptcy and even measure several years prior in some cases. In addition, the expected bankruptcy costs for many of the bankrupt firms are found to exceed the present value of tax benefits from leverage. This implies that firms were overleveraged and that a potentially important ingredient in the discussion of optimum capital structure is indeed the bankruptcy-cost factor. Finally, a study by Andrade and Kaplan (1998) of a sample of troubled highly leveraged firms estimates that costs of financial distress accounts as 10 to 20 percent of pre-distress market value. To summarize, the cost of financial distress and bankruptcy is:


Table Two: Costs of financial distress and bankruptcy

Indirect Examples
Uncertainties in customers’ minds about dealing with this firm- lost sales, lost profits, lost goodwill. Uncertainties in suppliers’ minds about dealing with this firm- lost inputs, more expensive trading terms. If assets have to be sold quickly the price may be low. Delays, legal impositions, and targets of financial reorganization may place restrictions on management action, interfering with the efficient running of the business, Management may give excessive emphasis to short-term liquidity, e.g cut R&D and training, reduce trade credit and stock levels. Temptation to sell healthy business as this will raise the most cash. Loss of staff morale, tendency to examine alternative employment. To conserve cash, lower credit terms are offered to customers, which impacts on the marketing effort,

Direct Examples
Lawyers’ fees

Accountants’ fees

Court fees Management time

Source adopted from: http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page40.htm Financial Distress and Taxes Saving:
Clearly, the cost of financial distress and bankruptcy significantly influence capital structure decision in complex ways. This allows us to expand the basic equation 17, which was derived under M&M theory, to indicate financial distress factor. Megginson et al (2007) represented the new expression as: VL=VU+ PV (Tax Shield)-PV (Costs of Financial Distress) The argument leads to the optimal capital structure, which refers that mangers think of the firm’s debt-equity decision as a trade-off between interest tax shields and the costs of financial distress. Myer (1984) asserts that a firm’s optimal debt ratio is usually viewed as determined by a trade-off of the costs and benefits of borrowing, holding the firm’s assets and investment plans constant. The firm is supposed to substitute debt for equity,


managers would maximize firm value by maximizing debt. capital budgeting and capital structure.or equity for debt. Optimum is reached when managers find the mix of debt and equity that maximize firm value. the results are consistent 28 . If there were no costs of adjusting capital structure. thus generating more taxes saving. They find moderate support that most firms have target debt ratios and follow the trade-off theory. Graham and Harvey (2001) surveyed 392 CFOs about the cost of capital. Beyond some point. Without cost of financial distress. Figure Seven: Optimal Debt Ratio Source from: Stewart C. the incremental expected bankruptcy costs offset tax advantages. a situation represented by the upper curve. Myers (1984) “ The Capital Structure Puzzle” According to the figure. until the value of the firm is maximized. Marsh (1982)’s study provides evidence that companies appear to make their choice of financing instrument as if they have target levels of debt in mind and more importantly. The following figure illustrates how debt to equity ratio affected firm’s market value. it increases both the probability that it will go bankrupt and its expected bankruptcy costs. then each firm should always be at its target debt ratio. As a firm borrows more. managers of all-equity companies can increases firm value by replacing equity with debt. There are a number of researches based on the existence of an optimal capital structure. We have to note that it is not in linear because of the cost of adjustment. The lower curve illustrates how the financial distress alters this conclusion.

tangible assets and plenty of taxable income to shield ought to have high target ratios. Furthermore. industry to industry. tends to support the modern balancing theory of optimal capital structure. 2006). the stability of the cash flow. profitability. According to Jalilvand and Harris (1984). Unprofitable companies with risky. there are costs. Rajan and Zingales 1995. together with the highly significant inverse relation between firm leverage and earning volatility. the nature of the asset base. Bradley. The findings of this study suggest different choices in capital structure across countries and legal institutions. Wald (1999) conducted a cross-country comparison and examined the factors correlated with capital structure. As far as firm specific factors are concerned. where 29 . However. firms can adjust only partially to their long term financial targets. The result stated significant differences between firms.With the notion that these target debt levels are themselves a function of company size. The strong finding of intra-industry similarities in firm leverage ratios and of persistent inter-industry differences. this supports trade-off theory in that different corporations operating different target debt ratio. will all be relevant. empirical studies suggest that the trade-off model seems to have a relatively low R2 (Myers. In addition. due to the existence of market imperfections. bankruptcy risk and asset composition. size and growth. large firms seem to adjust faster to the target level of long-term debt than do small firms. different business environment have Target debt ratio varies from country to country. Fama and French 2002 and Wald 1999). in adjusting to the optimum. 1984). Static trade-off theory suggests that companies with safe. Specifically. differences appears in the correlation between long-term debt/ asset ratio and the firm’s riskness. In contrast to previous studies that are based on time-series analysis of macro-data. Actual debt ratio vary widely across similar firms and an odd fact about real-life capital structure is that the most profitable companies commonly borrow the least (Titman and Wessel 1988. Jarrell and Kim (1984) used cross-sectional. Firms cannot immediately offset random events that bump them away from their capital structure targets. and therefore delays. intangible assets ought to rely primarily on equity financing (Brealy et al. firm-specific data to investigate the behaviour of 20-year average firm leverage ratios for 851 firms coving 25 two-digit SIC industries. and the quality of management. that is why always see random difference in actual debt ratios among firms which are having the same target debt ratio. and firm to firm. However.

30 . He observes that “management strongly favoured internal generation as a source of new funds even to the exclusion of external funds except for occasional unavoidable ‘bulges’ in the need for funds” (pp 67). Contrary to the traditional trade-off theory but consistent with empirical regularities. In this story. plus unpredictable fluctuations in profitability and investment opportunities. It also demonstrates that the speed of earnings reversion plays an important role in the determination of optimal capital structure as well as in the earning-leverage and volatility-leverage relationships. internal and external. Sticky dividend policies. mean that internally generated cash flow may be more or less than investment outlays. If external finance is required. That is. Each firm’s observed debt ratio reflects its cumulative requirement for external finance. one at the top of the pecking order and one at the bottom. then perhaps equity as a last resort. which stems from Donaldson’s study (1961) of the financing practices of a sample of large corporation. Their paper shows that mean reversion in the earnings process can reconcile the trade-off theory of capital structure with the empirical evidence. they start with debt. because there are two kinds of equity. 1984. They adapt their target dividend payout ratios to their investment opportunities.5 Pecking Order Theory Contrast to the static trade-off theory. their model predicts a negative relationship between earnings and optimal leverage ratio when earnings are mean reverting. then possibly hybrid securities such as convertible bonds. If it is less. although dividends are sticky and target payout ratios are only gradually adjusted to shifts in the extent of valuable investment opportunities. firms issue the safest security first.trade-off theory predicts exactly the reverse and fails to explain. Sarkar and Zapatero (2003) conduct an empirical study with a sample of firm in the S&P 500 Index.1. pp581): Firms prefer internal finance. there is another view of how financing decisions are made. there is no well-defined target debt-equity mix. the firm first draws down its cash balance or marketable security portfolio. 2. The key idea of pecking order theory is that managers raise new finance in a particular sequence (Myers. They re-formulate the trade-off theory with mean reverting earnings. This is “Pecking Order Theory”.

Pecking order theory starts with asymmetric information. Less profitable firms issue debt because they do not have sufficient internal funds for their capital investment and because debt financing is preferred to equity financing under the pecking order theory. the heavy reliance on internal finance and debt is clear. a firm with ample internally generated funds does not have to sell any kind of security (Brealey et al. Given sticky dividend policy. Then rates of investment will be similar within an industry. on average. More importantly. The pecking order is considered as a descriptive reasonable empirical model of corporate leverage. risks and values than do outside investors. In fact. 31 . Suppose firms generally invest to keep up with the growth of their industries. a few months after. When practical figures. this theory demonstrates the inverse relationship between profitability and financial leverage within the industry. Shyam-Sunder and Myers (1999) find strong support for this model with a sample of 157 firms over the period 1971 to 1989. internally generated cash covered. The most of external financing comes from debt. 2006) Pecking order theory explains why the most profitable firms generally borrow less. However.not because they have low target debt ratios but because they do not need outside money. Brealy and Myers’ studies (1984) provide evidence that the bulk of required external financing came from borrowing. 62% of capital expenditures. none of this says that firms ought to heavily relay on debt financing. However. Also. their work was cited by Chirinko and Singha(2000). For all non-financial corporations over the decade 1979-1982. This statistical figures make pecking order theory seem to be reasonable and at least provide a description of typical behaviour. including investment in inventory and other current assets. This is a persuasive and influential result. Alternative tests are needed that can identify the determinants of capital structure and can discriminate among competing hypotheses. even in the case of highly information efficient market. Net new stock issues were never more than 6% of external financing. the least profitable firms will have less internal funds and will end up with borrowing more. which indicates that managers know more about their companies’ prospects. Asymmetric information can in practice explain the dominance of debt financing over equity issues. who argue that empirical evidence can evaluate neither the pecking order nor static trade off models.

It cannot explain why financing tactics are developed to avoid the consequences of managers’ superior information. on average. In addition. financial distress. In 2003. security issuance costs. especially in the aspect of agency cost. it is widely found that debt financing does not dominate equity financing. most companies in their sample use significant external financing. which are hardly following the pecking order. Static Trade-off Theory The financial literature offers two competing models of financial decisions: static trade-off and pecking order theory. At the optimal leverage 32 . attempting to explain those decisions have to restart by recognizing the “managerial view” of corporate finance. firm’s internal financing. Donaldson (1969) admits that the financing decisions of the firm he studies before were not directed towards maximizing shareholders wealth. This may be due the inclusion of small firms in their sample. Frank and Goyal constructed a study on financing behaviour of publicly traded American firms over the 1971 to 1988 period. with the objective to maximize their value.It has to be concerned that the pecking order theory assumes that the mangers act in the interest of existing shareholders.6 Pecking Order Theory VS. All these facts are in contrast to what is suggested by pecking order theory. However. Myers (1984) critically states that pecking order hypothesizes cannot explain everything. There are plenty of examples of firms issuing stock when they could issue debt. According to their empirical results.1. Furthermore. such as Berle and Means (1932) and Berle (1954). and those scholars. or the set of investment opportunities available to a firm upon that firm’s actual capital structure. pecking order theory fails to explain the influence of taxes. As a result. Agency cost makes numerous scholars review their work and take new issues into consideration. firms identify their optimal leverage by weighting the costs of financial distress and the tax benefits. 2. agency costs. this is not always the case. is not sufficient to cover investment spending. Problems can particularly arise when a firm’s manager accumulates too much financial slack that they become immune to market discipline. The current portion of long-term debt is not considered as part of the financing deficit. Net equity issues track the financing deficit quite closely. Myer and Majluf (1984) demonstrate the possible conflict between interests of managers and shareholders. while net debt does not do so. In the trade-off model.

The trade-off theory still retains some explanatory power once pecking order motives are accounted for. although there was little evidence that asymmetric information was an important factor in financial decisions. Rajan and Zingales (1995) constructed a study of debt versus equity choice by large firms and they find that large firms tend to have higher debt ratios. mature companies that have access to public bond markets. These firms rarely raise equity and they prefer internal financing to external ones. They find that pecking order works best for large. yet turn to debt markets rather than equity when external financing is needed. This is not consistent with smaller. In a survey of US Chief Financial Officers. growth firms. 33 . In this theory. it has to be noted that many scholars have proved that there is in fact no conflict between these two theories. more profitable firms have lower debt ratios and firms with higher ratios of market-to-book value have lower debt levels. the two models share many predictions about dividends and leverage. firms always issue the safest securities first. Lemmon and Zender 2002. pecking order theory arises due to the existence of asymmetric information and transaction costs. Firstly. the pecking order theory stumbles (Shyam-Sunder and Myers 1999. younger. Scholars always try to run a race between them in order to find the circumstances in which one is superior to another (Myer and Majuf 1984. The theory is particularly helpful in explaining inter-industry differences and works best for those companies with tangible assets. Confirmed predictions shared by the trade-off and pecking order models are that more profitable firms and firms with fewer investments have higher dividend payouts. which are more likely to rely on equity instead of debt. Frank and Goyal 2003). It suggests that the debt ratio is lower in volatile industries where value depends on intangible assets and growth opportunities. Graham and Harvey (2001) also find evidences consistent with both theories.level. Nevertheless. firms raise funds in a particular sequence and follow two rules. corporations prefer internal financing than external ones. Fama and French 2002). In contrast. These results interpret evidences for both the trade-off and pecking order theories. Secondly. Here. It seems that one is competing the other one and they seem both reasonable to some extent. Fama and Frech (2002) state that though motivated by different forces. firms with high propositions of fixed assets to total assets have higher debt ratios. the benefit of the last unit of debt just offsets the cost.

