This chapter commences with background review of this study which delves into the determinants of capital structure in Malaysian context with emphasis on corporate governance. This is followed by outlining of problem statement, research objectives, research questions, definition of key terms and significance of the study. This chapter ends with brief overview on the organization of the remaining chapters in this thesis.



Capital structure, one of the most studied aspects in modern corporate finance school of thought, is an important decision for management to ensure the financial health of firm to be in good condition. The information on capital structure is essential for every stakeholders of a firm to make their decisions pertaining to the firm. Suitable capital structure is not only imperative for maximization of interest of every stakeholders of an organization, but also crucial for the organization to compete effectively and efficiently in its operating environment (Simerly and Li, 1999). Fallacious choice of capital structure would not only lead to its financial distress, but also ultimately drag the organization into insolvency (Eriotis et al., 2007).


Studying firm’s capital structure is important as it plays important role in creating value for the firm via the effect of tax, information asymmetry, and agency cost (Tang and Jang, 2007). Besides that, financial theory also has been used by firms to choose the best composition of capital structure that enhances the firms’ value (Eriotis et al., 2007). Therefore, study on capital structure would provide valuable insights on how strategic decision of firms in implementing investments would affect its value, which in return, used to determine its position in the market.

Modigliani and Miller (1958) initiated the most significant study on this topic, which was followed with various studies that have been conducted in diverse dimensions of capital structure. It was argued that after fifty years of Modigliani and Miller research,

understanding on firms’ financing choices is limited, where information on financing tactics such is apprehended well than information on financing strategy such as a firm’s choice of target capital structure (Myres, 2001). This is because objective of past studies has devoted much attention on usual determinants of capital structure, which includes variables like size, profitability, growth, tax-effect, stock price, etc. Relationship between these variables and capital structure has been extensively researched.

Despite its theoretical appeal and vast exploration, researchers in financial management have not achieved consensus on capital structure and its optimality. It was only the ways to achieve shortterm capital structure objective were able to be identified in most of these studies (Simerly and Li, 1999). It was pointed out that there is clear evidence of lack of consensus in identifying other determinants of capital structure (Delcoure, 2007).


Fast advancement of agency theory with emphasis on bankruptcy costs and agency cost has contributed the argument that corporate governance has important role in capital structure (Seifert and Gonenc, 2008). Among newly identified determinants that influence capital structure,

corporate governance has been identified as one of decisive factor that affects firm’s capital structure decision (Delcoure, 2007). For this purpose, ownership structure is commonly used as proxy for corporate governance (Booth et al., 2001; Zou and Xiao, 2006).

Prior to 1997 financial crisis, Malaysian firms were noted to be highly leveraged in view of their close relationship with local banking and financial institutions where bank-based borrowings were dominating the capital structure of these firms (Tam and Tan, 2007). This was even after the clear existence of conflict of interest between the lender and borrower. Existence of common directors or shareholders in both borrowing and lending organizations is a typical example of conflict of interest.

High reliance on debt financing was not purely a strategic decision on the part of many Malaysian firms before the 1997 financial crisis. Many large corporations took investment decisions with mere backing from the banking institutions. Hence, capital structure of most of Malaysian firms, both government-linked and non-government linked, was more aligned to debt financing as options of equity financing were very much less considered. This showed owner of the firms were making investment decision based on connections and links with the banks (Suto, 2003).


at a premium price that was deemed as an act of bailout which suggest weak corporate governance practices (Mitton. 2008). After nearly ten years of the Asian financial crisis. 2003). these factors also contributed to bad corporate investment decisions. United Engineers Malaysia (a government-linked corporation) acquired 32. 4 . 2002). which was once a roaring economy dragon of East Asia (Mitton. in November 1997. Two main causes cited for high risk capital structure in Asian corporations was attributed to weak corporate governance and crony capitalism (Du and Dai. 2004).This relates to weak path in corporate governance practices among Malaysian firms. For example. Besides high risk capital structure.6% of its financially troubled holding company. other internal and external factors have triggered the collapse of Malaysia’a economy. Renong. While weak corporate governance was not the mere factor that caused the Asian financial crisis. Troubled corporate sector of Malaysia during the 1997 financial crisis was ruined further by badly designed corporate investments that were induced by weakened corporate governance mechanism between banking sector and corporate sector (Suto. 2005). the affected countries have rebound and back on track with decent economy fundamentals. Post-crisis period exhibited better corporate governance policies implemented by the authorities to ensure firms choose best source of financing (Wei and Zhang. Weak corporate governance made the economy more defenseless and easy to be toppled. 2002). rapid diversification and risky financing practices (Samad.

were to test the relevance capital structure theories. firm size. tax shields. Turkey. Jordan. asset tangibility. growth opportunities and profitability) affect corporate financing choices based on extant capital structure theories.3 Problem Statement Modigliani and Miller (1958) who broke a new ground on capital structure studies had indicated capital structure is independent of the value of the firm under certain assumptions. 5 . asset size. among others. Subsequent studies pursuant to that had been undertaken to gauge various aspects of capital structure. profitability and growth. Brazil and Zimbabwe reported that same factors are also important in developed countries. Thus. However. there are numerous studies conducted to identify the determinants of capital structure of firms. Pakistan Mexico. Zou and Xiao (2006) had reviewed that Rajan and Zingales (1995) whom compared capital structure decisions across G-7 countries and report that in these countries the same sets of determinants (i. The objectives of these past studies. Capital structure determinants study by Booth et al. These studies have analyzed a variety of factors that determines capital structure. (2001) in developing countries like Thailand.e. there is need for a re-look on the same determinants and its effect on capital structure of local firms. to determine the optimal capital structure level and to establish relationship between capital structure and firm value. such as share price.. but their direction of influences differs across countries.1.

Prevalence of major shareholder owning and controlling quite a number of firms in Asia reflects discrepancy that contributes to agency cost problem (Wei and Zhang.e. 2002).Studies to ascertain corporate governance practices as determinant of capital structure are comparatively limited in local literature. On the same note. Ownership structure of Malaysian firms can be grouped into three categories. debt financing.e. 2006). i. substantial shareholders are able to victimize minority shareholders and managers given the control that they held in the firm (Mitton. The basic of agency cost arises from clear division of ownership and control. One dimension of corporate governance is type of ownership structure of the firms. In fact. family-owned. Different ownership structure provides basis for agency costs problems to exist. testing the implications of different type of ownership structure on capital structure would provide an insight on the relationship between both variables. state-owned and foreign-owned. 2006). is widely used as a tool to implement corporate governance practices. owners are able to avoid the managers from taking financing decisions that has advantage for themselves (Pindado and Torre. 2006). to address agency cost in firm. This is because corporate governance is usually considered as a diluted linkage in Asia’s corporate sector (Tam and Tan 2007). For instance. capital structure. Hence. which shape the capital structure of the firm (Arslan and Karan. 6 . tax shields are one of main benefit that surfaces from debt financing (Zou and Xiao. i. This is because via debt financing. 2008).

This would provide additional insight on how different type of ownership structure affects the capital structure decisions of Malaysian firms.Ownership structure effect on capital structure was studied to have impact where largely grouped firms usually has high debt ratio (Manos et al. which commonly can be evidenced in family-owned firms.4 Research Objective Primary objective of this research is to identify the determinants of capital structure of public listed companies in Malaysia. ownership structure noted to have impact on capital structure decisions of firms. offers incentives to managers to choose best financing method that maximize the firm’s performance and value. This is because large companies’ investment decisions are also affected by size and profitability of the group. 7 . Uniqueness of this study would be the enclosure of corporate governance link in the form of ownership structure as determinants of capital structure. providing fund to state-owned firms is risky affair given the high default probability.. 1. 2007). Conversely. where managers in these firms have less commitment to repay the loan given the low odds of the loan to be recalled (Zou and Xiao. 2008). Hence. This is because managers are accorded with monetary incentives to improve the corporate performance – solving the agency cost problem (King and Santor. Clear delineation between owners and managers that is apparent in state-owned and foreignowned firms. There is need to identify effect of Malaysian firms’ ownership structure on capital structure together besides the re-look into other capital structure determinants with other usual financial characteristics determinants. 2006). besides the usual financial characteristics variables.

8 . this research would attempt to answer the following research questions: - 1. Does ability of firm to service debt obligation affect the capital structure decision? 6. Does liquidity level of firm affect the capital structure decision? 5.5 Research Questions In order to achieve the objectives outlined above. The last question is designed to link ownership structure as determinants of capital structure. To examine the relationship between ownership structure and capital structure 1.In precise. Does growth of firm affect the capital structure decision? 3. Does size of firm affect the capital structure decision? 2. To examine the relationship between firm financial characteristics and capital structure 2. Does profitability level of firm affect the capital structure decision? 4. Does ownership structure of firm affect the capital structure decision? The first five questions are designed to identify the firm-specific financial characteristics as determinants of capital structure. the objectives of this study are as follows: - 1.

