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Determinants of Capital Structure

An Empirical Study from UK Firms

By

Lujie Chen

2007

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

ACKNOWLEDGEMENTS

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.

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ABSTRACT
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

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TABLE OF CONTENTS
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 2.1.4.1 Cost of Bankruptcy and Financial Distress……………………………..25 2.1.4.2 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

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

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....................5 The Summary of Statistical Results...................................................................................................5............4 Effects of Pension Scheme..68 REFERENCES..................58 4.............................60 4.....……65 CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS..3 Cross-sectional Research on Short-term Debt......3....................................................1 One-way Analysis of Variance (ANOVA)......50 3...71 APPENDIX ..........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 ....................1 Effects of Industry Classification..........2 Cross-sectional Research on Long-term Debt..........1 Impacts on Long-term Debt......57 4.............................53 4.........................................6 Research Limitations…………………………………………………………….....4..................62 4..............63 4.............64 4....................................2 Multiple Regression Analysis………………………………………………50 CHAPTER 4: RESULTS ANALYSIS…………………........................................................2 Impacts on Short-term Debt......................................................................................5..54 4......

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

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

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

which is as a result of asymmetric information. 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. 1. as though there are definite reasons for following certain patterns. % (Market Value) 9 8 56 1 0 1 0 10 15 10 Source From: “America’s Most Admired Companies” Fortune (March 7. 2005). 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 study of capital structure attempts to explain the mix of securities 9 . there is another leading theory called pecking-order theory. which is to copy each other. The pecking order theory stems from Donaldson (1961) and the key idea is that mangers raise new finance in a particular sequence. Each type of model is particular good for certain explanations and has been argued by conflicting empirical studies. In contract. However. Some argue that firms are simply following the Behaviour Principal of Finance. % (Book Value) 46 12 193 8 0 8 0 35 31 50 Debt-to-Equity Ratio. and author’s calculation The above table illustrates that these companies take different approaches when looking to raise capital. we believe this is too simplistic.2 Research Objectives The empirical evidence shows consistent attributes of leverage ratios. It is not appropriate to conclude that one theory is superior to another.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.

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

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

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

Using the assumption of perfect capital market and the Value Additivity Principle. the earnings of the firm exceed its debt obligations in every possible outcome. (Assume this must all be paid out as dividends). 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. This assumption plays a strategic role in the rest of the analysis. A risk class is defined as a set of firms.In other word. Existence of risk classes. Assume a company which has no debt in its capital structure. 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. However. with a constant perpetual net cash flow X. M&M state that the value of the firm is unaffected by its choice of capital structure. With the satisfaction of perfect market. VU=PV(X)=X/kU (1) Where KU is the expected rate of return for shareholders of the unlevered firm 13 . 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. the return of equity in any firm is significantly correlated with ones in other firms. In these ‘equivalent return’ classes. M&M derived the following two basic proportions and the extensions with respect to the valuation of securities in companies with different capital structures. Market value of the debt and the market value of common share are denoted by D and S respectively. which has an identical pattern of earnings and payoffs. Propositions I-No Tax Consider any company and let X stands as the expected return on the assets owned by the company. Value Additivity Principle is the central idea supported their analysis.

(4) This is to say. If the value of the firm and the coupon rate are denoted as VL and I. 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. which is the ratio of its expected return to the market value of all its securities. Proposition II.NO Tax M&M’s second important insight is that even though debt is less costly to issue than equity. 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. 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). Base on the core financial principle that investors expect compensation for risk.Now assume the company is partly financed by perpetual riskless debt. KU=KL That is. 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. shareholders of levered firms demanding higher returns than shareholders in all-equity companies. with nominal value D. 14 . we have VU=VL. issuing debt causes the required return on the remaining equity to rise.

on the stock of any company is the function of leverage. we can obtain that KLSL= KU (SL+D)-ID (11) Divided by SL. (2) recognizing 15 . plus a premium for financial risk.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. 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. the required rate of return on equity for a geared company is equal to that for an ungeared company. 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. we finally derived: KL=KU+(D/SL)*(KU-I) (12) In proportion II.

proposition I remains unaffected as long as the yield curve is the same for all borrowers. 1958) By the same type of proof used for the original version of proportion I. certain interpretation must be changed. ( Modigliani and Miller. the after-tax capitalization rate KL can be no longer identified with the ‘average cost of capital’ which is KL=X/VL. and (3) acknowledging the presence of market imperfections which might interfere with the process of arbitrage. 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. the relation between common stock yields and leverage will no longer be the strictly linear one given by the original. Although the form of propositions is unaffected. 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.the extension of a multiplicity of bonds and interest rates. * * In their extension. corporation finance and the theory of investment’. (Figure 1) Figure One: Average Cost of Capital and Debt Ratio Source Adopted From: M&M (1958) ‘ The cost of Capital. 16 . In particular.