3 This is the same with FRS 17 (Financial Reporting Standard). follow a “balance sheet” approach to accounting for the pension scheme contributed by the employer. Secondly. SSAP 24 misleads the balance sheet position and does not require companies to report the assets and liabilities on the balance sheet accurately. The purpose of a pension is to grant people some money when they are retired. pecking order theory is offered as a complement to rather than a substitution for. Defined benefit plans guarantee to provide a pension to the retired employee which is a proportion of their final salary or some average of their latter years working at the company. 2. After a relatively long discussion. which has been criticized regarding a number of aspects.2 Overview of Pension Scheme and Accounting Standards With the objective to examine how the adjusted accounting standards on pension scheme affect capital structure. SSAP 24 was replaced by the new accounting standard IAS 19 (International Accounting Standard) which redefines how all employee benefits were to be accounted for. Pension scheme was originally ruled based on SSAP 24 (Statements of Standard Accounting Practice). it is always too simplistic to say one is superior to another. Either one is good at explaining certain issues and has obtained a number of empirical supports. we will next provide an introduction on how pension scheme works and what is the adjustment under new accounting standards. Employee Benefits. There are two major types of pension schemes. Typically pension schemes are funded by the company putting money into a separate fund. Pension is defined as post-retirement benefits and it is company’s obligation to pay pensions to former employees. Firstly. the company pays fixed contribution to the fund and has no obligation to further payment if the play assets are not sufficient to pay the pension benefits. which is difficult to justify and could give rise to unrealistic pension provision being made. namely defined benefit and defined contributions. IAS 19. in 2000. Under a defined contribution plan. 34 . the traditional trade-off model. More appropriately speaking.To sum up. and the fund pays out the pension.3 Different from SSAP 24. SSAP 24 requires the use of actuarial valuation basis for both assets and liabilities.

2. generally supporting the idea that the UK market is more testable and in principle more consistent with capital structure theories.Defined contribution plans are relatively easy to account for: contributions payable to the plan are recognized as an expense as the employee provides services. However. Some leading companies also have been affected by the new accounting standard. IAS 19 requires the company to make an estimate of the pension obligation at the balance sheet date ( the present value of its defined benefit obligations for current and past service of employees) and to recognize a defined benefit liabilities (a kind of provision). Based the revised IAS 19. in other cases negatively. For example. The new accounting standard also defines how the balance sheet asset or liability should be built up. This will directly push down the company’s share price. IAS 19 has been subject to some heavy criticism. and pension deficits are likely to influence the rating of individual shares. companies adjusted their balance sheet format and disclosed ‘pension’ as an individual item of liabilities from 2005. large pension deficits on the balance sheet appear to be an early sign of trouble.3 Worldwide Capital Structure Patterns Panno (2003) investigates the empirical determinants of capital structure choice by analyzing security issues made by companies in the UK and Italy between 1992 and 1996. On the whole. in some cases positively. It has been argued that a deficit should not be recognized as a business liability because the final amount that companies need to pay may be no actually estimated. net of the fair value of the funded plan assets. He examines how companies actually choose between financing instruments at a given point in time and in different financial contexts. This adjustment has brought a significant impact on many companies. For defined benefit plans. British Telecom has warned that its pension fund will show a 5 billion pound deficit on their balance sheet. when figures are calculated they are likely to produce bigger deficits than it would under the old system. The results provide evidence of interesting differences between the two financial markets. the results support positive effects of size and negative 35 . For example. and could start to impact on company’s profit. IAS 19 will make company accounts appear more volatile. Actually. As companies begin to adopt the new standard.

There is some evidence that. but taxes alone cannot explain differences in leverage across firms. Research and observation established a set of key facts that a capital structure theory should explain. Capital structures vary across countries III. for both markets. Firms in the same industry often have similar capital structures regardless of their home country. We can conclude that although with different constitutional environments. In the following part. we have provided an integrated picture on existing capital structure theories and empirical studies. Megginson et al (2007) implemented a survey on companies’ capital structure around the world. together with the negative correlation between leverage and available reserves. the results are in line with the notion that the tax advantage of debt financing plays a relevant role in capital structure decisions. leverage varies inversely with profitability Source From: Megginson et al (2007) “Corporate Finance” After looked at the literature review.impact of liquidity conditions and bankruptcy risk on the financial leverage of companies. I will propose a study on the topic of capital structure in UK firms. capital structure patterns seem not vary too much between countries. It is also suggested that firms in well-developed financial systems (UK) may have long-term target leverage ratios. the pattern of long-term and short-term debt ratios across industries for the period before and after the adjustment of accounting policy should be discussed in depth. Markets interpret leverage-increasing events as “good news” and leverage-creasing events as ‘ bad news’ VI. II.. Corporations strive to maintain target capital structures VII. In general. Leverage ratios vary inversely with financial distress costs IV. This. which are taken as an indicator of internally generated funds. Corporate and personal taxes influence capital structures. answering the questions like “What are the determinants of capital structure in UK firms?” “How these determinants affect firms’ long-term and short-term leverage?” and “How does the change in treatment of pension scheme affect firms’ capital structure?” 36 . while in less efficient markets (Italy) an optimal debt level does not seem to be a major concern. industries. With the objective to fill the gap of researchers that have not yet been conducted. capital structure research documents the following patterns. or countries V. Table Three: Worldwide Capital Structure Patterns I. Finally. within industries. tends to support the pecking order theory of capital structure.

2005). 3. they will consider different forms of debt. To run the research models. Long-term debt always has a par value equal to the face value.org/cgi/content/abstract/13/2/171 37 . According to World Bank Research. how much a firm borrows is obviously measured as dependent variables. dependent variables and independent variables need to be selected.1 Dependent Variables: With the aim to assess companies’ gearing level. called the maturity date. firms in industrial countries use far more long-term financing than short-term ones and the analysis concludes that long-term debt tends to be associated with productivity 4 . and debt price is often expressed as a percentage of the per value. et al. firstly and most importantly.Chapter Three: Methodology Having reviewed a number of literatures in term of capital structure. quantitative rather then qualitative method will be used. Long-term corporate debt is a promise by the borrowing firm to repay the principal amount by a certain date. When companies raise fund. we will now conduct an empirical study on UK listed non-financial companies. answering the following research questions: • • • What are the determinants of firms’ capital structure? How are these determinants influence companies’ borrowing decision? How dose the change of IAS 19 on pensions affect firms’ capital structure? In this study. Analysis of variance (ANOVA) and multiple regression analysis will be applied to examine the significances and correlation between different variables. The borrower using long-term debt generally pays interest at a rate expressed as a fraction of par value (Ross. An active stock market and an ability to enter into long-term contracts also allow firms to 4 http://wbro. Here we distinguish between short-term and long-term debt because they play different roles in financing decisions and believed to obtain different empirical results.oxfordjournals.

MM’s theory emphasized market value instead of book value and they stated that the level of gearing is independent to the market value of the company. Institutions like banks that want to enhance their ability to provide liquidity and credit to borrowers have to issue short-term debt. countries that have poor disclosure rules and inadequate investor protections. financial economists prefer the use of market values. we apply the debt/total assets ratio rather than the actual amount of debt. there are reasons for not doing this. which provide needed funds. However. In terms of indicators. it is suggested by many scholars that market-based values of leverage should be applied where possible for empirical studies. Although these variables could have been combined to extract a common ‘debt ratio’ attribute. 2005). we compute both short-term and long-term debt as the measurement of leverage. Also the bankruptcy cost asserts that capital structure choice matters only to the extent that it affects the market value of the firm. Some of the theories of capital structure have different implications for the different types of debt and hence the predicted coefficients in the structure model differ between long-term and short-term leverage. 38 . (Beaver. Rosenberg and McKibben 1973. Short-term borrowing provides maximum flexibility at a minimum cost. Consequently. When observing the debt level of firms. Jalilvand and Harris (1984) argue that expectations of lower long-term interest rates in the future seem to postpone the issuance of long-term debt and increase the use of short-term debt. are short-term debt and commercial paper programmes. which are demonstrated as dependent variables. it is important to distinguish between market values and book values (Ross et al. Similarly. Diamond and Rajan (2000) assert that companies do need short-term financing. Kettle and Scholes 1970. This is especially the case for companies in seasonal businesses in which large amounts of operating capital are needed for only a few months of the year. two primary sources of liquidity. This can protect from inaccuracy caused by different size of companies. Thompson 1976) However. for many companies. In general. It is a matter to choose between market value and book value of debt. Therefore. will find borrowing becoming increasingly relying on short-term as they have limited longterm debt capacity.grow at faster rates than they could attain by relying on internal sources of funds or short-term credit alone.

or other organization. government. we extend Harris and Raviv’s studies by adding some more 5 In accounting. corporate and personal taxes and profitability. Harris and Raviv (1990) summarized a number of empirical studies from US firms and they suggested that “leverage increases with tangible assets. so the misspecification due to using book value measure is probably fairly small. Proxies for these two dependent variables are expressed as following: Long-term debt ratio=long-term debt/ total assets Short-term debt ratio=short-term debt/ total assets 3. yet we cannot completely take away its validity. It is also the fact that restriction of debt in bond covenants are usually expressed in book values rather than market values. According to the worldwide capital structure patterns. 39 . leverage is affected by the industry classification. Book value is the value carried on the bookkeeping records of an economy entity. we use book value for both long-term and short-term debt ratio. we present a discussion of the attributes that different theories and empirical studies suggest may affect the firm’s debt-equity choice. Corporate treasurers also suggest that the use of book value is now becoming more popular because of the volatility of the stock market. book value is the value of an asset or liability according to its balance sheet. As a result.” Here. non-debt tax shields. bankruptcy risk and asset composition. The theories suggest that firms select capital structures depending on attributes that determine the various costs and benefit associated with debt and equity financing. growth rate firm size and decreases with profitability. The inherent volatility of the stock market makes market-based debt ratios change under a frequent basis. a number of theories have been proposed to explain the variation in debt ratios across firms. such as individual. Bowman (1980) demonstrates that the cross-sectional correlation between the book value and market value of debt is very large. This may lead to certain limitations.2 Independent Variables and their Expected Signs: In recent years.we use book value5 in our studies due to the restraint on data collection. Marsh (1982) demonstrated that companies’ target debt levels are themselves a function of company size. In this section. corporate.

Tax Shield=Interest Paid / Profit before Interest 40 . firm size and industry classification. DeAngelo and Masulis (1980) demonstrate a model of optimal capital structure that incorporates the impact of corporate taxes. it is hard to define an indicator for quantitative measurement. Although previous researchers have also concerned some other factors. which means the more interests companies paid. As a result. tax shield can be indicated as the interests divided by profit before interests and taxes. the value is increased. Proposed determinants in our studies are denoted by tax shield on interests. Theoretically. MM suggested firms should borrow as much as they can to maximize tax benefit. profitability. They argue that tax deductions for depreciation and investment tax credits are substitutes for the tax benefits of debt financing. Under the trade off theory. such as cost of financial distress. Consequently. This issue will be discussed in more details in the next section as model limitation. This is because interests is deducted before corporate tax. and non-debt-related corporate tax shields. Therefore. Interest tax shields: The tax shield refers to the tax deduction for interests paid and investment tax credits.determinants and apply into UK companies. the less tax amount will be deducted from profit. Tax shield is a crucial issue in trade off theory. tangible assets. every debt the company raises. financial managers of a firm often think of the debt-equity decision as a trade-off between interest tax shield and the cost of financial distress. personal taxes. In market value terms the balance sheet of a firm has the following form: Tax Benefit to Debt TCD Unlevered Assets Total Assets UA TA Equity Debt Total Assets E D TA According to above table. we make the hypothesis that there is a positive correlation between leverage and tax shield. adjusted accounting policy will be discussed as an influential factor of companies’ capital structure. dividend payout rate. Also. firms with large tax shields relative to their expected cash flow include more debt in their capital structure. growth rate.