1 Capital Structure Capital structure refers to the allocation between debt and equity in financing of a firm asset. 1. where the firm would borrow money from outsiders. specified source of financing. Debt holders would have priorities in settling their portion of obligation at any event of default of the firm. target capital structure. i. namely from capital market or financial institutions. its maturity and timing (Brigham and Ehrhardt. while equity is classified as common stock. 2005). preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure. commercial papers. A perfect capital structure decisions encompasses four main aspects. term-based financing or short term financing. 9 . The debt holders usually charge interest on the firm and this expense is tax deductible for the firm. Investopedia defines capital structure as a mix of a firm's long-term debt. where debt comes in the form of bond issues or long-term notes payable.1. specific short-term debt. common equity and preferred equity used to finance its overall operations and growth.2 Debt Financing Debt financing is external source of financing.6 Definition of Key Terms 1.e. Types of debt financing include bonds.6.6.

It has been argued that although theoretical and empirical research suggests that there is an optimal capital structure. Prevailing trend of local firms in addressing the type of financing choice for expansion ventures is of the essence for two reasons. common shares and preferences shares. which is usually in the form of new shares issuance.. which is less frequently used.e. Common shareholders are residual owners of the firm. The claim of these stockholders for a firm’s assets at the event of default falls between that of common share and debt.6. Basically. i. Common shares provide control right to the shareholders in the form of voting rights.7 Significance of Study This study would be providing fresh insights on factors that determine the capital structure mix of firms in Malaysia. there is no specified methodology formula to determine the ideal capital structure that fits to all industries across nations (Eriotis et al. 2007). 2007).6. utilization of retained earnings and issuance of bonus shares. usually has pre-determined dividend rate.1. there are two types of shares that would be issued by a firm. 10 . Preferred stock. 1.4 Optimal Capital Structure Optimal capital structure refers optimal mixes of debt and equity that has ability to maximize the stakeholders’ value (Tang and Jang.3 Equity Financing Equity financing refers to internal source of funding. 1.

1997. Factor that triggered the collapse of Malaysian firms during the Asian financial crisis in year 1997 is closely associated with lack of corporate governance measures. this study is undertaken after ten years from the occurrence of 1997 financial crisis. Suto. this study would enable to highlight whether the trend of capital structure since the crisis period is still maintained after various new corporate governance practices introduced after that.Firstly. Samad. weak corporate governance was noted as one of the causes of the crisis (Wei and Zhang. i. 2003. 2004. 2008). this study also would offer insights how local firms’ ownership structure plays important role in the capital structure decisions.e. this study would provide a link to identify whether local firms still has high concentration on debt financing in their capital structure (Tam and Tan. Secondly. These ventures were implemented with high reliance on debt financing. Hence. Hence. 2002) or they have reduced the reliance on debt financing. This is because local corporations were aggressively involved in high risk investment ventures. 11 . compared to internal funding. Mitton. It provides guidelines for potential stakeholders like customers. precisely bank borrowings. suppliers and even bankers to understand local listed companies’ characteristics in terms of financing choice. where collapse of local firms then were highly associated with bad financial management practices. As highlighted in earlier sections.

1. Chapter 2 sets out the review of secondary literatures pertaining to purpose of this study. In Chapter 4. also resulted in heavy borrowing by these corporations. As a whole. where in ample cases the corporations’ major stakeholders are Government itself. 12 . 2004). In this chapter. concise discussions of the empirical results are done. research questions. some conclusions are drawn from the most outstanding results and some directions for future research are suggested. Additionally. the theoretical framework of the study is introduced and hypotheses to be tested are formulated.These corporations were able to obtain bank borrowings easily as both lender and borrower are closely linked with the banks use to hold stake in the firm (Deesomsak.8 Organization of this Proposal The thesis is divided into five chapters. Hence. definition of key terms and significance of sutdy. Chapter 3 describes the sample and variables used and also explanation on the empirical method. the study would indicate the prevalent trend of Malaysian firms’ characteristic towards their existing operating financial and economy environments in the context of financing choice. This chapter encompasses an overview of capital structure. These were the bad practices that facilitated the collapse of local corporations upon the trigger of contagion effect of regional financial crisis. the result of this study would indicate whether type of ownership structure (dimension of corporate governance) has influence on capital structure decision after the 1997 financial crisis. connections of these corporations with Government. In the final chapter. statement of problem and outlines the research objectives. It can be inferred that erroneous capital structure decision driven by bad corporate governance practices had contributed to 1997 financial crisis.

13 .CHAPTER 2 LITERATURE REVIEW 2. The study proved that given the mentioned conditions. the next generation of researchers explored into meticulous conception of capital structure that made possible to emergence of two more prominent theories in capital structure literature. In making decisions on capital structure. the firm should always gauge its operating environment.1 Background Capital structure is a fundamental aspect of corporate finance that delves into the study on the approach a firm chooses its source of financing to fund its investments in acquisition of assets.e. 2. tradeoff theory and pecking order theory. 2008). As theory by Modigliani and Miller (1958) lack of practicality in its assumptions. firm value has no relationship with capital structure. 2001). i. transaction costs or other market imperfections. Modigliani and Miller (1958) initiated the first study on capital structure which concludes that capital structure is immaterial in a corporate world without taxes.. both external and internal (Hovakimian et al.2 Overview on Theories An essential matter in corporate finance involves understanding how firms choose their financing choices and it is apparent that there is no consensus on theories that explains a firm's perfect capital structure (Seifert and Gonenc.

One main consideration was taxations that were included as one of determinants of capital structure (Eriotis et al. The term trade-off theory is used by different authors to describe a family of related theories. bankruptcy costs and information is available for everyone in the market. Modigliani and Miller (1958). Ultimately. in other words.1 Modigliani-Miller Theorem This pioneer study was designed by Modiagliani and Miller (1958) on assumption that there is existence of market perfection in capital market.2. Subsequent studies after Modigliani and Miller (1958) were conducted premised on lesser limiting conditions. 2. the market operates without transaction costs. i. imperfections in market is apparent. Tax incentive is vital for corporate borrowings as it is able to take advantage of interest tax shields (Myres. 2007). Therefore. 2003). For the non-leveraged firm. As a result. cost of equity is same for firms which are. 2001). asserted that financing decisions of firms are undertaken with identical interest rate and without tax.. 14 .e. marginal costs and marginal benefits (Frank and Goyal. premium is included for financial risk. leveraged and non-leveraged. It is based on firm’s choice of source of financing after equating the cost and benefits of each of the source.2 Trade-Off Theory Modigliani and Miller (1958) argument that capital structure does not exist in perfect market is irrelevant as in real world.2.2. both. This includes tax rate on corporate earnings. these assumptions are pointing out that value of the firm is independent to its capital structure. tax rate on dividend income and tax rate on interest inflows income. This weakness is addressed in trade off theory.

In debt financing. 2006). Hence. 2008). which reduces the taxable income of the firms (Jiraporn and Liu. 15 . It has been emphasized in the theory that firm with sound tangible assets would borrow more than firms with high intangible assets. firm’s debt position should be at the level where the tax advantages of additional debt are equal or more of the costs of possible financial distress (Myres. firm should weigh these two aspects in deciding its optimal capital structure level. 2008). 2008). firms would incur interest expenses that is deductible from earnings before interest and tax. designed under presumption that optimal capital structure is achieved when advantage of the tax shield benefits of debt is equal to increased likelihood of incurring debt-related bankruptcy costs (Beattie et al.. The theory. The tradeoff theory states that a taxable corporation should increase its debt level until its tax advantages of borrowing against the costs of financial distress is balanced. debt financing is exposed to default risk that points towards probability of bankruptcy. Debt level is expected to be increased to the limit where marginal value of tax shield is equal or lesser to present value of possible financial distress costs (Delcoure. 2007). However. deemed static. Thus. 2001).The balancing of both aspects determines the optimal capital structure (Seifert and Gonenc. Trade-off theory explains that debt financing is a better financing choice given its ability to provide tax shield. Limitation of trade-off theory is apparent from its failure to explain stock market reaction to leverage-increasing and leverage-decreasing transactions (Seifert and Gonenc.

internal fund such as retained earnings is preferred and as for external financing.3 Pecking Order Theory If in trade-off. 2008). 1984) the asymmetric information element is included. debt is chosen over equity (Tang and Jang. 2007). If a firm’s use of external financing would indicate that the firm is not profitable. 2008). in pecking order theory (Myers. which starts from internally generated financing to debt and lastly outside equity (Seifert and Gonenc. The pecking order hypothesis describes a hierarchy of financial choices for a firm.2. 2007). whereas firms with low profitability tend to use external financing. The theory can be related to few aspects like agency costs. bankruptcy cost is included. The theory asserts opposite relationship between profitability and debt usage (Tang and Jang. 16 . This related to information asymmetric where the managers usually have more information on the firm. Based on this theory. they would issue new shares when it is believed that the stock price is fairly or overly priced only. its stock price may be adversely affected. transaction costs and information asymmetries (Seifert and Gonenc. Therefore. in the context of internal finance.2. Pecking order theory suggest that management would prefer equity financing in favor of debt financing in view of information asymmetry condition and benefit of reduced transactions costs. taxes. Based on this theory. highly profitable firms will tend to use internal funding.