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

moreover. M&M consider three major financing alternatives open to 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. an investment is worth undertaking if. If a firm in class risk k is acting in the best interest of stockholders for any financial decisions. plus a premium for financial risk. and only if KL##≥KL. how the theory of firm value can lead to an 18 . managers who operate business in imperfect market know how to choose one capital structure over another. this dose not mean that the owners or managers have no reasons for preferring one financial plan to another. To establish this result. M&M derive a simple rule for optimal investment policy. retained earnings. However. Proposition III− No Tax: On the basis of their propositions with respect to cost of capital and financial structure. In summary. They are bonds.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. That is. This is especially true in the case of common stock financing. In each case. 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. or that there are no other policy or technical issues in finance at the level of the firm. 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. M&M propositions are important in modern finance because by understanding why capital structure has no value impact in ‘perfect market’. and common stock issues. Proposition II: The required rate of return on equity for a geared company is equal to that for an ungeared company. They have shown.

the result is restricted by a number of assumptions and is not suggested for practical guidelines. therefore. arbitrage will make values a function of expected after-tax returns. 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. They also assert that within any class.operational definition of the cost and how that concept can be used as a basis for rational investment decision-making within the firm. 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.1. More importantly. the equation 11 becomes: VL=PV(1-T)X -PV(ID)+T∗PV(ID)+PV(ID)=PV(1-T)X+T.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. 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. 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 quantitative difference between the valuations implied by their propositions and by the traditional view is narrowed. we finally get VL=VU+TD (17) 19 . tax rate as well as leverage level. if the two firms have different degree of leverage. However.PV(ID) (16) Based on equation (14) VU=PV(1-T)X and PV(ID)=D. 2. To this extent.

every more debt the firm raises. However. firms are not financed by 100% debt in the real world due to the cost of financial distress. 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. the value of the firm is increased.Obviously. the presence of debt increases the value of the firm and under the consideration of corporate taxes. the cost of equity in the geared up firm consequently changes. Similarly. which can be rewritten as: VL=(X-ID)(1-T)/KL + D (18) Take D from both sides and multiply KL. In other words. Start from VL=SL+D. firms physically should use as much debt finance as possible. 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 . we obtain: KLSL=KUSL+KUD(1-T) -ID(1-T) Finally.

when firms gear up. the cost of equity increases as a result of increasing financial distress. the rise is not at such a rate as to outweigh the tax shield on debt. which is the extreme gearing level.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. A summary of the main M&M theory results with taxes can be presented as following: 21 . Moreover. However.

No transaction cost. because the risk to equity rises with leverage 2. 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.1. Proposition II: The cost of equity rises with leverage. He points out that in a world with differential personal taxes. 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.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. Individual and corporation borrow at the same rate.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. corporation leverage lower tax payments. Miller (1977) offers an explanation for the puzzle.

Leveraged corporation have the advantages of deducting their interest payments to bondholders in computing their corporate income tax. the formula can be reduced to VU+TD. as the interest rate on corporate debt is taxed as income for the holder of corporate debt. The upward-sloping line represents the demand curve for debt. the only investors holding corporate bonds are tax-exempt investors and taxable investors facing a personal tax rate on 23 . 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. This relationship can be presented in the following figure. and indicates that bonds must offer higher rates to attract investors from higher tax brackets.According to the above equation. However this advantage of deductibility may not always be the case. At this point. 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#. This line intersects the Y-axis at which the interest rate on corporate debt exactly offsets debt’s corporate tax advantage. 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. In this case.

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

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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.

2.1.4.1 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

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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:

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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

2.1.4.2 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,

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

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

pp581): Firms prefer internal finance. Their paper shows that mean reversion in the earnings process can reconcile the trade-off theory of capital structure with the empirical evidence. In this story. 1984. Contrary to the traditional trade-off theory but consistent with empirical regularities. although dividends are sticky and target payout ratios are only gradually adjusted to shifts in the extent of valuable investment opportunities.1.5 Pecking Order Theory Contrast to the static trade-off theory. That is. plus unpredictable fluctuations in profitability and investment opportunities. there is no well-defined target debt-equity mix. If external finance is required. internal and external. because there are two kinds of equity. then possibly hybrid securities such as convertible bonds. The key idea of pecking order theory is that managers raise new finance in a particular sequence (Myers. which stems from Donaldson’s study (1961) of the financing practices of a sample of large corporation. then perhaps equity as a last resort. They re-formulate the trade-off theory with mean reverting earnings. Sticky dividend policies. firms issue the safest security first. mean that internally generated cash flow may be more or less than investment outlays. their model predicts a negative relationship between earnings and optimal leverage ratio when earnings are mean reverting. there is another view of how financing decisions are made. 2. they start with debt. 30 . one at the top of the pecking order and one at the bottom. If it is less. 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). They adapt their target dividend payout ratios to their investment opportunities. the firm first draws down its cash balance or marketable security portfolio. Each firm’s observed debt ratio reflects its cumulative requirement for external finance. This is “Pecking Order Theory”. 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. Sarkar and Zapatero (2003) conduct an empirical study with a sample of firm in the S&P 500 Index.trade-off theory predicts exactly the reverse and fails to explain.