Jensen (1986) and Willamson (1988) define debt as a discipline device to ensure that managers pay out profits rather than build empires. Although many theories and empirical studies have considered profitability as one of the most significant factors in capital structure. Profitability= Net Income/Net Sales Revenue Dividend rate: According to M&M irrelevant theory. the preference of internal fund to external ones suggest that firms which have been profitable in the past will have high-retained earnings and low borrowings. high debt can restrain management discretion. Differences in competitive strategy and product mix cause profit margin to vary among different companies. if the shareholder receives a smaller dividend than desired. For firms with sufficient free cash flow or high profitability. Moreover. The proxy of profitability in our study is profit margin. Baskin (1989). Griner & Gordon (1995). Tax based models suggest that profitable firms should borrow more in order to maximize their tax shield benefits. he or she can 41 . Profit margin is an indicator of company’s pricing policies and its ability to earn profit. there is no consistent conclusion on the relationship between profitability and leverage. He states that the past profitability of a firm. and hence the amount of earnings available to be retained. the dividend policy is irrelevant in a perfect market because the shareholders can effectively undo the firm’s dividend strategy. should be an important determinant of its current capital structure. we predict a negative coefficient of profitability in our regression model. Conversely. Kester (1986). Ozkan (2001). In contrast. Thus. Shyam-Sunder & Myers (1999) supporte the inverse relationship between profit and leverage. If a shareholder receives a greater dividend than desired. worldwide capital structure patterns and empirical studies from Bennett & Donnelly (1993).Profitability Myers (1984) cites evidence from Donaldson (1961) that suggests that firms raise capital in a preferred sequence. he or she can reinvest the excess.

how much the firm pays out as dividend is irrelevant to its market value. This argument is similar to their irrelevant-leverage concept. However. Due to the reverse relationship between risk and leverage6. 42 . larger companies with less asymmetric information problems and better access to capital market tend to have more equity than debt and thus have lower leverage. According to pecking order theory. Jarrell and Kim (1984). In theory. This is because that a lower dividend payout rate indicated that firms spent a significant amount of profit in reinvestment and there are less needs to borrow from outside. we use the following measurement: Dividend rate= Dividend Paid / Profit after Firm size: According to Storey. the highest preference for firms is to use internal financing before resorting to any form of external funds. It argues that firms have lower dividend rate and significant internal reinvestment turn to have lower leverage.sell off extra shares or stock. Therefore. corporations in the real world view the dividend decision as quite important. Watson and Wynarczyk (1987) and Chittenden. the size of firm has a significant effect on capital structure. Early study Gupta (1969) asserts the debt ratio was negatively related to size of the corporation. we predicate a positive relationship between debt level and dividend rate. because it determines what funds flow to investors and what funds are retained by the firm for reinvestment. To indicate the proportion of profit that has been paid out as dividend. However. which means that they are less risky and have a lower bankruptcy cost. lower probability of bankruptcy could result a higher debt level. DeAngelo(1981) and Jaffe and Westerfield(1984) have supported the reverse relationship between volatility and borrowing. larger companies also tend to be more diversified. Keasey. In this case. The relationship between firm size and leverage level has been fairly conflicting in both theoretical and empirical studies. He attributes this to the very high cost of outside equity funds for smaller 6 Bradley. Hall and Hutchinson (1996).

In contracted.corporations and the various psychological factors associated with their management which result in their being reluctant to take in new equity. we hypothesize a positive relation between tangible assets and debt level. However. results from Jalilvand and Harris (1984)’s studies indicate that larger firms tend to use more long-term debt in responding to their remaining financing need than do small firms. Smith (1977) also provides evidence to support the negative correlation between firm’s size and leverage. however. the use of revenue here may lead to high correlation between two independent variables. Moreover. They provide evidences that direct bankruptcy costs appear to contribute a larger proportion of a firm’s value as that value decreases. As what has been discussed above. and McConnell (1982) argue that large firms should rely on high leveraged. To indicate this variable. Marsh (1982) finds evidence that firms with greater bankruptcy risk are more likely to issue equity. A number of researchers use natural logarithm of revenues to indicate the firm size7. there is little evidence that executives are concerned about assets substitution when deciding the target leverage ratio. we use: 7 For example: Titman and Wessels (1988) 43 . Chua. in that companies with most tangible and safe assets did borrow the less. Warner (1977) and An. Airlines can and do borrow heavily because their assets are tangible and relatively safe. Myers (1984) suggests that static trade-off theory seems to have an relatively low R2 which he considers as unacceptable and in the real world. He states that small firms pay much more than large firms to issue new equity. the coefficient is predicted as positive: Firm size= Log (Number of Employees) Assets composition: Trade off theory did explain how companies actually behave when making financial decisions. This is because we have already included the profitability as one of our variables. In our studies. we here apply the number of employees instead of revenues. This suggests that small firms may be more leveraged than large firms and may prefer to borrow short-term rather than issue long-term debt because of the lower fixed costs associated with this alternative.

(2001) provide consistent evidence for the negative relationship. This is because growth may be considered as an alternative quality signal. It has been confirmed by many studies that growth rate is significantly correlated to the level of debt. This issue is also supported by the pecking order theory. Wald (1999) uses a five-year average sales growth. The cost associated with this agency relationship is likely to be higher for firms in growing industries.Assets composition = Tangible assets/ Total assets Growth rate Growth opportunities are capital assets that add value to a firm but cannot be collateralized and do not generate current taxable income. Both trade-off and agency cost theory suggest a negative correlation between growth and debt level. Rajan & Zingales (1995) and Booth et al. However. Take the agency cost into consideration. tend to borrow less than firms holding more tangible assets because growth opportunities cannot be collateralized. Myer (1977) notes this agency cost could be mitigated if the firms issue shortterm debt rather than long-term debt. Expected future growth should thus be negatively related to long-term debt levels. equity-controlled firms rarely invest optimally as they have tendency to expropriate wealth from the firm’s bondholders. Kim & Sorensen (1986). Specifically. the majority of empirical studies support the negative relationship between growth opportunities and leverage. which are in the form of intangible assets. fast growing companies borrow less because of increase expected cost of bankruptcy. firms holding future growth opportunities. applying various methodologies. This suggests that short term debt ratios might actually be positively related to growth rates if the short term debt can substitute the long term debt. Smith & Watts (1992). which states that fast growing companies are likely to use more debt. According to trade-off theory. which would predict less need for leverage. After all. Titman and Wessels (1988) measured capital investment scaled by total assets as well as research and development scaled by sales 44 . which have more flexibility in their choice of future investment. Wald (1999).

As what have been argued by previous scholars. the relationship between industry classification and firm leverage can be predicted as following: 45 . we will here apply the five years average turnover growth. DeAngelo-Masulis (1980) and Masulis (1983) argue that these similarities in leverage ratios were caused by tax code and tax rate. Similar with Wald’s method. There are very significant inter-industry differences in debt ratios that persist over time. negative coefficients with long-term debt and positive one with short-term debt respectively. with relatively few investment opportunities and slow growth. This is the case even when the need for external financing is great. we foresee contradicted correlation of long-term and short-term debt variables. (2001) use market-to-book ratio of equity to measure growth opportunities. which is already calculated by the firm and shown on their financial statement. To summary. Trade off theory is particular helpful in explaining differences in capital structures across industries. Titman (1984) suggests that firms that make products requiring the availability of specialized servicing and spare parts will find liquidation especially costly. Industries such as primary metals and papers. Bradley et al (1983) find that the industry factor has strong influence on firm leverage ratios.to proxy growth opportunities. Growth Rate t=(Turnover t − Turnover t-1) / Turnover t-1 Industry: Both pecking order and trade off theory assume that firms’ leverage is affected by the industry they operate in. It has been empirically supported by many studies that debt ratios tend to be very low in high growth industries with ample future investment opportunities such as the drugs and electronics industries. tend to use the most debt. Rajan and Zingales (1995) use Tobin’s Q and Booth et al. Pecking order theory also supports the intra-industry similarities. This indicates that firms manufacturing machines and equipment should be financed with relatively less debt.

g equipment manufacturing) In our studies. Industry will be represented as dummy variables in the research model.g drugs and electronics industries) Industries requiring specialized servicing (e. firms operating in ten industries according to “Financial Times London Share Service” will be measured.g airline) Slow growth industries (e. the indicator of both dependent and independent variables as well as predicted signs of their coefficients can be summarised as below: 46 .Table Four: Industry Classification and Leverage Level of Debt Higher Leverage Industry Characteristics Safe and tangible assets firms (e. Overall.g metals and paper) Industries with low specialization Lower Leverage Risky and intangible assets firms High growth industries (e.

it is believed that companies should also adjust their targeted capital structure since the amount of liabilities appear to increase. With the aim to increase transparency by showing the pension fund surplus/deficit clearly on the balance sheet.Table Five: Summary of Variable Indicators and Predicted Signs Variables Dependent Variables Long-term Debt (LTD) Short-term Debt (STD) Independent Variables Interest Tax Shield (TaxS) Indicators Long term debt/Total Assets Long term debt/Total Assets Predicted Signs Interest Paid / Profit before Interest + Profitability (Prof) Net Income/Net Sales Revenue - Dividend Rate(Div) Firm Size(Siz) Assets compositions (Ass) Growth Rate (Grow) Dividend Paid / Profit after Log(Number of Employees) Tangible assets/ Total assets (Turnover t + + + / LD: SD: + − Turnover t-1) Turnover t-1 Industry (Ind) 10 Dummy Variables 3.3 The Impact of Pension Fund: Revised IAS 19 requires the company to make an estimate of the pension obligation and disclosed it on the balance sheet. we divided the entire time period into pre-pension 47 . especially the level of debt. and its cost in the P&L account. most companies have started to treat pension fund as an individual item of long-term liability in balance sheet. Since 2005. To capture how the new accounting standard has influenced companies’ capital structure.

Similar with Bradley (1983). (1982) 48 . While other studies employ the Standard Industrial Classification (SIC) codes for industry analysis. Industries and firms observed are: 8 9 http://www. We excluded the financial firms because the balance sheet of the firms operate in the financial sector (banks. In order to capture the impact of adjusted accounting standard.bvdep. Cross-sectional data set are collected from annual report of 80 non-financial UK listed companies in 10 industries. 9 We classify UK sample firms into 10 industries using sector information provided by the Financial Times London Share Service. we use the average value of the testing period to avoid time bias. the test of the existence and determinants of inter-industry differences in leverage studied by Bowen et al. insurance companies and investment trusts) have an obviously different structure. we can detect the impact from different treatment of pension fund.scheme period 2001-2004 and post-pension scheme period 2005-2006. we divide the entire timeperiod into the pre-pension scheme period: .4 Data Description: Our data come from Financial Analysis Made Easy (FAME)8.fame. 3.com/athens For example.2001-2004 and the post-pension scheme period: . which provide a financial and accounting database covering the majority of UK public and private companies. The time period under consideration is a time span of six years from2001 to 2006. By comparing results obtained from both periods.2005-2006. which provide an exogenous means for grouping firms into functionally defined industries.