Information asymmetric also occurs when external financing signals the firm’s red profitability. 2001). 2. 2008). 2004). Large cash reserves and availability of financial slack are resultants of this type of corporate practice (Seifert and Gonenc. firms are expected to identify their capital structure that is consistent with tradeoff models of capital structure choice (Hovakimian et al.2. easy access to internal fund and lesser transaction costs are reasons for utilization of internal fund first before debt financing (Chen. Nevertheless.4 Agency Cost Theory Tang and Jang (2007) reviewed Jensen and Meckling (1976) that agency cost theory induces positive relationship between level of debt and shareholders’ value. There are two forms of agency conflicts. This may again be wrongly interpreted as the firm is not profitable and sourcing for external financing. For example. The theory also does not back optimal capital structure as it is believed to be dynamic over time (Romano et al. manager-shareholders and creditors-shareholders. in long run. Besides in information asymmetric. where the conflict between manager and shareholders is about fulfilling the respective parties’ individual interest. It is also argued that profitable firms borrow less for the reason that they have their own internal fund to be use first (Myres. Therefore. debt would be used first instead of new stock issuance for financing requirement. Hence. which may affect the share price. Hence. 17 . 2001).. 2001). the managers are not committed to debt-repayment.. managers in profitable firms use equity financing given the availability of free cash flow. new shares would be issued only when stock price of the firm is deemed favorable.

2.This would potentially reduce the shareholders value (Tang and Jang. 2002. there were continuous studies made in relation to capital structure. 3 Determinants of Capital Structure Consequent to these theories. 18 . which make less valuable companies more likely to fall into bankruptcy – hence predicts that the firms with the best earnings and growth prospects will employ the most leverage. This model states the firm with higher value would use more debt as it has less probability of being insolvent – hence suggesting that firms with high growth rate and large size would resort in debt financing (Chen. the researchers also have attempted to determine the optimal capital structure level and cohesively concluded that there is no optimal capital structure level for specific firm. debt financing is identified as tool to ensure that managers increase shareholders' value instead of making money for themselves (Chen. Shyam-Sunder and Myers. 2003) as reviewed by Beattie (2006).5 Signaling Hypothesis Model Signaling hypothesis model states that high-value firms are able to use more debt financing because debt has its dead weight costs. 2. Fama and French.2.g. 2007). alternative argument states negative relationship between growth and leverage in view of the fact that growth opportunities cannot be collaterized (Lang et al.. Thus. 2004). and Frank and Goyal. 2004). In pursuing these studies. 1996). However. 1999.. Noteworthy numbers of studies were embarked on to compare and test the relevancy of these theories (e.

Turkey by Arslan and Karan (2006). Africa. Swiss by Gaud et al.e. (2005). Most researches on capital structure concentrate on factors that determine the capital structure of firms. the Middle East. There were other aspects also included in past studies. 19 . The studies were conducted based on countries. comparison among East Asia countries by Driffield (2007). Ghana by Boateng (2004). Study by Boateng (2004) in Ghana has included ownership structure as one of determinant given the fact that Africa is perceived to be a risky place to do business. i. of which the data was taken prior to 1997 financial crisis. 2007). emerging countries in Latin America. and Eastern Europe by Mitton (2008) and in Malaysia by Suto (2003).. The study in Malaysia. US by Jiraporn and Liu (2008).Existence of optimal capital structure level still remains vague with no proper methodology specified to ascertain the said level of capital structure based on individual firm’s financial standing. It is always the level of capital structure that maximizes the value of the firm that is regarded as optimal capital structure (Eriotis et al. Asia (excluding Japan). Studies in each countries differs according exclusive environment of the country with similar determinants. has included dependency on banks as one of determinants given close relationship of government-linked companies with banks in the country during that period of time.

state-owned and foreignowned. would be classified as ownership structure of the firm. 2006) and corporate control concerns (Ghosh et al. where firms are differentiated based on family-owned. growth. which is key thrust of this study. Trade-off theory lays down that large firms are expected to have a higher debt capacity given the fact that large firms tend to be well diversified and has lesser probability to be financially distressed which may lead to insolvency and bankruptcy cost (Nivorozhkin.4. The second set of determinants. the exposure to higher transactional costs and bankruptcy cost reduces (Chen.1 Size of Firm Size of firm are one most common variables used to be tested as explanatory factor for capital structure. which gives new perspective to capital structure studies. 2005). 2. These determinants are classified as financial characteristics of the firm. 2005). liquidity and interest coverage of the firm. 2005).There were also refined studies conducted to further examine functions of capital structure in terms of maturity structure of corporate debt (Datta et al. 2004).4 Financial Characteristics As highlighted earlier. (2007). Du and Dai. 20 . firm-stakeholder interaction (Arslan and Karan. 2. profitability. most studies in identifying capital structure has revolved around similar sets of determinants such as size.. As a firm becomes more diversified. All the determinants are explained based on its theoretical relevance and empirical evidence describing the relationships between the determinants and capital structure.

would enable easy decision making by the managers to borrow (Delcoure. The relationship between the firm size total and short-term debt is positive and statistically significant (Delcoure. Past studies (Gaud et al. it can be related to usual association of these large firms with government-sponsored investment programs. as stressed in trade-off theory. any failure of these firms may carry huge social and economical implications (Nivorozhkin. Finally. 2005). firms which has large and safe tangible asset has more tendency to borrow given the value of collateral that can be raised from these assets (Myres. 2005). 2006). 21 .Generally. the lower risk with larger firms encourages banks to borrow to these companies more than smaller companies which have higher risk in defaulting (Boateng. 2007). Fourthly. which primarily constituted by banking and financial institutions. whereby there is explicit and implicit guarantee from the government on borrowings by these firms (Nivorozhkin. 2004). Thirdly. 2007). larger firms has capability to negotiate better pricing and minimizes the transactional cost that makes debt financing a better choice for these companies(Beattie et al. etc.) have concurred that size of firm has positive relationship with debt ratio. large firms that usually have diluted ownership. Mitton (2008). The positive effect of firm size on leverage target can likely be explained by the fact that size serves as a stability proxy for lenders (Nivorozhkin. given the large size of these firms. In terms of agency cost in relations to debt. 2001). Firstly. 2005). managers of large firms are able to increase the firm’s leverage without much problem. larger firms have better access to debt market. for few reasons. Secondly. Huang and Song (2006). (2005). Therefore.. Arslan and Karan (2006).

. As in trade-off theory.2. 2006). 2005).. Asset substitution effect may cause high growth firms to capitalize from debt holders to shareholders. firms with good growth opportunities has less probability to borrow based on growth opportunities as it cannot be used as collateral in borrowing – hence would resort for equity financing (Gaud et al..4. which at the end would result in lower debt ratio (Hovakimian et al. Upward stock price movement is usually associated with improved growth opportunities. 22 . Agency cost also plays important effect on financial decision for high growth firm. 2005). 2008). 2001). 2004). hence firms to rely on equity financing more (Chen. 2007). The effect of asymmetric information between managers and owners would encourage lesser commitment of debt financing (Nivorozhkin. Equity financing would be sought to undertake new projects instead of debt financing by firms with high growth opportunities as a mechanism to minimize agency costs (Jong et al. hence leverage is expected to be negatively related with growth (Huang and Song. Firms with high-growth opportunity resort for debt as last option.2 Growth of Firm Pecking order theory stipulates that firms with higher growth opportunities would use more of equity financing as they would reserve the debt financing for period after the realization of the growth (Delcoure.

the profitable firms choose to commit debt for the same reason that their future profits would be subject to terms and conditions by the lenders – thus resulting in inverse relation between profitability and leverage (Deesomsak et al. 2005. Firstly.. Study by Gaud et al. Nevertheless. Fattouh et al. to avoid incurring excessive tax. (2001) also revealed statistically significant negative relationship between profitability and leverage. Secondly. debt and finally new equity (Jong et al. Study by (Deesomsak et al. 2004).. 2007.. 2004). 2008).. especially on their future earnings (Tang and Jang. 2007).4. 2005. Additionally. 23 . 2006). hence showing negative and significant relationship with leverage. this is again has to be weighed against the expected bankruptcy costs. it would be not wise to commit with debt servicing without having solid cash inflow (Deesomsak et al.3 Profitability of Firm Pecking order theory states that profitable firms would tend to use internal funds to finance their expansions (Tang and Jang. Asymmetric information theory suggests that firms’ use of fund would follow the hierarchy of retained earnings.High growth firms also avoid debt financing for few reasons. tax-based models recommends profitable firms should borrow more and incur interest cost. Chen (2004) and Booth et al.. Chen. 2007).. as growth is intangible. As an alternative argument. 2004) revealed that Malaysian firms prefer to use internal sources of funding when profits are high. 2004) asserted that growth is negatively associated with leverage. (2005). debt financing may cause the firms to be dictated by the lenders. Past studies (Gaud et al. instead (Huang and Song. Delcoure. 2.