However. Net new stock issues were never more than 6% of external financing. none of this says that firms ought to heavily relay on debt financing. 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. on average. a firm with ample internally generated funds does not have to sell any kind of security (Brealey et al. internally generated cash covered. This is a persuasive and influential result.not because they have low target debt ratios but because they do not need outside money. risks and values than do outside investors. In fact. 62% of capital expenditures. Then rates of investment will be similar within an industry. Shyam-Sunder and Myers (1999) find strong support for this model with a sample of 157 firms over the period 1971 to 1989. their work was cited by Chirinko and Singha(2000). this theory demonstrates the inverse relationship between profitability and financial leverage within the industry. Suppose firms generally invest to keep up with the growth of their industries. More importantly. The pecking order is considered as a descriptive reasonable empirical model of corporate leverage. When practical figures. the heavy reliance on internal finance and debt is clear. 31 . even in the case of highly information efficient market. However. The most of external financing comes from debt. Also. Alternative tests are needed that can identify the determinants of capital structure and can discriminate among competing hypotheses. including investment in inventory and other current assets. For all non-financial corporations over the decade 1979-1982. Brealy and Myers’ studies (1984) provide evidence that the bulk of required external financing came from borrowing. which indicates that managers know more about their companies’ prospects. the least profitable firms will have less internal funds and will end up with borrowing more. a few months after. Given sticky dividend policy. This statistical figures make pecking order theory seem to be reasonable and at least provide a description of typical behaviour. 2006) Pecking order theory explains why the most profitable firms generally borrow less.Pecking order theory starts with asymmetric information. 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.

Furthermore. with the objective to maximize their value. This may be due the inclusion of small firms in their sample. most companies in their sample use significant external financing. It cannot explain why financing tactics are developed to avoid the consequences of managers’ superior information. financial distress. firm’s internal financing. such as Berle and Means (1932) and Berle (1954). firms identify their optimal leverage by weighting the costs of financial distress and the tax benefits. According to their empirical results. on average. Myer and Majluf (1984) demonstrate the possible conflict between interests of managers and shareholders. However. Agency cost makes numerous scholars review their work and take new issues into consideration. this is not always the case. Problems can particularly arise when a firm’s manager accumulates too much financial slack that they become immune to market discipline. Donaldson (1969) admits that the financing decisions of the firm he studies before were not directed towards maximizing shareholders wealth. pecking order theory fails to explain the influence of taxes. 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. is not sufficient to cover investment spending. especially in the aspect of agency cost. attempting to explain those decisions have to restart by recognizing the “managerial view” of corporate finance. At the optimal leverage 32 . In addition. and those scholars. The current portion of long-term debt is not considered as part of the financing deficit. it is widely found that debt financing does not dominate equity financing. Frank and Goyal constructed a study on financing behaviour of publicly traded American firms over the 1971 to 1988 period. Net equity issues track the financing deficit quite closely. In 2003.1. security issuance costs. agency costs. Myers (1984) critically states that pecking order hypothesizes cannot explain everything. All these facts are in contrast to what is suggested by pecking order theory. In the trade-off model. As a result.It has to be concerned that the pecking order theory assumes that the mangers act in the interest of existing shareholders. while net debt does not do so.6 Pecking Order Theory VS. 2. There are plenty of examples of firms issuing stock when they could issue debt. or the set of investment opportunities available to a firm upon that firm’s actual capital structure.

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

IAS 19.3 Different from SSAP 24. SSAP 24 misleads the balance sheet position and does not require companies to report the assets and liabilities on the balance sheet accurately. Pension is defined as post-retirement benefits and it is company’s obligation to pay pensions to former employees. follow a “balance sheet” approach to accounting for the pension scheme contributed by the employer. There are two major types of pension schemes. 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. the traditional trade-off model. 2. 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. 3 This is the same with FRS 17 (Financial Reporting Standard). SSAP 24 requires the use of actuarial valuation basis for both assets and liabilities. 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.To sum up. Employee Benefits. Firstly. Secondly. The purpose of a pension is to grant people some money when they are retired. we will next provide an introduction on how pension scheme works and what is the adjustment under new accounting standards. More appropriately speaking. After a relatively long discussion. Pension scheme was originally ruled based on SSAP 24 (Statements of Standard Accounting Practice). Either one is good at explaining certain issues and has obtained a number of empirical supports.2 Overview of Pension Scheme and Accounting Standards With the objective to examine how the adjusted accounting standards on pension scheme affect capital structure. namely defined benefit and defined contributions. in 2000. 34 . Under a defined contribution plan. which has been criticized regarding a number of aspects. and the fund pays out the pension. it is always too simplistic to say one is superior to another. which is difficult to justify and could give rise to unrealistic pension provision being made. Typically pension schemes are funded by the company putting money into a separate fund.