Renishaw Unilever. Carphone Warehouse. Croda. Beale. Minerva BT Group. Findel. Zotefoam. British Airways Carnival. 3. Chloride. Luminar Alexon. Universe. XP Power. PGI. KCOM Thus. ICI JOHNSON MATTHEY. Dana Petroleum Acambis. Diageo Devro. CLS Holdings Daejan. Dechra Brixton. Elementis SMITH & NEPHEW Abacus. Treatt. Burren Energy XP Power. Ryanair Labrokes. Vanco Vodafone. Laird. Tate&Lyl SABMiller.Table Six: Sample of Targeted Industries and Companies Industries Automobiles Chemicals Number of firms 2 Sample of firms GKN. Hunting. Savills. Dairy Crest Abbot Group. which refer to the 49 . we apply different model for dummy variables and non-dummy variables. Lookers. and limited resources force us to skip those firms whose annual report from 2001-2006 are not available from FAME. Vernalis Astrazenca. Greggs 10 Electronic Equipment 11 Food and beverage 10 Oil and Gas 10 Pharmaceuticals and Biotech 6 Real Estate 9 Telecommunication 8 Travel and leisure 8 Retailers 6 The sample of industries and firms are randomly chosen from Financial Times. Liberty International Segro. To regress dummy variables.5 Research Model: Due to the different nature of independent variables. Dialight Halma. Volex Spectris. Aminex. BP. Kerry Group IAW Group . Inensys. EasyJet. Glanbia. Vectura Group BTG. Xaar. Freeport Grainger. Marston's. HMV. we have to make sure that all sample firms make clear estimates about the pension deficit of long-term liability from 2005 in their balance sheets. This will be discussed with more details in the limitation part. Torotrak Carclo. Victrex. Porvair. Importantly. JKX. BG Group. Emap Arriva. Tullow.

The population of scores for the dependent variables should be normally distributed. To regress nondummy variables. examining how industry classification has affect companies leverage. which are the rest proposed determinants of capital structure. we apply multi-regression analysis. To evaluate the impact of industrial classification on companies’ leverage. 50 . Finally. and it is also a test for which groups are equally drawn. Indi refers to the 10 dummy variables representing industry classification. We use the following two multiple regression models: 10 11 Refer to different level of debt in this study. 3. the categories of the independent variable are assumed to be fixed. we use one-way analysis of variance (ANOVA). which are introduced in the early part of the chapter.5. βi is the estimate of the coefficient number for explanatory variables and e is the error term. In addition. (Malhotra. error term has to be uncorrelated. we applying the following model: Yi=α+ ∑ βi Indi + e Where. α is the constant number which represents the interception for the regression line.5. Yi refers to the two dependent variables (LTD and STD). 2004) 3.industry classification in this case. Refer to different industries in this study.2 Multiple Regression Analysis: To examine how factors affect companies’ level of debt.1 One-way Analysis of Variance: (ANOVA) We use analysis of variance because it compares the variance among the different groups10 (believed to be due to the independent variable) with the variability within each of the groups 11 (believed to be due to chance). We have to be aware that basic assumptions under ANOVA have been made.

the error term is constant. To apply the regression analysis. dividend rate (Div).75) or high VIF. The reason of choosing such model is because regression analysis is able to examine associative relationship between a metric dependent variables and one or more independent variables by identifying relative importance of independent variables (e.Yi=α+β1Sizi+β2Profi+β3TaxSi+β4Divi+β5Groi+β6Assi +ei Yi ∗=α+β1Sizi+β2Profi+β3TaxSi+β4Divi+β5Groi+β6Assi +ei Endogenous variables Yi and Yi * represent long-term and short-term debt respectively.g the mathematical equation relating the dependent and independent variables).75 and thus it appears that there is no problem of Multicollinearity 51 . Following tables represent the value of VIF/Tolerance coefficient of independent variables. profitability (Prof). Diagnose the problems of Multicollinearity: Classical linear regression model is that there is no multicollinearity among the regressors. which could result inaccurate β and artificially high R2. The sign is a low tolerance (less than 0. tax shield (TaxS). Exogenous variables are these proposed influential factors discussed in early part. growth rate (Grow) and assets compositions (Ass). predicting the values of the dependent variable (e. The problem of multicollinearity occurs when there is a strong relationship between two or more explanatory variables. independent and under a normal distribution. They are referred to firm size (Siz).g how long-term debt would increase if the dividend rate has increased) and determining the structure or form of the relationship (e. We can see that none of the tolerance is lower than 0.g what is the relative impact of firm size on long-term debt). we assume that there are linear relationship between leverage and those six factors.

017 Data are summarized according to appendix two To sum up.874 .092 1.159 1.047 1.902 .023 1.053 2001-2004 Tolerance .970 .849 2005-2006 VIF 1.177 1.144 1.956 .092 1.144 1.108 1.047 1.983 2005-2006 VIF 1.983 .Table Seven: Summary of Collinearity Statistics Long Term Debt 2001-2004 Tolerance TaxS Prof Ass Div Gro Siz .978 .950 . observing the capital structure patterns of 80 UK listed firms operating in 10 industries.850 .023 1.902 .031 1.120 1.978 .874 . 52 .850 . the statistical analysis of secondary data is applied in our study.956 .108 1.915 .863 .849 Short-term Debt 2005-2006 VIF 1.893 .053 1.970 .159 1.863 .178 2001-2004 Tolerance .950 2005-2006 VIF 1.120 1.177 1.031 1. The research models used are one-way ANOVA and multiple regression analysis and results obtained from these models will be interpreted in the following part.178 2001-2004 Tolerance .915 .017 1.893 .

According to our results. When looking separately at long-term and shortterm debt ratios. we can observe a huge diversity between the expected results and actual ones. However. we will first broadly evaluate the three most important features of regression model.Chapter Four: Results Analysis Before discussing our empirical results in details. the sign of most variables stay the same. 53 . In terms of different forms of debt. those factors play different roles and the significance level of coefficients differs with each other.05 STD: + + +# - + +# -# - Data are summarized according to appendix two According to the above table. One of the most important features of regression analysis is the significance level of explanatory variables. variables itself has different signs for pre-pension scheme and post-pension scheme period. Statistical results can be summarized as below: Table Eight: Signs and Significance Level of Independent Variable Variables Tax Shield Profitability Asset Compositions Dividend Expected Signs + - + + LTD: - 2001-2004 LD + - + - STD +# + + - 2005-2006 LD - - +# - STD -# - + + - - Growth Size # Significant at p≤0. which will be discussed in more details in the later part. Also. significance of proposed determinants and finally the model fitness (R2). only a few proposed determinants have significant effects on firms’ leverage. this is not the case for profitability observed from 2001 to 2004 and dividend rate examined from 2005 to 2006. They are signs of variables coefficients.

we will provide detailed interpretation on obtained statistical results.1 Effects of Industry Classification To examine the impact on industry classification. R2 turns to be higher when including dummy variables (refer to industry classifications) in the independent variable. . This result is inconsistent with static trade-off theory and pecking order theory.269 . In addition.003 . Main results from ANOVA are as follow: Table Nine: Results from ANOVA ANOVA Sum of Squares 2. we included industries as dummy variables and apply the ANOVA analysis. In our case.319 Sig. R2 turns to be higher when we include dummy variables.475 19.002 F 1. indicating how those proposed factors influence long-term and short-term debt and how results modify when taking the new IAS 19 into consideration.270 Above table shows no evidence to conclude that industry classification affects both longterm and short-term debt (significance level>0. it provides no evidence to 54 .794 16.3. However.Another aspect of regression models is goodness of fit. which emphasizes the intra-industry similarity and inter-industry differences on firms’ leverage. it is possibly because data are measured as book value instead of market value.203 df 9 70 79 9 70 79 Mean Square . In the following paragraphs. it refers to the explanatory power of our proposed determinants of capital structure.267 . Also. 4.243 LTD/TA Between Groups Within Groups Total STD/TA Between Groups Within Groups Total 1. we can argue that R2 is relatively low in all regression models at around 0.235 .174 .028 . which is a summary measure of how well the sample line fits the data. According to Appendix Three.05). In this study. which can lead to misleading results. Low explanatory power indicates that relationships between variables are not necessarily linear and can be caused by improper model or measurement problems.310 .

the lowest leverage ratio in our sample is 0. they are considerable different in terms of profitability. This indicates that although firms are operating in the same industry. We can view that the only determinant. is tangible assets (significance level<0. However. Appendix four reports the correlation between industry and other independent variables.11 (oil and gas industry) and the highest ratio is 0. it is not surprising to observe differences in actual debt ratios among firms having the same target debt ratio. with the exception of pharmaceuticals and biotech industry. What we have observed are actual debt ratios rather than the targeted debt ratio.09 (food and beverage industry).85 (pharmaceuticals and biotech industry) regarding to long-term debt.03 (automobile industry) and the highest ratio is 0. the insignificance may be because firms are not able to adjust their debt level to optimum without delay. Turning to short-term borrowing. When looking at industries individually (figure 8 and 9). the lowest leveraged industry is 0. therefore. dividend rate. Therefore.05). growth rate. We can conclude that the majority of industries in our samples have similar debt ratio. tax shield and firm size. which is significantly correlated to industry. which indicates that industry factor have strong influence on firm leverage ratios. 55 . trade-off theory admits the existence of adjusting cost and delays. Firms cannot immediately offset the random event that bump them away from their capital structure targets.support Bradley et al (1983)’s investigation.

Figure Eight: Mean of Leverage Ratio by Industry Mean of Leverage Ratio by Industry 1 0. 8 1. Devi at i on of Lever age Rat i o by Indust r y Std.Deviation Value Pharmaceutical s and Biotech Telecommunicat ion Travel and Leisure Automobiles Electronic Equip Food and Beverages 1. we can observe that firms in 56 .4 0. 6 0. 8 0.8 0.2 0 F ood and B ev erages P harm ac eutic a ls and B iotec h T elec om m unic ation O il and G as R eal E s tate T rav el and Leis ure E lec tronic E quip A utom obiles C hem ic als Retailers M ean V alu e LTD/TA STD/TA Industries Source adopted from appendix five Figure Nine: Standard Deviation of Leverage Ratio by Industry St d. 4 1. 6 1.6 0. 2 1 0. 2 0 Chemicals Oil and Gas Real Estate Retailers LTD/ TA STD/ TA Indust r i es Source adopted from appendix five According to the value of mean and standard deviation. 4 0.

004 Std.127 .956 .251 . which has been confirmed by many studies on its high correlation with debt ratio.015 -.129 -.967 .171 .144 1.001 .497 . The diversity may be caused by selection of different variable measurement.712 -. The coefficients estimates between long-term debt and tax shield as well as tangible 57 .219 . This comes as surprising results and is not consistent with static trade-off theory.2 Cross-sectional Research on Long-term Debt The regression result where long-term debt is the dependent variable are presented in the following table: Table Ten: Regression Results of Long-term Debt Model Unstandardized Coefficients B 1 (Constant) Tax Shield Profitability Tangible Assets Dividend Growth Rate Size .101 . In addition.178 t Sig.898 . Wald (1999) uses sales growth and Titman and Wessels (1988) uses total assets as the indicator of growth rate while we use turnover to indicate the growth rate. which argues that growth industries with intangible assets always have lower leverage. Only one of our six empirical proxies of determinants of firms leverage has significant influence on long-term debt ratio. the positive sign of its coefficient supports neither trade-off nor pecking order theory.030 -.001 a Dependent Variable: LTD/TA When dependent variables are measured in long-term debt ratios our proposed determinants have little explanatory power with R2 equal to 0. However.394 -.023 1.120 1.019 .077 -. It is growth rate (sig. Myers (2006) particularly takes pharmaceutical industry as an example to explain the pattern of capital structure.028 -2. level<0. Collinearity Statistics Tolerance VIF -.05).893 .902 .001 .005 .849 1.978 .479 . Error .439 -.001 .147 .683 .pharmaceuticals and biotech industry borrowed far more long-term debt than other firms and firms within this industry differs a lot on long-term financing.041 3.108 1.137 .985 .042 .33E-005 .061 Standardized Coefficients Beta . “ 4.874 .307.925 .047 1.002 .

variables of dividends and firm size hold negative relationship with firm’s longterm debt ratio. the insignificance of size differs with some scholars’ research (Storey. Fama and French 1999. asserting the debt ratio was negatively related to size of the corporation. Myers (1984). Donaldson (1961) and Brealey and Myers (1984)’s studies state that the past profitability and the amount of earnings are important factors of its current capital structure.3 Cross-sectional Research on Short-term Debt The regression result where short-term debt is the dependent variable is presented in the following table: 58 . which indicates that companies with safe. the inverse correlation between profitability and long-term debt provide evidence to support pecking order theory and those researches. Chittenden. Wald 1999). Rajan and Zingales 1995. who indicates that in real-life capital structure. (Titman and Wessel 1988. This result is contradictory with our hypothesis and in some ways rejected pecking order theories. Keasey and Wynarczy 1987. However. Hall and Hutchinson 1996). The insignificance of profitability is surprising for us.assets are positive but insignificant. Moreover. which demonstrates the importance of firm size on capital structure. it provides support to Gupta (1969) and Smith (1977). most profitable companies commonly borrow the least. Meanwhile. tangible assets and plenty of taxable income to shield ought to have high target ratios. 4. Looking at more details. the observed negative coefficient provides evidence for pecking order theory and is consistent with our hypothesis. Also. The positive correlation is consistent with our prediction and provides evidence for trade-off theory.