. Hence this shows higher liquidity available to finance growth as argued in pecking order theory (Hovakimian et al.4 Liquidity and Interest Coverage In assessing the credit application by firms. which is the ratio of current assets to current liabilities. 2004).. 2001).. Similarly.. 2007. 2004. which is reflected in the firm’s interest coverage ratio. 1990. Deesomsak et al..4. This is also tied to the liquidity level of the firm. 2004). Manipulation by managers to use liquid assets in favor of shareholders instead of debt holders raises the agency costs of debt – resulting in negative relationship between liquidity and leverage (Deesomsak et al. Additional debt would deteriorate the current ratio furthers and makes the firm’s financial standing weak (Eriotis et al. increases in cash refer to increase in current assets that result in high current ratio. 2007). et al.. It indicates the ability of the firm to pay creditors in the short-term (Manos. 24 . Eriotis et al. 2007).. banking and financial institutions give paramount importance to ability of firm to service debt obligations. Liquidity and leverage are expected to have negative relationship as firms tend to use the extra cash to finance their investment instead of incurring interest costs (Deesomsak et al. Manos et al. 2007). There is a negative relation between the debt ratio of the firms and quick ratio and interest coverage ratio as proven by past studies (Harris and Raviv..2.

This underlines the fact that capital structure decision can influence the action of the managers (Lópezde-Foronda et al. Clear separation of shareholders and management is the fundamental basis for agency cost. Therefore. When the firm is committed to debt. Debt financing able to minimize the self benefits of managers reaped from their controlling position (Pindado and Torre. 25 . 2008). including capital structure decision.5 Ownership Structure Different types of ownership have influence in determining the capital structure of firm. 2006). Each group has their own interest in decision making process of the firm. Conflicts of interest in agency cost are grouped into conflicts between shareholders and managers and conflicts between shareholders and debt holders (Huang and Song. the managers are obligated to service the interest payments – failing which results in insolvency of the firm.2.. Risk aversion of the managers also determines the level of financial leverage (King and Santor. This will ensure the managers to work towards the aim of increasing the firm value.. 2006). Ownership structure is long considered as a tool in managing agency cost. 2006). Apprehending this factor would enable shareholders to impose debt financing as a tool for corporate governance. The existence of clear separation between ownership and control requires debt financing as tool to monitor the performance of managers (Datta et al. shareholders are able to prevent managers from misusing their positions and instead focus their resources in increasing the firm’s value. This places pressure on managers to ensure performance of the firm is not affected by their self-interest actions (Kochhar. 1996). 2007). by having debt financing as control tool.

2005). 2007). The majority of corporations in most countries exhibit concentrated ownership (Du and Dai. This not an encouraging development as it would lead to various agency problems. 2005). Concentrated ownership here can be related to family-owned firm. 2007). In Malaysian context. The financial crisis in late 1990s has highlighted the problems of corporate governance in South East Asian corporations. where individuals and close family members having accumulated large interest in the firm. Rapid growth of Malaysia’s economy was not able to disperse the ownership concentration in Malaysian firms (Tam and Tan. where largest shareholders with high concentration have the control over the firm’s management.. Recent studies of corporate ownership structure demonstrate that dispersed ownership structure is far from a norm around the world. Tam and Tan (2007) reviewed studies by Zhuang et al. in 1998. (2000) that. Managerial ownership is prevalent in current times. 26 .Separation of ownership and management which is prevalent in state-owned and foreign-owned firms would be useful to determine the characteristics of managers in these types of firms in their capital structure decisions. which of particular concern are ownership structure which was overly concentrated (Driffield. more than forty percent of substantial shareholders are held by single large shareholder. Individual or family shareholders are predominant as large shareholders in Malaysia. Corporate ownership structure has been cited as one of the reason for risky capital structure of South East Asian corporations prior to crisis (Du and Dai. (2001) and Claessens et al.

The 5% cut-off value for determination of major shareholder is based on studies done by Samad (2004). they have studied the relationship between ownership structure and financial leverage of public listed firms in China. the 5% cut-off value is used and that too for direct shareholding only. 27 . are able to exert their control for proper and wise capital structure decision to be decided and implemented (López-de-Foronda et al. which includes family-owned. the study by Zou and Xiao (2006) would be most relevant. If any of these entities has 5% or more share in the firm. 2006). whereas control right refers to right to vote by common stock shareholder (Du and Dai. who has the control right. 2005). it is classified according to the respective entity. 2005). The ownership structure is classified into three large categories.. Study in transition economies proved that concentrated ownership tends to reduce debt financing (Nivorozhkin. substantial shareholders are those who has more than 5% stake in a corporation and names of these shareholders are reported the companies’ annual reports. Block shareholders. 2007). For complication avoidance reasons. state-owned and foreign owned. In the study. this is different to the usual cut-off value of 20% determined by Bank Negara Malaysia to differentiate the major shareholder. Additionally. However. in determining the effect of different types of ownership structure towards the capital structure. Therefore.Cash flow right refers to right to claim dividends. according to the Bursa Malaysia requirement. The study was done to ascertain the managerial incentives to raise equity in view of high agency problems in the country. This is able to avoid managers from venturing into projects that has risky potentials (Miguel and Pindado.

who shares same organizational motivations (Tam and Tan. 2. 2007). Therefore. the owners themselves act as managers. 28 . shareholdings of family ownership are expected to be negatively correlated with leverage (Zou and Xiao.1 Family-owned Firms A firm is considered a family-owned if an individual together with his/her family members have more than 5% shareholding in the firm. 2006).2 State-owned Firms Firm is regarded as state-owned if more than 5% of its total shares are held by any government and/or government related agencies.5. there is less need for debt to function as disciplining tool for managers. At most times.2. Agency cost literature argues that large institutional shareholders should have enhanced incentives and capabilities to monitor managerial behavior closely. Zou and Xiao (2006) predicted that firms with substantial state ownership are more likely to have a higher debt ratio than other firms as it is argued that state-owned firms has green lane for bank borrowing. Thus. This also supports the argument of negative relationship between family-owned firms and leverage. Family legacy and concentration of family wealth in the business also causes family-owned to have less appetite for debt financing (King and Santor.5. 2008). Family encompasses both individual and family investors.

29 . state-owned structure is expected to have positive relationship with leverage. debt financing noted to be best option for foreign owners to assess the performance of the local subsidiaries. Tam and Tan.. 2007.3 Foreign-owned Firms Any direct interest from foreign parties. 2. Flexibility in repayments from home countries plus perception of local bank banks towards foreigners warrants for debt financing for foreign owned forms (Boateng. 2003. 2006). 2004). Hence. These reasons thus suggest a positive impact of foreign ownership on the use of debt. Zou and Xiao. both individual and corporation. 2007). in local firm with more than 5% stake is considered as foreign firm.Financial decisions of state-owned firms are different from other firms as these firms are easy to obtain loans given preferential treatment by the banks due to state ownership (Manos et al.5. The foreign owners are able to discipline the local managers via debt financing as foreign firms uphold corporate value and transparency (Suto. Requirement for monitoring tool for the managers.

The independent variables. the following theoretical framework is designed to facilitate the research. This variable is divided into family-owned. This variable is measured by the firm’s size. stateowned and foreign-owned firms. It depicts the relationship between capital structure and its explanatory variables.2.1 Theoretical Framework Dependent variable in this study is capital structure. growth. which are the explanatory variables.6 Theoretical Framework Derived from the literature surveyed. profitability. The first independents variable is financial characteristics of the firm. The second independent variable is ownership structure of the firm. which is measured by debt ratio. 30 . liquidity and interest coverage. are classified into two main groups. FINANCIAL CHARACTERISTICS Size Growth Profitability Liquidity Interest Coverage OWNERSHIP STRUCTURE Family-Owned State-Owned Foreign Owned CAPITAL STRUCTURE Figure 2.