However. 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. companies adjusted their balance sheet format and disclosed ‘pension’ as an individual item of liabilities from 2005. This adjustment has brought a significant impact on many companies. IAS 19 will make company accounts appear more volatile. the results support positive effects of size and negative 35 . net of the fair value of the funded plan assets. generally supporting the idea that the UK market is more testable and in principle more consistent with capital structure theories. and pension deficits are likely to influence the rating of individual shares. The new accounting standard also defines how the balance sheet asset or liability should be built up. in other cases negatively. This will directly push down the company’s share price. 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.Defined contribution plans are relatively easy to account for: contributions payable to the plan are recognized as an expense as the employee provides services. For example. He examines how companies actually choose between financing instruments at a given point in time and in different financial contexts. in some cases positively. 2. As companies begin to adopt the new standard. Actually. 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).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. Based the revised IAS 19. British Telecom has warned that its pension fund will show a 5 billion pound deficit on their balance sheet. IAS 19 has been subject to some heavy criticism. On the whole. For defined benefit plans. large pension deficits on the balance sheet appear to be an early sign of trouble. For example. Some leading companies also have been affected by the new accounting standard. and could start to impact on company’s profit.

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

When companies raise fund.Chapter Three: Methodology Having reviewed a number of literatures in term of capital structure. 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. The borrower using long-term debt generally pays interest at a rate expressed as a fraction of par value (Ross. and debt price is often expressed as a percentage of the per value. 2005). dependent variables and independent variables need to be selected.1 Dependent Variables: With the aim to assess companies’ gearing level. 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. quantitative rather then qualitative method will be used. 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 . we will now conduct an empirical study on UK listed non-financial companies. An active stock market and an ability to enter into long-term contracts also allow firms to 4 http://wbro. et al. To run the research models. called the maturity date.org/cgi/content/abstract/13/2/171 37 . According to World Bank Research. 3. Long-term debt always has a par value equal to the face value. firstly and most importantly. Analysis of variance (ANOVA) and multiple regression analysis will be applied to examine the significances and correlation between different variables. Long-term corporate debt is a promise by the borrowing firm to repay the principal amount by a certain date.oxfordjournals. how much a firm borrows is obviously measured as dependent variables. they will consider different forms of debt.

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. which are demonstrated as dependent variables. 2005). Thompson 1976) However. Therefore. (Beaver. Institutions like banks that want to enhance their ability to provide liquidity and credit to borrowers have to issue short-term debt. two primary sources of liquidity. In general. Kettle and Scholes 1970. will find borrowing becoming increasingly relying on short-term as they have limited longterm debt capacity. Short-term borrowing provides maximum flexibility at a minimum cost. 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. Rosenberg and McKibben 1973. countries that have poor disclosure rules and inadequate investor protections. This can protect from inaccuracy caused by different size of companies. 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. we apply the debt/total assets ratio rather than the actual amount of debt. Diamond and Rajan (2000) assert that companies do need short-term financing. there are reasons for not doing this.grow at faster rates than they could attain by relying on internal sources of funds or short-term credit alone. Similarly. it is important to distinguish between market values and book values (Ross et al. However. 38 . which provide needed funds. for many companies. When observing the debt level of firms. Also the bankruptcy cost asserts that capital structure choice matters only to the extent that it affects the market value of the firm. are short-term debt and commercial paper programmes. Consequently. It is a matter to choose between market value and book value of debt. 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. financial economists prefer the use of market values. we compute both short-term and long-term debt as the measurement of leverage. 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.

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

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

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

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

However. we use: 7 For example: Titman and Wessels (1988) 43 . the use of revenue here may lead to high correlation between two independent variables. They provide evidences that direct bankruptcy costs appear to contribute a larger proportion of a firm’s value as that value decreases. In our studies.corporations and the various psychological factors associated with their management which result in their being reluctant to take in new equity. however. Warner (1977) and An. To indicate this variable. Marsh (1982) finds evidence that firms with greater bankruptcy risk are more likely to issue equity. This is because we have already included the profitability as one of our variables. As what has been discussed above. in that companies with most tangible and safe assets did borrow the less. Moreover. In contracted. Smith (1977) also provides evidence to support the negative correlation between firm’s size and leverage. He states that small firms pay much more than large firms to issue new equity. there is little evidence that executives are concerned about assets substitution when deciding the target leverage ratio. 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. we here apply the number of employees instead of revenues. 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. we hypothesize a positive relation between tangible assets and debt level. 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. 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. A number of researchers use natural logarithm of revenues to indicate the firm size7. and McConnell (1982) argue that large firms should rely on high leveraged. Chua.