However. This finding supports static trade-off theory against pecking order theory in that most profitable corporations with tangible assets borrow the most.902 . The beta value of tangible assets and dividend on short-term debt are different from 59 . The result supports Myers (1977)’s finding which suggest a positive correlation between growth rate and short-term debt because agency cost could be mitigated if firms issue short-term debt rather than long-term debt.978 .120 1. financial managers are more likely to take these aspects into consideration.861 2.076 .025 . which represents that when borrowing short-term debt. The positive relationship between firm size and short-term debt ratio is consistent with our hypothesis and it is in line with McConnell (1982) and Marsh (1982)’s study.000 .799 .704 .017 Std.874 . Most of the variables coefficients go in line with our prediction.010 .862.330 .019 . However. The R 2 has increased to 0. Firms’ growth rate in this case is no longer significant. Error .849 1.022 .047 1.Table Eleven: Regression Results of Short-term Debt Model Unstandardized Coefficients B 1 (Constant) Tax Shield Profitability Growth Rate Tangible Assets Dividend Size .002 .008 .208 .004 .862 .108 1.312 Standardized Coefficients Beta . firm size shows a reverse correlation with long-term and shortterm debt.392 . Different from long-term debt. the positive coefficient is consistent with pecking order theory and the hypothesis.144 1.178 t Sig.956 . Profitability turns to be the least important variable with significance level 0.000 .008 . the sign of coefficient shows a positive correlation with debt ratio.006 .727 . There are two significant variables for short-term debt.174 .980 -1.92E-005 . Growth rate also turns to be insignificant when we regressing short-term debt.956 .893 .048 .000 -.329 from 0.201 .014 .110 -.381 1.040 4. which are tax shield and firm size.307. Collinearity Statistics Tolerance VIF When dependent variables are measured in short-term rather than long-term debt ratios our proposed determinants seem to have more explanatory power.023 1.095 . We can see that firms behave very diversely when borrow long-time and short term. The positive coefficient of tax shield is steady with results obtained from long-term debt. asserting that large firms should be more highly leverage.

This may be caused by the selection of sample firms and their desired debt ratio cannot be actually observed.471 Mean 0. To compare results obtained from 2005-2006 to ones from 2001-2004. we can observe the impacts of revised IAS 19 on firms’ capital structure.255011 0.ones on long-term debt. Table Twelve: Comparison of Leverage between Pre-pension Scheme Period and Postpension Scheme Period 2001-2004 Without Pension Fund N LTD/TA STD/TA 80 80 N LTD/TA STD/TA 80 80 Minimum 0 0 Minimum 0 0 Maximum 4.5050481 2005-2006 With Pension Fund Source was summarized according to Appendix Five Results on industry analysis have little different with pre-pension scheme period 2001- 60 .120403 Std. the test on dividend falls on our prediction with pecking order theory.186 4. The mean of both long-term and short-term debt ratio has increased from 2005.2599 Maximum 12. we divided our period into pre-pension scheme and post-pension scheme period. Deviation 1. This comes as surprising results because in order to keep the book value of liability stable. which suggests a positive correlation with leverage.4 Effects of Pension Scheme To examine how the treatment has influenced firm’s financing behaviour. According to table 12. Deviation 0.438621 0.056951 Mean 0. It is surprising to see that tangible assets have a negative relationship with short-term debt. However. we can see that most firms adjusted their debt ratio after 2005.2689 0. corporations are assumed to borrow less face to the inclusion of pension deficit in balance sheets.4938795 0. the rise of standard deviation indicates that different firms have different pension positions. 4. which observes the opposite results from trade-off theory.050671 Std. Also.5965297 0. The increase of both short-term and long-term debt will definitely make firms look suffering more deficits.

it is reasonable to assume that pension deficit is larger in firms operating telecommunication industry.772417 for STD/TA) and interestingly. Pharmaceuticals and biotech still have the highest leverage debt (2. 5 1 0. Compare to figure 8.145838.316917 for LTD/TA and 0. 5 0 Automobiles Chemicals Electronic Equip Mean Value LTD/ TA STD/ TA Pharmaceutical s and Biotech Telecommunicat ion Food and Beverages Oil and Gas Real Estate Travel and Leisure I ndust r i es Data are summarized from appendix six Retailers 61 . firms in telecommunication industry are just a little behind on long-term borrowing. Figure Ten: Mean of Leverage Ratio by Industry for Post-pension Scheme Period M ean of Lever age Rat i o by Indust r y 2.2004. with the mean of 1. 5 2 1.

Deviation Value 6 5 4 3 2 1 0 Automobiles Chemicals Electronic Equip LTD. which means the explanatory power of proposed determinants has weakened when testing on data collected from 2005-2006.250 of post-pension scheme period (appendix three). we can see that new accounting policy has changed the signs and significance of some variables. Deviation of Leverage by Industry for Post-pension Scheme Period St d.1 Impacts on Long-term Debt The model fitness has dropped from 0. In terms of significance. TA STD/ TA Pharmaceutical s and Biotech Telecommunicat ion Food and Beverages Oil and Gas Real Estate Travel and Leisure I ndust r i es Data are summarized from appendix six 4.307 of pre-pension scheme period to 0. This finding indicates that have disclosed pension fund in their balance sheet.4. Looking at the following comparative table. Retailers 62 .Figure Eleven: Std. firms started to take more factors into considerations rather than just those proposed determinants. Tax shield and growth rate have showed a contradictory correlation with long-term debt. profitability and firm size have turned to become significant apart from growth rate. Devi at i on of Lever age Rat i o by Indust r y Std.

491 -0.02 -0.Table Thirteen: Comparison of Long-term Debt Regression Results between Pre-pension Scheme Period and Post-pension Scheme Period 2001-2004 Beta (Constant) Tax Shield Profitability Tangible Assets Dividend Growth Rate Size . Tax shield. just like long-term debt.039 Data are summarized according to appendix two 4.094 -0. The most significant determinants become the most insignificant from 2005 (p value changes from 0.2 Impacts on Short-term Debt When regressing the short-term debt from 2005-2006. This is hard to explain because firms with more debt ought to have more tax shield no matter what they have included in their long-term liability.015 -.077 -.817). with the value of 0.08 0.048 0. because pension deficit is recognized as one item of longterm liability. 0.967 .147 .394 -.05 0. which is also the case with long-term debt ratio.001 .178 0. In theory.985 2005-2006 Beta Sig. However.189.234 -0.479 . tangible assets and growth rate showed a reverse correlation with short-term debt in post-pension scheme period. tax shield is still significant yet has negative relationship with short-term leverage ratio. Interestingly.101 . .4.86 0.43 0. the model fitness is even lower. the inclusion of pension liability should have less effect on short-term debt rather than long-term ones. the sign of variable coefficients and the significance of determinants have changed under the revised accounting policy. The poor explanatory power indicated that financial managers seldom consider these proposed factors when facing short-term finance decision.898 .497 .034 -0.005 .002 Sig.008 to 0.178 0. 63 .

Although some of our proposed determinants have significant influence on firms’ leverage. same as many previous studies. To conclude.208 0.127 0.125 -0. only little firms have no debt and cash and marketable securities are only a small fraction of liabilities. In addition.201 0. the insignificance of industry classification provides no evidence to support both static trade-off theory and pecking order theory. In terms of coefficients signs.817 Data are summarized according to appendix two 4.5 The Summary of Statistical Results Take a general look at our results.33 0. with little short-term as well. which makes the industry have the highest debt ratio and standard deviation.392 0.11 -0. For example.026 Sig. The reason for this will be 64 .219 0.029 0.055 0. long-term debt in certain firm even exceeds the amount of total assets such as Vernalis in pharmaceuticals and biotech industry (LTD/TA=4. 0.019 0.689 0. however. Whereas in our samples.Table Fourteen: Comparison of Short-term Debt Regression Results between Pre-pension Scheme Period and Post-pension Scheme Period 2001-2004 Beta (Constant) Tax Shield Profitability Tangible Assets Dividend Growth Rate Size 0. we find it is not consistent with Agrawal and Nagarajan (1990)’s studies on US firms. most of variables go in line with our hypothesis. observation on some variables rejects our hypotheses for both long-term and short-term debt ratio. Agrawal and Nagarajan (1990) state that firms are averse to leverage of any kind.008 2005-2006 Beta -0. they have levels of cash and marketable securities well above their leverage counterparts.078 0.312 Sig. statistical results obtained from our empirical studies have a relatively low explanatory power and are conflicting with leading theories.704 0.862 0.2689).076 0. 0.048 0.095 0.512 0.114 -0.081 -0.047 0. such as dividend rate. Surprisingly. the most of variables are insignificant.

the findings are based on a relatively small sample of UK public companies (80 companies in 10 industries). Book Value vs. After all. data examined in this study are cross-sectional data. In addition. the sign of coefficients even differ between pre-scheme period and post-scheme period. The change in the treatment of pension deficit makes firms adjust their leverage ratio for both long-term and short-term aspects. suppose a firm buys back shares of its own stock and finances the purchase with new debt. 4. Market Value When observing the capital structures of firms. due to the time and data constraint for constructing this study. the conflicting results are in some ways due to the research shortcomings. the firm has fewer outstanding shares and more debt regard to the mix of equity 65 . For example. which may lead to misspecification. which are data on one or more variables collected at the same point in time. crosssectional data has their own problems. which will be discussed in details in the following part. 2005). specifically the problem of heterogeneity. the small sample size and avoidance of private companies cannot provide an integrated picture of UK firms and may lead to a research bias. Companies and industries are randomly chosen without any criteria. Just as other types of data. This would suggest that the firm’s debt level should go up and its reliance on equity should go down.discussed in the following research limitation part. Apparently. 2003). (Gujarati. it is important to distinguish between market values and book values (Ross et al. For some determinants.6 Research Limitations Limitations on Data and Sample Collection Firstly of all. After all. We have diagnosed the problem of multicollinearity yet ignored the possibility of heterogeneity and autocorrelation.