Larger firms are well diversified. Hence.7. Huang and Song (2006). growth. Delcoure. The theoretical framework is constructed subsequent to the literature review. Nivorozhkin. (2005). these firms are expected to have more inclination towards debt financing.. Firm-specific factors like firm size. Arslan and Karan (2006). (2005). (2007) and Mitton (2008). tangibility and profitability has been tested widely across various nations and noted to be significant and consistent with capital structure theories (Jong et al. hence it minimizes the risk of bankruptcy costs of these firms as argued in trade-off theory. Therefore. Hypotheses for this study are developed based on the literature review done. 2008).2. This was concurred in past studies by Gaud et al. risk. Financial characteristics of the firm are expected to be the main the determinants of capital structure. the hypothesis would be as follows:- H1A: There is positive relationship between size of firm and debt ratio 31 .1 Financial Characteristics and Capital Structure Capital structure is measured by debt ratio. 2.7 Hypothesis Development The objective of this study is to identify the determinants of capital structure of public listed companies in Malaysia with stressing the role of ownership structure of these companies.

(2004) and Eriotis et al. 2006). (2005). 2004. Other studies also concurs this argument (Booth et al.. the hypothesis would structures as the following:- H1C: There is negative relationship between profitability of firm and debt ratio Basing on the pecking order theory. Fattouh et al. which is in line with the pecking-order theory of finance (Nivorozhkin. (2005). 2005)). 2005).. 2001. (2007) have proved this relationship in their respective studies. Gaud et al.. Delcoure (2007) and Jong et al. 2004.. the relationship between these liquidity and leverage is expected to be negative. Gaud et al. As a result.Pecking order theory suggests firms will use retained earnings before taking up debt and external equity (Huang and Song. firms would keep debt financing as last choice resulting in negative relationship between growth of firm and debt ratio. The hypothesis would be as follows: - H1D: There is negative relationship between liquidity level and debt ratio 32 . Thus. the hypothesis is developed as follows:- H1B: There is negative relationship between growth of firm and debt ratio Profitability of companies has a uniform negative and significant effect on leverage across all countries considered. With this. Chen (2004). Deesomsak et al. Chen. Deesomsak et al. (2008) have concluded in their respective studies that growth is negatively related with leverage.

Past studies that have tested this relationship are Harris and Raviv (1990). it is important to recognize how different types of ownership structure are influencing the capital structure of public listed firms in Malaysia. (2007) and Manos et al. Studies by Zou and Xiao (2006) and King and Santor (2008) have tested the negative relationship between family-owned firms and debt ratio.Similar to the liquidity measure. Hence. 2007). This brings to hypothesis as follows: - H2A: There is negative relationship between family-owned structure and debt ratio 33 . 2007).2 Ownership Structure and Capital Structure Ownership concentration is able to minimize agency conflicts of firms and maximizes firms’ value via capital structure decisions (Driffield. Hence. Listed companies are still within the control of the promoters who still has close relationship with the management of these companies (Tam and Tan. Eriotis et al. (2007).7. the interest coverage also expected to have negative relationship with debt ratio. the hypothesis developed would be as follows: - H1E: There is negative relationship between interest coverage and debt ratio 2.

State-owned firms are expected to have positive relationship with leverage (Zou and Xiao. which pursued the conception of the theoretical framework of this study. Tam and Tan.It is predicted that state-owned firms would have high leverage given its connection with the lender and implied support by the authorities.8 Summary In this chapter. Finally. Thus. A brief look on conventional capital structure theories and past studies in relation to capital structure was presented first. a thorough review of earlier literatures on capital structure was presented. This followed by review of literature on variables to be tested in this study. 2003. Zou and Xiao. 2006. 2006). The hypothesis for this variable would be as follows: - H2C: There is positive relationship between foreign-owned structure and debt ratio 2. positive relationship is expected between two (Suto. developed based on the framework designed. hypotheses were 34 . 2007). The hypothesis developed would be as follows: - H2B: There is positive relationship between state-owned structure of firm and debt ratio Foreign-owned firms are expected to use high level of leverage to assert its managerial control and to use debt financing as remedy for agency cost conflicts.

sampling method and procedure of the analysis. 2006. 3. emphasis is given to the ownership structure of the company.1 Introduction This chapter discusses the methodology that has been used to identify the determinants of capital structure in public listed companies in Malaysia.2 Research Design The purpose of this study is to undertake a hypothesis testing to identify the predictive variables of capital structure of public listed companies in Malaysia. It is also determined to establish the cause-effect relationships between the dependent variable (leverage ratio) and independent variables (determinants of capital structure). Mitton. identification of variables.. It outlines the research design that was adopted. 2007. This is to determine the influence of type of ownership in deciding the capital structure of the companies. Though substance of this study is to identify the determinants of capital structure. Delcoure. Most studies done in the past has focused on the company-specific financial characteristics in their study of capital structure (Booth et al. 2001. 35 . 2008). Zou and Xiao.CHAPTER 3 RESEARCH METHODOLOGY 3.

The motivation to include ownership structure in the said study was the unique environment in China where noticeable numbers of corporations are directly or indirectly linked to the government.However. LIQDI. it would be of use to establish whether capital structure of local firms is driven by the firm’s ownership structure. there are few tested models used in the past studies to identify the determinants of capital structure. the model would include new variables such as ownership structure. the model to be used in this study is as follows: - Debt Ratio = ƒ {SIZEI. Driffield et al. 2008. there was evidence of heavy reliance on bank borrowings by local companies in their capital structure (Tam and Tan. Studies by Zuo and Xiao (2006). FOROI} + αI + єI 36 . King and Santor. which provides these corporations easy access to bank borrowings. STAOI. PROFI. besides the usual independent variables. For this study. FAMOI. in Malaysia. Similarly. has precisely included the role of ownership structure as one of determinants of capital structure. where various aspects of corporate governance is weighed as one of the determinants of capital structure. liquidity and ability to service debt. etc).. GROWI. Hence. few studies have included corporate governance dimensions (Du and Dai. 2005. as a point of interest. 2007. ATSDI. Based on literature reviewed. Hence. 2007).

i.3 Variables As depicted in Figure 1. there are two types of variables used in this study. Dependent variable is the leverage measurement of a firm.e. dependent variable and independent variables.1. SIZEI GROWI PROFI LIQDI ATSDI FAMOI STAOI FOROI αI єI = = = = = = = = = = size of firm growth of firm profitability of firm liquidity of firm ability to service debt family-owned firm state-owned firm foreign-owned firm beta error terms 3. 37 .Where. Independent variables are financial characteristics of the firm and ownership structure of the firm.

Debt can be classified into short term debt and long term debt. 2006). 2005. Larger firms are usually well diversified.3. Zou and Xiao.3. all three leverage measures are used to determine the gauge comprehensive effect of the study. 2007. Additionally. Chen. and short-term leverage measured by the ratio of book value of short-term debt to total assets (Delcoure. 2004. Data limitations dictate the use of book values rather than market values for all variables. 2006). The first cluster is the financial characteristics of the firm which consist of five variables. 3. larger firms incur lesser transactional costs that enable these firms to borrow more with minimal charges. which would entail lower failure probability.3. 38 . the first variable that would be tested is firm size. The second cluster is the ownership structure of the firm with measurement of three variables.. failure cost and transactional cost (Nivorozhkin.2 Independent Variables There are two clusters of independent variables in this study. long-term leverage measured by the ratio of book value of long-term debt to total assets. In this study.1 Dependent Variable The dependent variable to measure leverage is debt ratio. Beattie et al. There are three financial leverage measures: overall leverage measured by the ratio of book value of total debt to total assets. Under the financial characteristics. This is also due to reliance of Malaysian public limited companies to banking sector that structures its lending both on long and short term basis. Size is linked with diversity.

which is classified into family-owned. is another cluster of independent variable. Jong et al. and future capitalization of growth (Nivorozhkin. state-owned and foreign-owned firms.. which is also widely tested in capital structure studies. Profitability is another variable. 2006. Zou and Xiao. 2007). Delcoure. 2005. Ownership structure. agency cost. profitable firms tend to use internal funds first before resorting to external funds (Tang and Jang. Huang and Song. 2006). 2004. 2008). Liquidity and ability to service interest are two variables which have been limitedly used in past studies that are incorporated in this study (Deesomsak et al. Firms with high growth opportunities would deter debt financing for reasons such as asymmetry information flow. Each type of structure has different effect on the capital structure of the respective firms (Tam and Tan. 2007. 39 . Eriotis et al. 2007). 2007. King and Santor. 2008. These variables are included due to its function to explain the repayment capacity of the firm in fulfilling its debt obligations. which is the crux of this study..Second variable is growth rate of firm as determinant of capital structure. Advocated in pecking order theory..

(2001) EBIT Profitability Total Assets Jong et al. (2004) Current Assets Liquidity Current Liabilities Manos. (2007) Harris and Raviv (1990) EBIT Ability to Service Debt Interest Expenses Eriotis et al. Table 3. et al. (2004) Eriotis et al. (2005) Booth et al.2 Summary of Ownership Structure Variables Variable Proxy for Measurement Past Studies Deesomsak et al. (2007) Zou and Xiao (2006) 40 .1 Summary of Financial Characteristics Variables Variable Size of Firm Proxy for Measurement Logarithm of Total Assets Past Studies Huang and Song (2006) Delcoure (2007) Mitton (2008) Chen (2004) Growth Sales Growth Fattouh et al. (2007) Table 3. (2005) Gaud et al. (2008) Deesomsak et al.All the variables with its proxy for measurement and past empirical studies are summarized below.