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

Rajan and Zingales (1995) use Tobin’s Q and Booth et al.to proxy growth opportunities. This indicates that firms manufacturing machines and equipment should be financed with relatively less debt. 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. Bradley et al (1983) find that the industry factor has strong influence on firm leverage ratios. (2001) use market-to-book ratio of equity to measure growth opportunities. we foresee contradicted correlation of long-term and short-term debt variables. 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. This is the case even when the need for external financing is great. To summary. As what have been argued by previous scholars. 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. we will here apply the five years average turnover growth. Titman (1984) suggests that firms that make products requiring the availability of specialized servicing and spare parts will find liquidation especially costly. the relationship between industry classification and firm leverage can be predicted as following: 45 . tend to use the most debt. There are very significant inter-industry differences in debt ratios that persist over time. Pecking order theory also supports the intra-industry similarities. Industries such as primary metals and papers. which is already calculated by the firm and shown on their financial statement. Trade off theory is particular helpful in explaining differences in capital structures across industries. with relatively few investment opportunities and slow growth. negative coefficients with long-term debt and positive one with short-term debt respectively.

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

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. it is believed that companies should also adjust their targeted capital structure since the amount of liabilities appear to increase. Since 2005. With the aim to increase transparency by showing the pension fund surplus/deficit clearly on the balance sheet. most companies have started to treat pension fund as an individual item of long-term liability in balance sheet.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. and its cost in the P&L account. we divided the entire time period into pre-pension 47 . To capture how the new accounting standard has influenced companies’ capital structure. especially the level of debt.

In order to capture the impact of adjusted accounting standard.bvdep. we can detect the impact from different treatment of pension fund. we divide the entire timeperiod into the pre-pension scheme period: .2001-2004 and the post-pension scheme period: . 3.2005-2006. which provide a financial and accounting database covering the majority of UK public and private companies. Industries and firms observed are: 8 9 http://www.4 Data Description: Our data come from Financial Analysis Made Easy (FAME)8. While other studies employ the Standard Industrial Classification (SIC) codes for industry analysis. (1982) 48 . Similar with Bradley (1983). The time period under consideration is a time span of six years from2001 to 2006. we use the average value of the testing period to avoid time bias. By comparing results obtained from both periods. insurance companies and investment trusts) have an obviously different structure. the test of the existence and determinants of inter-industry differences in leverage studied by Bowen et al. 9 We classify UK sample firms into 10 industries using sector information provided by the Financial Times London Share Service. We excluded the financial firms because the balance sheet of the firms operate in the financial sector (banks. Cross-sectional data set are collected from annual report of 80 non-financial UK listed companies in 10 industries.fame.com/athens For example. which provide an exogenous means for grouping firms into functionally defined industries.scheme period 2001-2004 and post-pension scheme period 2005-2006.

Savills. Chloride. Liberty International Segro. and limited resources force us to skip those firms whose annual report from 2001-2006 are not available from FAME. 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. Ryanair Labrokes. Aminex. Carphone Warehouse. ICI JOHNSON MATTHEY. Treatt. Tullow. Glanbia. Dechra Brixton. JKX. EasyJet. Inensys. we apply different model for dummy variables and non-dummy variables. Minerva BT Group. CLS Holdings Daejan.Table Six: Sample of Targeted Industries and Companies Industries Automobiles Chemicals Number of firms 2 Sample of firms GKN. Dialight Halma. PGI. British Airways Carnival. KCOM Thus.5 Research Model: Due to the different nature of independent variables. Beale. Croda. Tate&Lyl SABMiller. To regress dummy variables. Volex Spectris. Dana Petroleum Acambis. This will be discussed with more details in the limitation part. which refer to the 49 . Marston's. Universe. Laird. Vanco Vodafone. Dairy Crest Abbot Group. Freeport Grainger. Importantly. 3. Hunting. BP. Victrex. Vernalis Astrazenca. Porvair. Kerry Group IAW Group . Zotefoam. 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. Elementis SMITH & NEPHEW Abacus. Diageo Devro. BG Group. Emap Arriva. Vectura Group BTG. Xaar. XP Power. Luminar Alexon. Renishaw Unilever. Burren Energy XP Power. Lookers. Findel. HMV. Torotrak Carclo.

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

Following tables represent the value of VIF/Tolerance coefficient of independent variables. We can see that none of the tolerance is lower than 0. 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 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. The sign is a low tolerance (less than 0.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. tax shield (TaxS).g what is the relative impact of firm size on long-term debt). They are referred to firm size (Siz). the error term is constant.75 and thus it appears that there is no problem of Multicollinearity 51 . The problem of multicollinearity occurs when there is a strong relationship between two or more explanatory variables. profitability (Prof).g the mathematical equation relating the dependent and independent variables). To apply the regression analysis. predicting the values of the dependent variable (e. growth rate (Grow) and assets compositions (Ass). independent and under a normal distribution. we assume that there are linear relationship between leverage and those six factors. Exogenous variables are these proposed influential factors discussed in early part.g how long-term debt would increase if the dividend rate has increased) and determining the structure or form of the relationship (e. dividend rate (Div).75) or high VIF.