Dividend payout ratio was defined as current ordinary dividends divided by profit after taxes. 1982). For example.88. which certainly contained the problem and may have led to the disparity between empirical results and theoretical predictions. Similarly. we failed to consider the signs of some items in P/L statement. The analysis is more complicated than it seems because the market value of the firm’s remaining share of stock may go up and offset the effect of the increased debt. such as dividend rate and tax shield. which refers that the debt ratio can still show a significant correlation to proposed determinants even if debt levels are set randomly. Therefore. Differences between market value and book value are important sources of spurious correlation. Therefore. then differences in market value across firms will not necessarily affect the amount of debt they issue. For example. dividend ratio is suggested to set as zero when no dividend was paid and 100% when dividends exceeded earnings (Marsh. Rosenberg and McKibben (1973) and Thompson (1976) use market value for bonds and preferred stock in their studies. If managers set debt levels in terms of book value rather than market value. However. suppose if some firms use book value targets while others use market value targets. Since companies may still pay dividends even when there is a loss. the statistical ratio may then not reflect the real situation and can be very misleading. The matter of applying book value or market value is believed to be the central issue of why there is a disparity between the theoretical results and the empirical tests on capital structure. the dividend of XP Power was calculated as 625. We can then explain why obtained dividend results are not consistent with our prediction for both long-term and short-term debt. the relationship between dependent variables and independent variables have been examined will then be spurious. we failed to consider this issue and ignored the sign of profit.and debt. Kettle and Scholes (1970). the ignorance of a loss when calculating tax shield may cause misleading interpretation. most empirical tests use book-value measures due to the data restriction. Issues related to independent variables In this study. 12 66 . The theory is based on market-value measure of leverage. which may lead to the inaccurate sign of variable coefficient. With few exceptions12. Beaver.

given more time. In addition. market condition and timing variables claimed to be an important determinant of the debt and equity choice. I would have included the total debt ratio as another dependent variables. which are difficult to measure statistically. the relatively low explanatory power R2 may be caused by exclusion of some important variables. which we fail to consider in our study (Altman. according to Marsh (1982). there are still no empirical evidences to support that argument. Although some scholars argue that firm size could be a proxy of financial distress. we know from Marsh (1977) that there is a substantial difference between the pre-issue share price performance of debt and equity issuers. The most obvious one is the cost of financial distress. most companies in real world only count the amount of total debt when make decision on capital structure. After all. 67 . taking these variables into consideration would have increased the explanatory power and obtained a better descriptive model of firms’ leverage. In addition. The most common measurement of financial so far is the Z-Score. Moreover.As what has been discussed before. 1968). with equity issues tending to follow unusually good share price performance. A study on total debt level could help us gain an overview of firms’ capital structure. In fact. Financial distress is especially important under the argument of static trade-off theory and it has been proved by many scholars that the cost of financial distress and bankruptcy significantly influence capital structure decision in complex ways.

such as dividend rate. significances and signs. After choosing proxies for each variable. 68 . yet they differ significantly for long-term debt. who assert that long-term debt is more representative of a firm’s policy regarding to its capital structure. When looking at industries individually.Chapter Five: Conclusions and Recommendations It is argued that in well-functioning capital markets with no taxes. which provides financial reports for most of UK companies. Companies in pharmaceuticals and biotech industry have borrowed far more long-term debt than others. The insignificance is not in line with both existing theories and numerous empirical studies such as Bradley (1983) and Titman (1984). debt policy does not matter. This result is contradictory with Brealey et al ’s argument (2006) “it is rare to find a pharmaceutical company that is not predominantly equity-financed. our model came up with a relatively low explanatory power (R2 is around 0. Glamorous growth companies rarely use much debt despite rapid expansion and often heavy requirements 13 The data set is selected from FAME. In addition.3). The obtained signs of proposed determinants were not always consistent with our predictions. However. As discussed in the research limitation. Results on certain variables are conflicting with our hypothesises for both long-term and short-term leverage. The reason for this has been explained in the limitation part and is believed due to the ignorance of profit signs. we conducted statistical models to examine what are the determinants of a company’s leverage. the poor explanatory power maybe mainly due to the measurement of book value. the mean of leverage stays constant in shortterm borrowing. With the aim to gain an insight into how companies actually choose between equity and debt. In our studies. data were collected from financial reports of 80 UK public companies operating in 10 industries13. although it is higher when we include the dummy variable in our model. few financial managers could accept this issue as practical guidelines. This can be explained by the study of Bennett and Donnelly (1993). ANOVA and multiple regression analysis were developed to observe their coefficiences and significances. In general. Our empirical results rejected the significance of industry classification regarding to both long-term and short-term debt ratio. results varied between long-term and shortterm debt in the term of variable coefficients.

In terms of long-term. Companies have adjusted their target ratios from 2005. Importantly. To explain why our studies provide some conflicting evidence with theoretical 69 . all other proposed determinants indicated a different correlation with either long-term or short-term debt. In terms of short-term leverage. profitability has different signs in aspects of longterm and short-term debt. which may have caused high mean value. Furthermore.2689. Furthermore. transparency of pension fund in balance sheet is believed and has been proved by our empirical studies. tax shield and firm size turned to become significant with p value less than 0. to have impacts on firms’ leverage. Apart from tangible asset. Again. The negative coefficients of dividend rate showed no evidence to support pecking order theory. which supports neither static trade-off theory nor pecking order theory. Yet its positive correlation with short-term debt ratio can be explained by tax-based model. yet it is not helpful when explaining short-term leverage. the choice of book value is possibly the reason for this conflicting result. both growth rate and firm size became significant to long-term debt apart from growth rate. tangible assets came with positive coefficients. Growth rate is the only significant factor influences firm’s long-term debt. the explanatory power has decreased under the disclosure of pension deficit. we noted that certain company in pharmaceutical and biotech industry rely extremely on debt with the debt ratio 4. Results showed that there is a positive correlation between growth rate and leverage.05. the negative sign supports pecking order theory and a number of empirical studies such as Kester (1986). tax shield showed a positive relation with both long-term and short-term debt. yet in unexpected ways. tangible assets and dividend could explain neither long-term nor short-term leverage. In addition. A great number of researches find that profitability plays an important role in firms’ financing decision and it could significantly influence how much firms borrow. firm size no longer has impact. The amount of leverage has increased after 2005. Stick to what has been argued in static trade-off theory. Same with our prediction. Results on firm size seem vary between different forms of debt with unpredicted signs. However. The insignificance of profitability is surprising for us. When regressing short-term debt. Industry classification still has no effects on companies’ capital structure. which is contrary to the hypothesis.for capital” (pp 469) To explain this disparity.

expectations. However. Furthermore. the research limitation has been discussed. the limitations of this study cannot be avoided and therefore some further researches are suggested. Used in this way. The predictive model from regression analysis could be used by investment analysts to forecast the financial policy of particular companies. For example. To take an example. total debt should have been included as another dependent variables. Despite these limitations. our studies have some valuable implications and provide practical guidelines to financial managers. 70 . financial managers looking to raise capitals could use the model to gain an insight into the decision other managers would make under the same circumstances. the number of sample size may not truly reflect the whole picture of capital structure in UK companies. covering more non-financial companies and more industries are advocated and given more time and sufficient resources. researches with larger sample size. the model provides managers with some indication of what the market was anticipating.

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4: Financial Statement Analysis) Session 4: Indicators and Sources of Financial Distress http://www.bvdep.htm Financial Analysis Revised (Chapter 8: Module 1.edu/kewlcontent/cdoutput/TR505r/page40.com/athens 78 . Journal of Finance.Williamson O.wsu. http://cbdd. p567-591. (1988) Corporate Finance and Corporate Governance.fame. 43.

39% 12.1139 0.0733 2.0854 0.1250 3.1351 0.2333 0.0400 0.3088 0.1148 22.23% 9.3021 2.0000 0.3170 0.0925 0.3400 0.6900 0.29% 15.57% 18.3756 0.7269 0.1182 Prof 0.1827 0.4121 0.0100 0.6752 4.0200 1.1500 0.5424 0.0500 0.4216 0.4009 0.1600 0.0475 0.1170 0.0963 0.3100 0.0213 0.9564 4.5400 0.0921 0.7706 3.3900 0.3004 0.1881 0.2400 0.2100 0.1287 0.0287 0.8900 2.1843 0.7083 0.9800 0.1063 0.0570 0.8000 0.1960 0.5319 1.2751 0.0000 0.0478 0.0400 0.2300 0.0328 0.81% 19.0060 0.0575 0.3600 0.20% 31.3309 0.1458 0.0481 0.0042 0.0375 0.58% 8.0000 0.1000 0.5600 3.1250 3.8131 0.2360 STD/TA 0.30% Siz 4.1400 0.0503 0.6800 1.1460 0.0000 0.0000 0.1990 0.1013 0.1652 0.Appendix Appendix One: Firms’ Financial Information 2005-2006 Company GKN Torotrak Carclo Croda ICI JOHNSON MATTHEY Porvair Treatt Victrex Zotefoam Elementis SMITH & NEPHEW Abacus Chloride Dialight Halma Inensys Laird XP Power Xaar Volex Spectris Renishaw Unilever Tate&Lyl SABMiller PGI Kerry Group IAW Group LTD/TA 0.4950 4.1221 0.3100 0.2044 0.9530 3.0235 0.2700 0.1479 0.0056 0.0996 0.2100 3.2467 2.41% 8.0114 0.2900 0.0491 0.3000 4.2200 0.2591 0.2023 0.5319 0.1800 0.64% 3.0400 0.2730 Div 0.2709 5.80% 9.34% 27.47% 12.1900 0.0500 0.9954 0.5359 2.86% 5.3600 0.2591 0.5266 4.2700 0.0896 0.0064 0.97% 9.94% 1.43% 13.0171 Ind Automobiles Automobiles Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages TaxS 0.1624 Gro 2.4667 0.0437 0.0541 0.2096 0.0910 0.8100 0.57% 11.39% 14.0067 2.1032 0.3142 0.27% 0.0030 0.2267 0.0000 0.1136 0.2421 0.2288 0.2098 0.0700 0.1499 4.76% 5.1149 0.1040 0.87% 6.3100 0.0058 0.1471 0.62% 0.1982 2100 1.3609 0.2551 0.2109 0.3865 3.83% 14.9893 3.6656 0.0243 0.1346 0.64% 9.3122 3.1208 0.6700 3.0909 0.4500 0.2218 0.5545 2.5142 0.2745 0.74% 18.1640 0.1440 0.0729 0.49% -2.5396 0.0100 0.2902 0.1577 0.4472 3.00% -5.0100 0.0635 0.2111 0.0091 0.1760 0.1662 0.0952 0.0000 0.8194 0.2293 0.0959 0.5040 0.22% 36.3353 0.0081 0.5601 0.5740 79 .0787 TanAss 0.6800 2.0208 0.0120 0.1593 0.8200 3.6600 0.1552 0.0100 0.3668 3.0400 0.9281 2.0364 0.1409 0.2620 0.7500 0.1671 0.4500 0.

0054 0.3255 0.3120 0.0001 0.0074 0.0002 Food and Beverages Food and Beverages Food and Beverages Food and Beverages Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Telecommunication Telecommunication 0.0284 0.0587 0.0579 0.7230 0.0000 0.0017 0.4874 0.0000 0.6656 0.5354 0.0057 0.29% 77.2651 0.1383 0.1082 0.0327 0.30% 4.21% 15.1928 0.4155 0.18% 3.2862 0.3837 0.3045 0.3905 2.1525 0.0003 0.2576 0.0939 0.5051 5.33% -4.1675 0.2488 0.1538 2.2476 4.0450 0.32% 11.1013 0.6047 0.0358 0.2486 0.0000 0.0502 0.1261 0.1697 0.0405 0.0196 0.45% 63.0753 0.1155 0.0149 0.1672 0.65% 38.2686 0.0657 0.5959 0.1813 1.4168 0.0251 0.96% -2.7081 4.3580 0.4250 0.1314 0.0041 0.0636 0.5774 0.4406 0.2887 0.4280 0.22% 32.4327 0.1574 0.4148 0.0018 0.0000 0.5820 0.0453 2.1860 1.5040 0.1541 1.1511 0.1040 0.8357 1.7457 1.0638 0.0135 0.0000 0.1320 0.1599 0.49% 26.83% 40.0857 0.22% 34.8898 0.1063 0.55% 0.0178 0.17% 77.4183 0.0019 0.0094 0.0133 0.11% 66.1993 0.0197 0.5509 0.0795 0.1194 0.64% 20.0056 3.1426 0.0418 0.7240 0.11% -4.4852 0.26% 8.2098 0.4259 0.0000 0.3821 0.0894 2.0000 0.3360 0.1318 0.4710 0.1170 0.0000 0.0600 0.2014 2.5514 2.55% -4.1940 0.0007 0.1244 0.1629 0.1181 0.0104 0.4041 80 .0032 0.2719 0.3384 0.8775 0.3407 3.2019 0.0093 0.0810 2.2213 0.97% -0.1455 0.2509 0.4537 0.0304 0.14% 3.0916 0.1227 0.0000 0.3173 0.8215 2.0212 0.0000 0.8192 2.6144 2.5205 0.0011 12.3001 0.0635 4.1232 0.5890 4.0103 0.1375 0.8864 0.5359 3.1017 0.2558 0.04% 11.5449 0.4986 0.0364 0.4168 0.2820 1.4750 0.2851 0.0191 2.6088 0.1936 0.0337 0.90% -1.01% 1.3231 0.1489 0.4805 0.0017 0.7881 0.5554 0.3648 0.1040 0.27% 9.4500 0.0293 0.4314 3.0158 0.1346 0.2718 1.1444 0.1147 0.50% 2.0881 0.2671 0.8535 3.0894 3.2697 0.0039 0.0000 0.9934 2.1152 0.3006 0.01% 30.4250 0.7559 2.0012 0.1490 0.4472 2.Glanbia Diageo Devro Dairy Crest Abbot Group Aminex BG Group BP Burren Energy XP Power Hunting JKX Tullow Dana Petroleum Acambis Vernalis Astrazenca Vectura Group BTG Dechra Brixton Liberty International Segro CLS Holdings Daejan Freeport Grainger Savills Minerva BT Group KCOM 0.0417 0.3578 3.2422 0.4392 0.3956 0.0188 0.28% 13.28% -9.0103 0.1167 0.8422 0.4935 0.0000 0.2823 0.0467 0.09% 4.4960 0.3118 4.2303 0.