Unit of analysis would be public listed companies. firms listed on Industrial Products portfolio of the Main Board of Bursa Malaysia are selected as sample. respectively. Websites of Bursa Malaysia and Securities Commission has laid out that classification of firm into Industrial Products portfolio is based on requirement where the firm’s major portion of 41 . 2007). In this study.4 Population / Sample This study uses data retrieved from Datastream and Annual Reports of Malaysian public listed companies for the period from 2001 to 2006.More than 5% owned by individual and/or Family Owned family members More than 5% of total shares by any State Owned government or related agencies More than 5% of total shares are owned by Foreign Owned any individual or corporation from foreign countries Zou and Xiao (2006) King and Santor (2008) Zou and Xiao (2006) Tam and Tan (2007) Suto (2003) Zou and Xiao (2006) 3. (2007) reviewed study on Malaysia by Cheong et al. Lim et al. Financial data (financial characteristics) and non-financial data (ownership structure) are captured from Datastream portal and Bursa Malaysia website. (2007) that classified post-crisis period as January 2001 onwards. Periods after year 2000 considered as stable after Asian financial crisis as significant restructuring of the economy has taken place prior to this period (Chang and Shin.

automotive parts. 1999). In February 1998.3% respectively in the first quarter of 1999 (Ariff and Yanti. plastics. Industrial portfolio consists mainly by firms that are involved in manufacturing activities.revenue shall be contributed by manufacturing of industrial products such as cement. steel. which contributes 30.9% of Malaysia GDP is contributed by industrial sector. Industrial Product portfolio is selected as sample given its prominence contribution to Malaysia economy. etc. the industrial and manufacturing output contracted by 3.390 million in year 2007. rubber. energy.4% and 4. paper. Companies that are excluded as sample are due to one of the following reasons: • • • Firms with inconsistency in data in Datastream (3 firms) Firms that are classified under PN4 and PN17 list (4 firms) Firms with lesser than five consecutive annual reports (39 firms) 42 . During the 1997 financial crisis. Industrial Product portfolio in Main Board is comprised of 152 firms. Asian Development Bank Report on Malaysia for year 2006 pointed out that 49. industrial sector was also badly hit. Based on Bank Negara Report. As firms in these industries are listed on Industrial Product sector. it would be more relevant to study the capital structure of firms in this portfolio.3% of the Malaysia’s GDP or equivalent to RM152.

The first set is financial data which are needed to establish the financial characteristics of the firms included in the sample. The said information is available under Shareholders Statistics section in every Annual Report. and profitability values of the firm. Second set of data are to determine the ownership structure of the firm. Variables identified in the study are collected for the period of 2001 to 2006. 3. The substantial shareholders are determined from the Substantial Shareholders sub-section. As highlighted by Sekaran (2003). This includes variables such as debt value. 43 . These data are tabulated in the relationship model to determine the predictive power of the independent variables to establish relationship with the dependent variable. This set of data is retrieved from Datastream portal. liability value. asset value. where in this section firms are regulated to list name and percentage of shareholdings of shareholders who has more than 5% interest in the firm. In order to obtain this data. revenue.5 Procedure There are two sets of data required for this study. Number of companies employed in this study is 106 companies. Annual Reports of all targeted firms were downloaded from Bursa Malaysia website. where ownership structure of the firms are identified. ideal sampling size should range from 30 to 500.The List of Accepted Companies is attached in Appendix I.

the firm differences are controlled. it would not represent ultimate ownership given difficulty in obtaining information for public sources (Zuo and Xiao. Second model that has been used is the two way-effect model. This included T-test. 44 . cross-effect model and time-effect model. Annual Report of year 2001 and 2006 were used to determine the type of ownership. Goodness of Fit and nonparametric test like Durbin-Watson test. In cross-effect model. For clarity purposes. In order to estimate regression using the panel data. The same method is employed for family-owned and foreign-owned firms. i. which controls both firm and time differences.The firm is classified as state-owned if its substantial shareholders fall into the category of state and has cumulatively more than 5% interest in the firm. two types of models has been used in this study. 3. whereas in time-effect model. 2006). which has combination of both cross-section and time series data. Despite the fact the classification follows methods specified in previous study. which is divided into two sub-models. These statistics were important in doing the selection of best procedure among the three to estimate the empirical model of this study.6 Data Analysis Econometrics method was used in this study given its ability to estimate the relationship between debt ratio and determinants of capital structure. The panel data were streamed in all three models with commonly used statistics for regression analysis derived using statistical tools. This study used panel data. time differences are controlled.e. The first is the fixed effect model. F-test.

data was obtained and analyzed accordingly. the methodology to be used in collection and analysis of data is presented.3.7 Summary In this chapter. This enables the step to estimate the relationship between the dependent and independent variables to be undertaken appropriately.1 Introduction 45 . With the methodology clearly specified. CHAPTER 4 RESULTS 4.

0481 -0.1 Results of Correlation Analysis & Descriptive Analysis Panel I: Correlation Analysis SIZE PROF LIQD -0.4452 -0.1618 1 0. correlation between the dependent and independent variables for firm-specific financial characteristics were determined. Correlation analysis is undertaken to ensure that there is no multicollinearity among variables tested. From Table 4. Differences between all three leverage measures used to calculate debt ratio were insignificant.0179 -0.0979 -0. Firstly.0650 ATSD -0.This chapter presents the results of analysis conducted to determine the capital structure of local public limited companies. 4.0280 0. hence only ratio of book value of total debt to total assets was used in final estimation. This is followed with a descriptive analysis. The analysis is started with a brief preliminary analysis on simple correlation among the variables.2 Preliminary analysis Preliminary analysis is first undertaken for dependent and first independent variable.1457 1 0.2391 DEBT SIZE PROFIT DEBT 1 GROW 0.00378 0. which is firm-specific financial characteristic. the output of analysis showed that there was low correlation between debt and firm-specific financial characteristics variables.0187 -0.1147 46 . size and liquidity. Table 4. The third section demonstrates the results of estimated empirical model as described in the previous chapter. The lowest value is observed in growth and followed by ability to service debt.1.

Profitability.098 30. The small growth level is recorded due to the marginally long periods that ranged from year 2001 to 2006 with year 2001 was considered as aftermath of crisis period – that witnessed many firms stabilizing their financial position.6472 2.0498 3. Liquidity and ability to service debt reported an average value that reflects the 47 . in the empirical model that was used in this study. Growth level also averages at 1.6629 0. this leads to the point that Ordinary Least Square of this model is valid.2992 0. The highest r-value is between profitability and liquidity.0344 -0. It showed that debt ratio of firms taken as sample averaged at 0. which revealed that there was low correlation among the said variables.816 No of firms = 107 Family-owned firms = 75 Second testing was done to determine the correlation among the firm-specific financial characteristics variables. The firm size averaged at RM12.7 million.1408 5. Panel II: Descriptive analysis DEBT SIZE PROF LIQD GROW ATSD 0. which was proxied by earning before interest and tax (EBIT) over total assets.4455 29. The lowest r-value was observed between ability to service debt and growth.05%. both dependent and independent. Hence. Dev. where not any of the independent variable is a linear function of another independent variable in the model. averages at 0.65%.0107 1 Mean Std.7110 0.27 times.1394 1. it is noticeable that there is no issue of multicollinearity among the variables.0049 1 0.2719 12.1.LIQUIDITY GROWTH ABILITY 1 0.6540 1. From the result of correlation analysis in Table 4.

5684) -0.3 Discussions The analysis started by weighing the output obtained via using the three models or procedures of panel analysis that were mentioned in earlier chapter.8246) -0. As for ability to service debt.0003 (2.0003 Panel I: Estimated Model Time-Effect Cross-Effect 0. 4. ability to service debt ratio that averaged at 2.0003 Two-Way Effect 1.4661) -0.0067 (0.2 Estimated Panel Analysis Pooled 0.3991) 0. The exceptional situation in growth was presumably caused by unique growth rate of firms within the said sample. Similarly.ideal ratio level in practical commercial world.3984) -0. With this. Average liquidity value of 3.1336) -0.2601 (1. the large dispersion was due differential rate in debt of individual firms.0003 CONSTANT SIZE GROW 48 .0654 (-1.0057 (0. Standard deviation measures the dispersion of data of the samples from its average value.1882** (1.66 pointed towards good debt servicing capability of the firms. the best one is identified to estimate the empirical equation.1403** (2.2471 1.14 times shows good short term repayment capability of firms tested.0692* (-1. The standard deviation noted to be low in all variables except growth and ability to service debt.4458) -0.3189) 0. Table 4.