970 .849 2005-2006 VIF 1. 52 .915 .108 1.850 .017 1.178 2001-2004 Tolerance .956 .108 1.902 .978 .023 1.031 1.874 .159 1.970 .053 1.874 .978 .053 2001-2004 Tolerance .120 1.902 .915 .144 1.023 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.983 2005-2006 VIF 1.177 1.950 2005-2006 VIF 1.893 .017 Data are summarized according to appendix two To sum up.092 1.092 1.863 .849 Short-term Debt 2005-2006 VIF 1.047 1.983 . observing the capital structure patterns of 80 UK listed firms operating in 10 industries.178 2001-2004 Tolerance .144 1.956 .120 1.863 . the statistical analysis of secondary data is applied in our study.893 .159 1.Table Seven: Summary of Collinearity Statistics Long Term Debt 2001-2004 Tolerance TaxS Prof Ass Div Gro Siz .950 .031 1.047 1.177 1.850 .

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

In the following paragraphs. Low explanatory power indicates that relationships between variables are not necessarily linear and can be caused by improper model or measurement problems.174 . we will provide detailed interpretation on obtained statistical results. In our case. However.319 Sig. R2 turns to be higher when we include dummy variables.310 . Main results from ANOVA are as follow: Table Nine: Results from ANOVA ANOVA Sum of Squares 2. In this study. indicating how those proposed factors influence long-term and short-term debt and how results modify when taking the new IAS 19 into consideration. In addition.243 LTD/TA Between Groups Within Groups Total STD/TA Between Groups Within Groups Total 1.203 df 9 70 79 9 70 79 Mean Square .475 19. which can lead to misleading results. 4.028 .05). This result is inconsistent with static trade-off theory and pecking order theory. R2 turns to be higher when including dummy variables (refer to industry classifications) in the independent variable. Also. it refers to the explanatory power of our proposed determinants of capital structure.269 . it provides no evidence to 54 . . which emphasizes the intra-industry similarity and inter-industry differences on firms’ leverage.267 .Another aspect of regression models is goodness of fit. which is a summary measure of how well the sample line fits the data. we can argue that R2 is relatively low in all regression models at around 0. it is possibly because data are measured as book value instead of market value.002 F 1.3.003 .235 .794 16. According to Appendix Three.1 Effects of Industry Classification To examine the impact on industry classification. we included industries as dummy variables and apply the ANOVA analysis.270 Above table shows no evidence to conclude that industry classification affects both longterm and short-term debt (significance level>0.

Turning to short-term borrowing.03 (automobile industry) and the highest ratio is 0.85 (pharmaceuticals and biotech industry) regarding to long-term debt. Firms cannot immediately offset the random event that bump them away from their capital structure targets. We can view that the only determinant. What we have observed are actual debt ratios rather than the targeted debt ratio.09 (food and beverage industry). tax shield and firm size. the insignificance may be because firms are not able to adjust their debt level to optimum without delay. dividend rate.11 (oil and gas industry) and the highest ratio is 0. which is significantly correlated to industry. Appendix four reports the correlation between industry and other independent variables. When looking at industries individually (figure 8 and 9). growth rate. 55 . is tangible assets (significance level<0. the lowest leveraged industry is 0.05). it is not surprising to observe differences in actual debt ratios among firms having the same target debt ratio.support Bradley et al (1983)’s investigation. the lowest leverage ratio in our sample is 0. Therefore. This indicates that although firms are operating in the same industry. with the exception of pharmaceuticals and biotech industry. We can conclude that the majority of industries in our samples have similar debt ratio. which indicates that industry factor have strong influence on firm leverage ratios. However. therefore. they are considerable different in terms of profitability. trade-off theory admits the existence of adjusting cost and delays.

Devi at i on of Lever age Rat i o by Indust r y Std.Figure Eight: Mean of Leverage Ratio by Industry Mean of Leverage Ratio by Industry 1 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 0. 8 0.8 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. 4 1. we can observe that firms in 56 . 2 1 0.6 0.Deviation Value Pharmaceutical s and Biotech Telecommunicat ion Travel and Leisure Automobiles Electronic Equip Food and Beverages 1. 6 0. 8 1. 6 1.

which has been confirmed by many studies on its high correlation with debt ratio.978 . The diversity may be caused by selection of different variable measurement. The coefficients estimates between long-term debt and tax shield as well as tangible 57 . which argues that growth industries with intangible assets always have lower leverage.028 -2.041 3. the positive sign of its coefficient supports neither trade-off nor pecking order theory.874 .077 -. However.129 -.849 1.2 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 .33E-005 .497 .120 1.479 .144 1.394 -.047 1.001 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 0.002 . level<0.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.967 . Myers (2006) particularly takes pharmaceutical industry as an example to explain the pattern of capital structure.127 . “ 4.178 t Sig.042 .307.019 . 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.219 .147 .683 .030 -.001 .171 .925 .137 .898 .004 Std.05). It is growth rate (sig.001 . Only one of our six empirical proxies of determinants of firms leverage has significant influence on long-term debt ratio.439 -.712 -.251 . Collinearity Statistics Tolerance VIF -.005 .985 .902 . Error .061 Standardized Coefficients Beta .023 1.893 .001 .108 1.956 . This comes as surprising results and is not consistent with static trade-off theory.015 -.101 . In addition.