1493 0.0000 Telecommunication Telecommunication Telecommunication Telecommunication Telecommunication Telecommunication Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Retailers Retailers Retailers Retailers Retailers Retailers 1.1253 0.0351 0.6833 0.0683 0.8100 0.1220 0.1608 0.0400 0.1300 0.0623 0.1403 0.7015 0.1325 0.0200 0.4200 0.8397 0.0000 0.7052 0.0100 0.0359 0.3343 0.1388 0.0100 0.7709 4.6709 4.0738 0.3775 1.3900 0.1938 0.1693 TanAss 0.0600 0.2400 0.3743 3.0443 0.81% -9.27% -1.0199 0.41% 7.2300 0.7900 3.22% 0.1409 0.0212 0.4000 0.3000 0.0500 0.3100 0.0300 0.0918 0.3464 0.1292 0.0900 0.3500 0.7380 0.30% -4.0837 Ind Automobiles Automobiles Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals TaxS 0.8477 0.1226 0.3264 0.5842 0.0242 0.3815 0.1495 0.0585 0.0300 0.7846 4.2796 2001-2004 Company GKN Torotrak Carclo Croda ICI JOHNSON MATTHEY Porvair Treatt Victrex Zotefoam Elementis SMITH & NEPHEW LTD/TA 0.3579 2.25% 4.5124 4.5092 3.0000 0.6628 0.5700 3.3294 0.4118 0.08% 11.7774 0.0335 0.20% 14.0243 0.7320 4.1517 0.4797 34.2760 0.1729 0.4153 4.4851 0.1400 0.0228 0.0045 0.8500 2.9765 4.8636 0.1600 0.2652 2.0126 0.1058 0.3300 0.2277 0.0287 0.0746 0.8700 2.3900 3.36% 6.0649 0.1000 0.3568 Gro 1% -4.2300 1.0761 0.1100 0.8197 0.3192 0.95% -1.0051 0.6591 2.4200 0.0006 0.55% 7.93% -8.3345 3.5479 0.1676 0.5840 0.0279 0.6457 0.1304 0.02% 30.85% 28.2960 0.5361 0.2600 1.0128 0.0489 0.16% -5.0400 -0.8638 3.3255 0.0020 0.1278 7.3201 0.2400 0.1274 0.3220 0.1365 0.0000 0.5108 4.0142 0.0081 0.19% 47.04% 2.0608 0.0300 0.7739 0.1157 STD/TA 0.2259 0.74% -8.0789 0.3045 0.2500 0.4138 3.3400 27.2500 4.0419 0.95% -4.0253 0.1750 0.36% 21.1089 0.1916 0.68% 4.0400 0.1206 0.1629 0.1524 -0.2900 0.1800 0.0000 0.0300 -3.54% Siz 4.2598 0.0200 0.4600 0.0652 0.0265 0.1136 0.2149 2.3401 14.4760 0.1709 0.2848 0.1300 0.Thus Vanco Vodafone Carphone Warehouse Universe Emap Arriva British Airways Carnival EasyJet Ryanair Labrokes Marston's Luminar Alexon Findel Lookers HMV Beale Greggs 0.0204 0.7700 3.38% -7.0508 0.2212 0.0322 0.88% 13.0000 3.3426 0.3298 0.0501 0.3390 0.9132 0.56% -1.0902 0.1796 4.5951 0.0630 0.2404 0.53% 3.5863 0.1300 0.0123 0.1864 0.0316 0.9255 3.1386 2.0840 3.3003 0.0000 0.1633 0.0827 0.70% 4.99% 26.44% 47.30% 11.0019 0.3749 3.1357 0.0835 0.0000 0.0053 0.0445 0.0714 Prof 0.1177 3.4044 23.0800 0.1676 0.3577 0.5051 0.1800 0.2092 Div 1.2912 0.0000 0.0282 0.4208 0.26% 32.8858 81 .0142 0.2108 0.6145 3.

7794 0.0539 0.0822 0.3028 0.7170 0.2921 0.2357 0.0204 0.8147 0.096 0.0000 0.1536 0.0047 0.2689 0.0893 0.0431 0.1904 0.1190 -0.1450 0.39% 12.0735 0.0052 0.53% -8.4309 0.394 2.1520 10.52% -2.0662 0.0165 3.1391 0.1939 0.5568 0.82% 185.0746 1.1714 0.2685 0.0590 -0.1597 0.1581 0.6604 3.3688 0.24% 12.2009 5.2053 0.0369 0.1441 0.7688 0.0430 0.5917 0.0427 0.0605 4.0899 -0.0609 0.1397 0.2765 0.0310 0.12% 2.2774 0.0929 0.1000 4.7779 3.5755 4.0788 0.0000 0.55% -11.1889 0.2199 0.6918 0.0672 0.0000 7.3027 0.6624 0.315 0.0602 0.0184 0.1683 0.3997 3.0910 0.0002 2.2648 0.3275 0.0843 0.0263 0.0768 0.8834 3.0746 0.7709 2.1386 0.0265 625.5639 4.8838 0.0430 0.3913 0.1160 0.0533 0.1090 0.5292 625.05% -7.3470 0.9037 0.0843 0.3692 3.2554 0.0807 0.59% 2.0214 0.3449 0.2301 0.3878 3.8328 1.4637 4.7232 0.2228 0.2449 0.3775 0.3225 0.0591 0.2139 0.1014 0.6588 3.0000 0.0668 0.0183 0.79% 0.5502 2.96% 224.3141 0.1080 0.7182 0.0496 0.1948 0.68% -16.83% 6.41% 12.6266 1.3707 0.8794 3.2124 0.1488 0.2082 0.1339 0.323 0.1594 0.59% 82 .0148 0.4001 2.0468 0.2266 0.92% 16.1379 0.3150 0.84% -8.1581 0.0564 0.5118 0.1754 0.0567 0.78% 13.1827 0.1232 0.4128 0.1418 0.02% -6.1795 0.39% 1.1339 0.0123 0.0681 0.2367 0.0000 0.0288 0.6566 0.8599 0.1405 0.1305 0.8800 0.71% 26.1173 0.0379 0.7186 0.3286 0.81% 1.6038 0.0540 0.0089 0.2798 0.229 0.5684 0.677 1 0.3960 0.7101 2.0596 0.69% 45.0069 0.9986 3.0028 0.0366 0.37% 30.07% 9.02% -2.5614 3.0237 0.3968 2.3695 0.3975 3.0000 0.89% -2.1418 0.2466 0.1772 0.0661 -0.66% -6.2363 0.3666 3.53% 250.1920 0.Abacus Chloride Dialight Halma Invensys Laird XP Power Xaar volex Spectris Renishaw Unilever Tate&Lyl SABMiller PGI Kerry Group IAW Group Glanbia Diageo Devro Dairy Crest Abbot Group Aminex BG Group BP Burren Energy XP Power Hunting JKX Tullow Dana Petroleum Acambis Vernalis 0.0566 0.01% -9.1785 3.1785 3.1414 7.0258 0.0472 0.508 0.0746 Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Electronic Equip Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Food and Beverages Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Oil and Gas Pharmaceuticals and Biotech Pharmaceuticals and Biotech 0.0788 0.0390 0.0005 0.0282 0.2560 0.1941 0.7392 3.0871 0.0000 0.3158 0.83% -21.9878 0.0825 0.34% -1.0000 0.1701 4.0001 0.2464 0.0947 0.0824 0.0003 0.8515 3.0382 0.4614 0.0844 0.7785 0.60% 33.3239 0.0643 0.0263 0.2919 0.0353 0.6909 3.6964 0.0756 0.0262 0.2167 0.6032 0.1392 3.

0185 0.1590 0.4040 0.1879 0.1062 0.1176 0.5527 0.3341 0.4114 0.7163 4.0161 0.0440 3.05% 17.8788 0.0119 0.1143 0.0000 0.4344 0.0430 0.1045 0.5107 0.0735 1.28% 33.0000 0.4226 0.4074 0.0202 0.16% 16.3105 0.8638 3.6229 0.1168 0.47% 4.0107 4.9073 0.16% 2.98% 34.7485 -1.4220 2.1350 0.4532 0.19% 5.6605 0.8948 3.2695 0.0131 0.3113 0.0583 0.0310 0.7911 3.5797 0.2064 0.0874 0.0077 0.4705 1.0950 0.74% 4.0814 0.4847 0.3428 3.2273 1.0552 0.58% 5.1808 0.5893 -0.8858 2.15% 37.3122 0.1829 0.3032 0.7427 1.3717 0.0034 0.0430 0.0448 0.1527 0.15% 43.61% 13.2089 0.4379 3.0736 0.3224 0.0212 0.3880 0.1700 0.06% 6.5764 0.0482 2.96% 4.3200 0.7506 0.8771 0.5688 0.0000 0.2350 -0.28% -3.0170 0.8979 0.1909 0.0101 0.6534 0.5104 0.4232 0.3687 0.0617 1.1754 0.0019 0.0745 0.0440 1.1824 0.2484 0.01% 11.49% 24.0066 -0.0842 0.3924 0.0000 0.4723 0.1597 -0.1645 0.0021 0.0294 0.1038 0.8131 0.1975 0.0000 0.0000 1.2640 0.0727 0.0560 0.0401 -0.2785 0.4202 3.1845 1.70% 14.2404 0.61% -2.70% 15.0829 0.1904 0.5720 0.0142 0.7244 0.18% 16.3754 0.0297 0.0962 0.0626 0.1987 0.3757 0.5012 4.0203 0.59% 6.277 2.2247 0.0775 0.0165 0.1390 0.3184 0.62% 39.4741 0.2599 0.0616 2.4124 4.5404 0.3227 0.9186 2.0000 0.6769 0.1874 0.0093 0.0685 0.4249 4.1803 0.0259 0.1152 Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Travel and Leisure Retailers Retailers Retailers Retailers 83 .7877 0.1118 0.0710 0.0019 0.5365 0.4227 0.44% -4.4843 5.0886 0.0538 0.0127 Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Real Estate 0.3544 0.2973 2.1031 0.0638 0.0164 -0.4172 0.35% 22.0227 0.7685 1.6628 0.0001 0.0759 0.0130 0.5172 0.0942 3.0305 0.2630 0.5061 0.2300 0.5255 0.0481 0.5106 0.2737 0.2382 0.0769 0.0467 0.4066 0.1330 0.9345 0.3465 3.7256 0.44% 11.83% 1.4988 0.2161 0.0606 0.0594 0.0494 0.4851 4.2002 0.0732 0.1084 -0.1176 Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Real Estate Telecommunication Telecommunication Telecommunication Telecommunication Telecommunication Telecommunication Telecommunication Telecommunication 0.9129 0.3524 0.8307 0.0944 0.9302 4.0054 0.1045 0.0000 0.0361 0.03% 4.7665 4.8275 0.1153 -0.7439 2.3909 3.1874 0.0853 0.3436 0.9138 2.9040 0.3175 0.68% -1.788 0.0290 0.0000 0.5115 2.2015 7.1952 0.0804 0.53% 2.62% 1.Astrazemc a Vectura Group BTG Dechra Brixton Liberty Internation al Segro CLS Holdings Daejan Freeport Grainger Savills Minerva BT Group Kcom Thus Vanco Vodafone Carphone Warehouse Universe Emap Arriva British Airways Carnival EasyJet Ryanair Labrokes Marton's Luminar Alexon Findel Lookers HMV 0.2169 0.42% 13.01% 21.