2442 25. F-Stat SIC D-W Stat Note • • Panel II: Model Criteria Pooled Time-Effect Cross-Effect 0.1914 0.4211) -0.0503 (-0.3207) -0.9399 [0.0478 Asterisks *. The existence of valid model is apparent in all three procedures as F-statistic suggests that all models are valid at 1% significant 49 .6340) -1.0041 (-1.0000] 1.0034 (1.6085 0. ** and *** denote significant at 10%.6253) -0.0000] 1. respectively.4558) 0.6079) -1.2594) 0. Figure in ( ) stands for t-value and in [ ] represents p-value Inferring from the outcome of the analysis as shown in Table 4.3338) -0.1690 2.0000] 0.3505 0.0569 (0.1296 2.9329 [0.3142) 0.2060 0.0485 R2 Adjusted-R2 S.6085 0.2442 7.0978) (-0.1942 0. The detail reasoning for the choice is explained in following paragraphs.6934 0.0037 (1.8036 0.PROF LIQD ATSD (-0.2.9130*** [0. the best procedure that was chosen to be used to estimate the empirical model is cross-effect procedure.1006*** 8.2235*** (-10.9737*** (-9.E.9926*** (-9.0462 (0.0069*** 14.3403) 0.6966 0.0956) Two-Way Effect 0.0039 (-1.3684) -0.2023 0.0000] 0.2355*** (-10.5981) -0. 5 % and 1% critical values.1682*** [0.8487 0.0382 (-0. of Reg.0732) (-0.1204) (-0.3510 0.

level. However, other criteria were taken into consideration to underline the suitability of cross-effect procedure.

The first criteria were Goodness of Fit test, which consist of coefficient of determination (R2) and adjusted-R2. Among three procedures, cross-effect

and two-way effect had higher explanatory power which is above 60% compared to time-effect that had only merely 20% explanatory power. Thus, nearly 60% of the debt ratio has been significantly explained by the five independent variables in cross-effect and two-way effect.

Secondly, standard error of regression was used to evaluate in order to obtain best procedure. The standard error of regression demonstrated that both procedures had same value. Thirdly, Schwarz Information Criteria (SIC) was used, where cross-effect procedure noted to have the lowest – hence the better one compared to two-way effect. The Durbin-Watson Test value of 2.05

indicated that there is no autocorrelation as it is in the range of 1.50 to 2.50. In précis, it was deduced that cross-effect model is the most suitable model to be used to estimate the empirical model in this study.

Hence, the empirical model derived with only considering the first dependent variable, which is the firm-specific financial characteristics is as follows: -


DEBT = 1.1882 0.9737PROF***


0.0003GROW (-9.3403)



– 0.0034LIQD – 0.0382ATSD (1.3338) (-0.0732)

Empirical equation derived above estimates the relationship between DEBT and firm-specific financial characteristics. From the equation, there were

only two variables that were significantly related to DEBT. SIZE noted to be negatively related with DEBT at 10% significant level, whereas PROF is negatively related to DEBT at 1% significant level.

Literature review has indicated that relationship between SIZE and DEBT is positive given the fact of diversity, failure cost and transactional cost (Nivorozhkin, 2005; Chen, 2004; Beattie et al., 2006). However, this was not the case in Malaysia as reflected in the result, which only considered the firm-specific financial characteristics in the empirical equation.

One of the reasons that could be related is the 1997 financial crisis. The crisis witnessed the collapse of large conglomerates which has diversified business interest. The enormous size of the firm enabled it to easily obtain finance from the banks (Tam and Tan, 2007). Research conducted after the crisis revealed that large firms were heavily indebted and this was due to lack of


corporate governance. Banks were easy source of fund for these large corporations which were also closely connected to the government. Hence, post-crisis, banks became more prudent and tighten their conditions in lending. This could have caused the trend for large firms to borrow less after the crisis period (Zhuang et al., 2001).

The relationship between DEBT and PROF is negative at significant level of 1%, which is in accordance to past literature. The same was proven by

Deesomsak et al. (2004) in his study, where Malaysian firms prefer internal funds more to finance their expansion. The pecking order theory states that firms would use internal funds first given the issue of ownership dilution posed by debt financing. Engaging in large amount debt causes firms to be dictated by the banks in terms that are favorable to the latter. To avoid this, public firms prefer equity financing more.

Relationship of DEBT with the remaining variables, i.e. GROW, LIQD and ATSD, in this study, were in same direction as argued in past literatures. However, these relationships were not proven at significant level. For

example, GROW level of firms in Malaysia averaged at only 1.65% with standard deviation of 29.1. The instability of data could have caused the

relationship was not established at significant level. LIQD and ATSD, was not


4408 S. when estimated with only firm-specific financial characteristics. goodness of fit as measured by R2 and adjusted-R2 shows more than 40% of dependent variables are explained by the independent variable. 70% of the firms are family-owned. The model is 53 . From Table 4. Ownership structure is the second independent variable included as focal point of this study.3. as explained in following section. of regression 0. Table 4.e. ownership structure. Standard error of regression is low and Durbin-Watson value is within acceptable range. i.2261 2. out of 107 firms included as sample.3 The Impact of Family-Owned Firm R2 Adjusted R2 F-statistic Model Criteria 0.0000) 0. However. Hence.0253 The cross-effect procedure is maintained to test the ownership structure variable.attested at significant level.4339 Durbin-Watson stat 64. This has caused inclusion of state-owned and foreign-owned variables providing insignificant impact on the model. However. these two variables provide different results when it is estimated with the second variable.6381 (0.E. only family-owned variable is included in the final empirical model of this study.

8537) (-1. Influence of family ownership in the form of negotiation for lower transaction cost incurred by large firm was among the reasons for the positive relationship between SIZE and DEBT after inclusion of FAMO. 7695PROF*** (3. This is in accordance to the past literature review. Relationship of DEBT and GROW remain insignificant.9317) – 0.1927) (0. which was negatively related with DEBT at 1% significant level earlier changed to positive relationship with DEBT at 10% significant level.2842) (-6.8999) From the empirical equation after inclusion of FAMO.valid as reflected in F test. Therefore.8352) (-14. this study supports the hypothesis that there is positive relationship between size of firm and debt ratio. It is apparent that PROF remains with negative relationship at 1% 54 . Hence. this study rejects the hypothesis that there is negative relationship between growth of firm and debt ratio.0195SIZE*** – 0.0001GROW – 0.0135LIQD*** – 0. it is apparent that SIZE. Following is the empirical equation derived by including the family-owned variable: DEBT = 0.0037FAMO (-3.0598 + 0.0451ATSD*** – 0.

the hypothesis that there is negative relationship between interest coverage and debt ratio is also accepted. past track record in banking relationship and feasibility of the purpose of lending. This could be related to the fact that bank’s lending practices has changed drastically after the 1997 financial crisis. Similarly. Importance is given to financial standing. Hence. the hypothesis that state there is negative relationship between liquidity level and debt ratio is accepted. this study accepts the hypothesis that there is negative relationship between profitability of firm and debt ratio. FAMO has negative relationship with DEBT as reckoned in literature review. Thus. Explanation to these changes in the relationship can be associated with influence of family ownership. the shareholders themselves would act as the managers – causing the absence of agency cost problem. Controlling stake by family would result in no separation of ownership and control in these firms. These two variables were estimated with negative relationship with DEBT at 1% significant level after the inclusion of FAMO variable in the empirical equation. Interesting point of this study is the indirect impact of FAMO on DEBT via LIQD and ATSD. With this. However. 55 . in this study.significant level as estimated earlier without the FAMO variable. Borrowing would not be preferred if the firms’ liquidity level is good as the owners probably intends to avoid high interest expense. this was not proven at any significant level. where character or name lending is no more an element in bank’s credit decisions.

The accepted hypotheses were attested at significant level of 1%. 4.3 as follows: - Table 4. family ownership of firm has no direct impact on the firm’s capital structure. This point towards the rejection of the hypothesis that states that there is negative relationship between family-owned structure and debt ratio From the hypothesis testing. the study included only family ownership structure. two hypotheses were rejected due to insignificant acceptance level and remaining four hypotheses were accepted.4 Summary of Findings Item H1A Hypothesis There is positive relationship between size of firm and debt Result Accept 56 . though the relationship is presumed to be negative.Hence. As highlighted earlier. due to limitations. The summary of the findings is presented in Table 4.e. i. it was derived that out of six hypotheses tested. firm specific financial characteristics and ownership structure.3 Summary of Findings This study has estimated the empirical model adapted for this study to estimate the relationship between capital structure and two groups of independent variables.