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

the positive coefficient is consistent with pecking order theory and the hypothesis.874 . We can see that firms behave very diversely when borrow long-time and short term.002 .010 .392 .008 .92E-005 .023 1.381 1. However.095 .076 .025 . The R 2 has increased to 0. financial managers are more likely to take these aspects into consideration.Table Eleven: Regression Results of Short-term Debt Model Unstandardized Coefficients B 1 (Constant) Tax Shield Profitability Growth Rate Tangible Assets Dividend Size . which represents that when borrowing short-term debt.799 .108 1. There are two significant variables for short-term debt.893 .978 .956 . 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.902 .120 1. 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.014 . 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.312 Standardized Coefficients Beta . Growth rate also turns to be insignificant when we regressing short-term debt. Different from long-term debt.144 1. However. The positive coefficient of tax shield is steady with results obtained from long-term debt.862.727 .704 . Profitability turns to be the least important variable with significance level 0.040 4. Most of the variables coefficients go in line with our prediction.862 .178 t Sig.174 .006 .861 2. which are tax shield and firm size.849 1. asserting that large firms should be more highly leverage.048 . firm size shows a reverse correlation with long-term and shortterm debt.980 -1.329 from 0.047 1.208 .004 . Firms’ growth rate in this case is no longer significant. Error .008 .330 .000 -.019 . the sign of coefficient shows a positive correlation with debt ratio.307.000 .201 .956 .022 .110 -.017 Std.000 . This finding supports static trade-off theory against pecking order theory in that most profitable corporations with tangible assets borrow the most.

we can see that most firms adjusted their debt ratio after 2005. It is surprising to see that tangible assets have a negative relationship with short-term debt.438621 0. However.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 . the rise of standard deviation indicates that different firms have different pension positions. The increase of both short-term and long-term debt will definitely make firms look suffering more deficits. Deviation 1. the test on dividend falls on our prediction with pecking order theory.4 Effects of Pension Scheme To examine how the treatment has influenced firm’s financing behaviour.186 4.4938795 0.5965297 0.2689 0.050671 Std. To compare results obtained from 2005-2006 to ones from 2001-2004. corporations are assumed to borrow less face to the inclusion of pension deficit in balance sheets. Deviation 0.471 Mean 0. The mean of both long-term and short-term debt ratio has increased from 2005.120403 Std. This comes as surprising results because in order to keep the book value of liability stable. Also. This may be caused by the selection of sample firms and their desired debt ratio cannot be actually observed. we divided our period into pre-pension scheme and post-pension scheme period. 4. According to table 12. which observes the opposite results from trade-off theory. 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 4.056951 Mean 0.ones on long-term debt.2599 Maximum 12.255011 0. which suggests a positive correlation with leverage. we can observe the impacts of revised IAS 19 on firms’ capital structure.

5 2 1. 5 1 0.145838. it is reasonable to assume that pension deficit is larger in firms operating telecommunication industry. Compare to figure 8.316917 for LTD/TA and 0. Pharmaceuticals and biotech still have the highest leverage debt (2. 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. 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 .2004. firms in telecommunication industry are just a little behind on long-term borrowing. with the mean of 1.772417 for STD/TA) and interestingly.

Tax shield and growth rate have showed a contradictory correlation with long-term debt. 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. Deviation of Leverage by Industry for Post-pension Scheme Period St d.4. Retailers 62 . Looking at the following comparative table. firms started to take more factors into considerations rather than just those proposed determinants. Devi at i on of Lever age Rat i o by Indust r y Std.1 Impacts on Long-term Debt The model fitness has dropped from 0. This finding indicates that have disclosed pension fund in their balance sheet.Figure Eleven: Std. profitability and firm size have turned to become significant apart from growth rate.250 of post-pension scheme period (appendix three).307 of pre-pension scheme period to 0. which means the explanatory power of proposed determinants has weakened when testing on data collected from 2005-2006. we can see that new accounting policy has changed the signs and significance of some variables. In terms of significance.Deviation Value 6 5 4 3 2 1 0 Automobiles Chemicals Electronic Equip LTD.