101 .144 1.009 .047 1.094 -.048 .127 .005 .902 .584 .177 -1.2358 Appendix Two: Tables of Coefficients Regression on Long-term Debt 2001-2004 Model Unstandardized Coefficients B .863 .020 -.381 .33E-005 .7085 8.0000 0.163 -. Collinearity Statistics Toleranc VIF e 1 (Constant) Tax Shield Profitability Tangible Assets Dividend Growth Rate Size 2005-2006 Model 1 (Constant) Tax Shield Profitability Tangible Assets Dividend Growth Rate Size Unstandardized Coefficients B 1.692 -1.2021 0.002 .025 .171 .936 .862 .310 Std.978 .000 Standardized Coefficients Beta .497 .980 .898 .524 -.394 -.144 t Sig.33% 10.000 Std.017 -.3490 -1.002 .742 .0887 0.010 .0232 0.430 .110 1.001 .092 1. Error .704 .023 1.0019 0.178 -.178 .219 .251 .952 -1.048 .030 -.015 -.Beale Greggs 0.050 .001 .970 .925 .712 -.001 .053 t Sig.197 Standardized Coefficients Beta 2.956 .1726 4.915 .178 t Sig.120 1.849 1.174 .000 -. Error .234 -.874 .019 .983 .019 .014 .850 .44% 3.008 . Collinearity Statistics Tolerance VIF 84 .004 .881 .080 -.0533 0.047 1.159 1.042 .0865 0.177 1.704 .001 Std.956 .978 .017 1.893 .147 .479 .572 .1121 0.040 .031 1.956 .950 1.137 .967 .860 .001 .004 -.208 .556 .439 -.028 -2.028 -.491 .129 -.0000 Retailers Retailers 0.330 . Collinearity Statistics Tolerance VIF Regression on Short-term Debt 2001-2004 Model 1 (Constant) Tax Shield Profitability Growth Rate Unstandardized Coefficients B .683 .041 3.034 .793 -. Error .108 1.039 .985 .4847 0.874 1.061 Standardized Coefficients Beta .077 -.023 1.

177 1.178 2005-2006 Model 1 (Constant) Profitability Tangible Assets Growth Rate Size Tax Shield Dividend Unstandardized Coefficients B .032 -.047 .095 .401(a) .861 2. Growth Rate 2005-2006 Model Summary Adjusted R Square Std.912 1.799 .063 -.392 .114 -.006 -.180 .850 .4706778 a Predictors: (Constant).078 .055 .228 .250 . Error .4350471 Model 1 R .659 -.081 -.307 .017 .110 1. Profitability. Growth Rate Model 1 R R Square Inclusion of dummy variables Model Summary Adjusted R Square .026 -1.017 t Sig.076 .040 4.003 .983 1. Tangible Assets.68E-005 Std.022 .Tangible Assets Dividend Size -.902 .512 .005 5.127 . Tangible Assets.817 . Size.302 . Collinearity Statistics Tolerance VIF Appendix Three: R2 Summary • Regression on Long-term Debt 2001-2004 Model Summary Adjusted R Square Std.915 .295 -.125 -.295 -.000 .029 .219 .053 1.5671772 a Predictors: (Constant).031 1. Error of the Estimate Model 1 R R Square . Error of the Estimate .92E-005 .002 -.987 -.232 .008 .408(a) R Square .312 -.950 .343 .970 .331(a) . Dividend.402 . Tax Shield. Size.727 .159 1.064 .893 .849 1.689 .092 1.863 . Error of the Estimate .201 .120 1.205 . Tax Shield.108 1.000 Standardized Coefficients Beta 1. Dividend.312 -1.389 85 .271 Std.013 . Profitability.

Tangible Assets 86 . Growth Rate. Error of the Estimate . Dividend. Size. Industry.450(a) R Square .268(a) . Profitability.189 -.329 a Predictors: (Constant). Size. Industry. Tax Shield. Tax Shield.207 Std. Dividend.124 Std. Profitability. Tangible Assets. Profitability.0474305 Model 1 R .0477150 Model 1 R .397 a Predictors: (Constant). Growth Rate Model 1 R R Square Inclusion of dummy variables Model Summary Adjusted R Square . Growth Rate. Profitability. Tax Shield. Tangible Assets • Regression on Short-term Debt 2001-2004 Model Summary Adjusted R Square .165 . Size. Tangible Assets. Dividend.5062158 a Predictors: (Constant).436(a) R Square .a Predictors: (Constant). Tax Shield. Dividend. Size. Error of the Estimate . Growth Rate 2005-2006 Model Summary Adjusted R Square Std. Error of the Estimate .

061 .305 80 .278(*) .097 .972 80 1 Dividend -.304(**) .097 .581 80 -.962 79 .552 79 1 Industry Industry Pearson Correlation Sig.004 . (2-tailed) N Profitability Pearson Correlation Sig.381 80 -.758 80 -.962 79 -.166 .113 .065 .061 .053 .875 80 -.193 .448 80 -.025 .134 .193 .065 .320 80 .589 80 .305 80 .Appendix Four: Correlations between Independent Variables Correlations Tax Shield -.758 80 -.085 80 .825 79 .035 .068 .581 80 . (2-tailed) N Tax Shield Pearson Correlation Sig.01 level (2-tailed).116 .006 80 1 80 80 * Correlation is significant at the 0.552 79 -.072 79 1 Size .278(*) .006 80 80 80 1 Tangible Assets .972 80 .004 .166 . (2-tailed) N Tangible Assets Pearson Correlation Sig.638 80 -.099 . (2-tailed) N Growth Rate Pearson Correlation Sig.875 80 80 -.005 .035 .143 79 -.085 80 1 Growth Rate .063 .638 80 -. (2-tailed) N Dividend Pearson Correlation Sig. ** Correlation is significant at the 0.113 .589 80 -.068 .005 .053 .099 .134 .235 80 . 87 .086 .072 79 -.204 .381 80 .025 .018 .397 79 .825 79 -. (2-tailed) N Size Pearson Correlation Sig.05 level (2-tailed).143 79 80 -. (2-tailed) N 1 Profitability .304(**) .567 80 .397 79 -.235 80 -.018 .448 80 79 -.013 80 .013 80 -.063 .204 .320 80 -.116 .567 80 -.086 .

0085773 .0836918 1.853433 .118667 -.037680 .1176 .0552174 .1038 .045057 .0000000 .0252788 .2599 .0019 .0134286 .361333 .291552 .062633 .0816634 .0000 .001003 .0513118 .0047 .252855 .0199900 .240000 .051383 .0992534 .149548 .0216289 .0455743 .060845 .2464 4.0000 .0837 .011247 .2400 .071921 .1451316 .2599 Pharmaceuticals and Biotech Real Estate Telecommunication Travel and Leisure Retailers Total STD/TA Automobiles Chemicals Electronic Equip Food Beverages Oil and Gas Pharmaceuticals and Biotech Real Estate Telecommunication Travel and Leisure Retailers Total 88 .016864 .0788 .114019 .118030 .088531 .301525 .1075131 .018042 .6882458 .151309 .067422 .045675 .0050000 .2689 .0745 .621092 .0070711 .4741 .6769 4.117513 .0328932 .1590 .056951 .0052 .0080319 .0264657 .Appendix Five: Descriptive Figures from ANOVA Test 2001-2004 N Mean Std.0151859 .019362 .005499 .0440 .0019 .0710983 .480821 .0142 .085903 .0489653 .0253 .038531 .098300 .1939 .0253990 .0799386 .068438 .068228 Minimum Maximum LTD/TA Automobiles Chemicals Electronic Equip Food Beverages Oil and Gas and 2 10 11 10 10 6 9 8 8 6 80 2 10 11 and 10 10 6 9 8 8 6 80 .3822477 .019511 .088740 .030627 .025000 .051950 .1829 .2633523 .036478 .240000 .0538 .3960 .0288724 .220550 .0313867 .0207539 .1968117 .915759 .1511528 .0300 .62262 6 .0257319 .1772 .0200 .0123 .204450 .0000 .1351450 .195084 -.240000 .2900 . Error 95% Confidence Interval for Mean Lower Upper Bound Bound .0000000 .4938795 .055849 .047521 -.0656039 .0000 .255011 .0001 .049763 . Deviation Std.0506710 .139601 .0000 .2689 .025278 .6229 1.167259 2.0056652 .137547 .0000 .0000 .064464 .6858511 .0224833 .3775 .0736 .0587010 .0000 .2400 .0503658 .0000 .497650 .107390 .0068396 .346367 .069275 .240000 .037879 .145104 -.364919 .175215 .

0631844 .0666903 .120403 .4710 STD/TA Automobiles Chemicals Electronic Equip Food and Beverages Oil and Gas Pharmaceutical s and Biotech Real Estate Telecommunica tion Travel and Leisure Retailers Total 89 .0630265 1.0000 .0424264 .0000 .044811 .41097 3 .7052 .045367 .1594941 .1787124 .1860 .0480893 .9886292 .068970 .0149 .112200 .484945 .6628 .1444 .561186 .0000 .0275889 1.0641758 .0000 .083331 -.0246850 .0042 .2700 .0100 .294155 .0199307 .0000 .145260 7.085650 .0872437 4.5396 .1212187 .475410 3.232795 Minimum Maximum LTD/TA Automobiles Chemicals Electronic Equip Food and Beverages Oil and Gas Pharmaceutical s and Biotech Real Estate Telecommunica tion Travel and Leisure Retailers Total 2 10 11 10 10 6 9 8 8 6 80 2 10 11 10 10 6 9 8 8 6 80 .1784974 .793912 .0629325 .180000 .0604657 .0006 .225304 .1633571 1.0199010 . Error 95% Confidence Interval for Mean Lower Upper Bound Bound -.0200000 .055856 .145838 .008010 .186130 -.0395585 .2215263 .3580 .1500 .0139860 .048950 .0300000 .082850 2.0282843 .224124 -.066534 .120725 .4208 12.2158549 2.0000 .000391 -.207440 .1629 4.308163 .0000 .0719516 .088645 .0000 .0158 .438621 .059233 .8477 .1525 4.7397616 .230826 .062238 -.0783214 .283633 .0000 .122963 .0000 .0000 .0383327 .1058824 .2719 12.316917 .335538 .0500 .0179414 .131600 .6600 .118155 .0683 .020440 -2.0334830 .0018 .059526 .086184 .023951 .0002 .2029418 .028141 .2005-2006 N Mean Std.4710 .094036 2.2100 .8120385 .143568 -1.207344 .7230 7.8711268 .1676 .5050481 .0564661 .42885 1 .0271548 .003864 -1.129201 .9579260 .030000 .7094239 .795017 .018088 .284124 .0538243 .149150 .1227 .1827 .108822 .033463 . Deviation Std.772417 .1860 .67403 4 .0900622 .2333 .309489 1.011005 .003438 .0000 .201186 .119298 .5965297 .113989 .

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