1 Introduction It encompasses brief This chapter wraps up the findings and outcome of this study. Reject Accept Accept Accept Reject CHAPTER 5 DISCUSSIONS AND CONCLUSIONS 5. only one was rejected. it was rejected due to insignificance on the relationship. As for hypothesis on ownership structure. recapitulation. implications and limitations of this study. out of five hypotheses on firm financial characteristics.ratio H1B H1C H1D H1E H2 There is negative relationship between growth of firm and debt ratio There is negative relationship between profitability of firm and debt ratio There is negative relationship between liquidity level and debt ratio There is negative relationship between interest coverage and debt ratio There is negative relationship between family-owned structure and debt ratio Based on the Table 4.3 above. discussions of the findings. 57 .

2 Recapitulation Purpose of this study is to identify the determinants of capital structure of public listed companies of Malaysia. The exception of two hypotheses from being supported can 58 . The dependent variable is capital structure estimated against two clusters of independent variables. state-owned and foreign-owned firms. there were three variables. 5. to certain extent. in the doing the analysis. liquidity of firm and ability to service debt of firm. of which. Econometrics approach was utilized in executing the analysis. four hypotheses was found to have significant relationship with the capital structure of firms. Emphasis was placed on the ownership structure of the firms as an element of corporate governance to determine the capital structure. growth of firm. i. profitability of firm. demonstrated results that were expected based on past literatures that were reviewed. Under the cluster of ownership structure.e.3 Discussion The result of this study has.Recommendations for future study are included at the end of the chapter. Time horizon was set after year 2000 till 2006. The firm financial characteristics variables consisted of size of firm.e. i. firm financial characteristics and ownership structure. 5. family-owned. However. which signals the period after the 1997 financial crisis which was plagued with corporate governance failures. Six hypotheses were formulated. It sums up with a conclusion remarks. state-owned and foreign-owned variables were excluded due to limited representation in the sample size.

1 Relationship between Debt Ratio and Size of Firm Larger size firms noted to have better borrowing capacity given its diversification of business that reduces the bankruptcy risk (Boateng. on average. These are the factors that could be related for the positive relationship between debt ratio and size of firm in this study. many public listed firms has tighten their belt in terms of borrowings for risky projects. 59 . 2004). 5. Firms taken as sample in this study are from Main Board. which is also in accordance to the pecking order theory. This approach can be used to explain the negative relationship between debt and profitability of firms used in this study.3. The profits are reinvested for the need in related to the unique business environment of Malaysia such as unstable average growth rate of the firms during the period. 2008).3. it has to be highlighted that banking industry in Malaysia has become very competitive that results in aggressiveness in lending and capturing market.. which is line with signaling hypothesis model theory. The listing status of the sample firms in this study also point towards the diluted ownership structure that simplifies the borrowing decisions by the management (Delcoure. which requires paid-up capital of more than RM60 million. Aftermath of the financial crisis in Malaysia. In that line.2 Relationship between Debt Ratio and Profitability of Firm Highly profitable firms have lesser tendency to borrow given the sufficiency of internal fund to finance its expansion (Jong et al. 5. 2007). Hence. the banks prefer to lend to larger firms given larger loan amounts (Chen. In terms of supply. firms taken as sample are comparatively large in size. 2004).

This pointed towards the indirect impact of family ownership on debt ratio via liquidity (Datta et al. as explained in pecking order theory.3 Relationship between Debt Ratio and Liquidity of Firm Earlier empirical equation used in this study without taking into consideration the ownership structure had estimated that relationship between debt ratio and liquidity was insignificant. The change in significant that occurred in liquidity after the inclusion family ownership also happened in this variable. 60 .4 Relationship between Debt Ratio and Ability to Service Debt of Firm The relationship estimation between debt and ability to service debt is negative as reviewed in past literature. It can be inferred that family ownership may have more control in not allowing managers to increase leverage and incur interest cost imposed especially when the firm has high level of liquidity. However. 2006).. after the family-owned variable included.3. This relates to the agency cost theory which states that debt financing is the best tool to manage the agency cost problem (Tang and Jang. Hence.3. profitable firms may use internal fund before resorting to debt financing. 5. The reasoning could be explained where firms with good repayment ability is financially sound and profitable.5. 2007). the relationship between both variables are significantly negative.

.3. Hence due to limitation that is spelled out in following section.5. directly and indirectly. only family ownership structure is considered in this study. However.6 Relationship between Debt Ratio and Family Ownership Ownership structure assumed to be the focal point of this study. this hypothesis was unsupported in this study. Afghanistan and Iraq invasion and SARS epidemic. family ownership failed to have significant relationship with debt ratio. 5. The post year 2000 has been a very rough period for business fraternity in the region (Tam and Tan. In addition. 2007). Thus. Deesomsak et al. 2004). affected the business sentiment. Negative effect from September 11 attack. which procrastinated with growth rate of individual firms (Mitton. 61 .5 Relationship between Debt Ratio and Growth The past studies have implicated negative relationship between growth and debt. limited growth opportunities had failed to have significant effect on debt of local firms. had. The practical inference that could be made from this result is that the time horizon used for this study. which means that family ownership structure has minimal effect of the capital structure of public listed companies in Malaysia. 2002.3.

62 . Hence. As the owners are functioning as managers. However.This result is inferring that tendency to have debt does not rely on the ownership structure. 2003). family ownership is expected to have indirect impact on debt ratio by means of liquidity and ability to service debt as explained in earlier sections. it is unclear whether family ownership would drastically change the borrowing appetite among such firms.4 Implications This study had shed some light on prevalent capital structure trend of public listed companies in Malaysia. However.. family ownership structure had little direct significance on capital structure. family owned firms may engage in borrowing depending on their need. One of last study conducted pertaining same purpose in Malaysia had concluded ownership structure ownership concentration mitigated conflict between managers and owners (Suto. in this study. 5. 2006). Apprehending this study. This is also can be explained that family owned firms has grey separation of ownership and control – which in turns results in easier decision making for borrowing purposes. there will be expectation for self-imposition of monitoring to align managerial and shareholder interests (Datta et al. but rather other fundamental aspects which are directly linked to the firm’s financial characteristics.

ownership structure for this study was only confined to family-owned. this study is important in understanding the change in trend of local public listed companies in their financing behavior. instead of stateowned and foreign-owned. The result of this study together with that of Suto (2003). concentrated ownership has effect on the way the companies decide on their financing methods to be aligned with prudent and sensible reasoning. Hence. Secondly.Nevertheless. Firstly. the sample chosen is only from Industrial Product sector of Main Board of Bursa Malaysia. 5. to have significant effect on capital structure. Zuo and Xiao (2006) and King and Santor (2008) had similar supposition that concentrated ownership. which has diversified sectors. in this case family ownership. Thus. where corporate governance was considered as weak link in corporate environment (Tam and Tan 2007). This can be inferred as improvement compared to the situation before 1997 financial crisis. it had affected the other independent variables. namely liquidity and ability to service debt. had direct or indirect effect on capital structure decisions of firms. This shows that corporate governance dimension in terms of ownership structure is also one of the factors that affect capital structure of local public listed companies.5 Limitations As for other studies. This was because the Industrial Product sector of Main Board of 63 . it does not represent the exact situation of public listed companies in Malaysia. Thus. This is important as pre-crisis period was plagued with negligent practice that led to collapse of large conglomerates. this one also carries its limitations.

some other independent variables identified in recent literature were not able to be included in this study such as tax-effect and stock price movement. 64 . Therefore. In determining the ownership structure. Due to limitation in data and access to information. independent variables like tax-effect. Studies were not only limited. but its result would provide insight on treatment of local debt trend by the firms. As highlighted earlier. the effect of having owners from these institutions in decision pertaining capital structure was not able to be identified. Main reasons for this were inadequate access to the data and complication is compiling these data.6 Future Research Future study to be undertaken in this subject should concentrate in analyzing capital structure of foreign-owned and state-owned firms in Malaysia.Bursa Malaysia has less representation from state-owned and foreign-owned. Finally. certain interesting elements were not being able to be highlighted. stock price and other relevant ones should be included in future studies. Thus. the exact percentage of the ownership was not being able to be included in the study. dummy variables were used to differentiate the type of ownership. 5.

e. 65 .5. Interestingly. The point of view in research is important given the function of ownership structure as a dimension of corporate governance. where family-owned corporations are largely prevalent. This would be more useful given the immaturity of capital market in Malaysia. As concluded in this study. The unique circumstances in Malaysia. the role of ownership structure in the form of family ownership though is not significantly related to capital structure. i. further study relating ownership structure and capital structure. its inclusion in the empirical equation changes the significance of other variables. which has been studied in the past that has been included in this study too. would able provide further insights on trend of financing choices among local public listed companies.7 Conclusion Capital structure of a firm is still dependent on various factors. except few that changes according to unique environment. where and when. The empirical result also tend to point towards the same direction. the study is conducted. ownership structure should be given more accentuation as few studies conducted in recent years has argued that it has direct and indirect implication on capital structure.

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