08 0. the model fitness is even lower.002 Sig. because pension deficit is recognized as one item of longterm liability.005 .4.497 .015 -.178 0. The poor explanatory power indicated that financial managers seldom consider these proposed factors when facing short-term finance decision.43 0.034 -0. 63 .101 .491 -0.479 .008 to 0. with the value of 0. which is also the case with long-term debt ratio.094 -0. However. the sign of variable coefficients and the significance of determinants have changed under the revised accounting policy.039 Data are summarized according to appendix two 4.189.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 . 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.048 0.178 0.2 Impacts on Short-term Debt When regressing the short-term debt from 2005-2006. The most significant determinants become the most insignificant from 2005 (p value changes from 0.147 . Interestingly. the inclusion of pension liability should have less effect on short-term debt rather than long-term ones.985 2005-2006 Beta Sig. just like long-term debt.86 0.05 0.234 -0.394 -.817).077 -. tangible assets and growth rate showed a reverse correlation with short-term debt in post-pension scheme period. .02 -0. 0. tax shield is still significant yet has negative relationship with short-term leverage ratio. In theory. Tax shield.898 .001 .967 .

we find it is not consistent with Agrawal and Nagarajan (1990)’s studies on US firms. For example.008 2005-2006 Beta -0.689 0.2689).078 0. observation on some variables rejects our hypotheses for both long-term and short-term debt ratio. The reason for this will be 64 . such as dividend rate.33 0. however. which makes the industry have the highest debt ratio and standard deviation. with little short-term as well.055 0. only little firms have no debt and cash and marketable securities are only a small fraction of liabilities.312 Sig.392 0. most of variables go in line with our hypothesis.208 0.076 0.114 -0.081 -0.047 0.5 The Summary of Statistical Results Take a general look at our results.029 0. 0. In addition. the most of variables are insignificant.817 Data are summarized according to appendix two 4.862 0. Surprisingly.048 0.095 0. In terms of coefficients signs. long-term debt in certain firm even exceeds the amount of total assets such as Vernalis in pharmaceuticals and biotech industry (LTD/TA=4.219 0. the insignificance of industry classification provides no evidence to support both static trade-off theory and pecking order theory.704 0.026 Sig. same as many previous studies.512 0. 0.125 -0.127 0.11 -0.201 0. To conclude.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 0.019 0. Agrawal and Nagarajan (1990) state that firms are averse to leverage of any kind. Although some of our proposed determinants have significant influence on firms’ leverage. statistical results obtained from our empirical studies have a relatively low explanatory power and are conflicting with leading theories. they have levels of cash and marketable securities well above their leverage counterparts. Whereas in our samples.

Apparently. which are data on one or more variables collected at the same point in time. Market Value When observing the capital structures of firms. which will be discussed in details in the following part. the small sample size and avoidance of private companies cannot provide an integrated picture of UK firms and may lead to a research bias. Just as other types of data. After all. the conflicting results are in some ways due to the research shortcomings. 2003). the sign of coefficients even differ between pre-scheme period and post-scheme period. In addition. it is important to distinguish between market values and book values (Ross et al. 2005). suppose a firm buys back shares of its own stock and finances the purchase with new debt. specifically the problem of heterogeneity. data examined in this study are cross-sectional data. Companies and industries are randomly chosen without any criteria. which may lead to misspecification. The change in the treatment of pension deficit makes firms adjust their leverage ratio for both long-term and short-term aspects.discussed in the following research limitation part. the findings are based on a relatively small sample of UK public companies (80 companies in 10 industries). We have diagnosed the problem of multicollinearity yet ignored the possibility of heterogeneity and autocorrelation. After all. the firm has fewer outstanding shares and more debt regard to the mix of equity 65 . For example. (Gujarati. For some determinants. 4.6 Research Limitations Limitations on Data and Sample Collection Firstly of all. due to the time and data constraint for constructing this study. Book Value vs. This would suggest that the firm’s debt level should go up and its reliance on equity should go down. crosssectional data has their own problems.

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

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

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

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

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

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

0854 0.8194 0.22% 36.9564 4.0100 0.1624 Gro 2.1063 0.27% 0.0114 0.5601 0.8900 2.57% 11.0478 0.1990 0.2200 0.7083 0.2100 3.0067 2.1409 0.2467 2.5142 0.2300 0.0896 0.9530 3.0000 0.1982 2100 1.0575 0.3609 0.1040 0.3600 0.5600 3.1900 0.1221 0.2620 0.2023 0.3100 0.1000 0.0996 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 0.5740 79 .86% 5.0364 0.1593 0.76% 5.1800 0.0081 0.9954 0.0910 0.1552 0.2591 0.2551 0.1346 0.0400 0.1139 0.2709 5.0042 0.3088 0.1460 0.1149 0.0060 0.2591 0.0475 0.4500 0.0503 0.2700 0.2111 0.0200 1.1250 3.0243 0.0729 0.6900 0.0570 0.0235 0.1458 0.1662 0.3400 0.2218 0.0328 0.2400 0.0787 TanAss 0.0500 0.1136 0.4950 4.0000 0.4121 0.3000 4.1287 0.1440 0.30% Siz 4.3100 0.1170 0.3865 3.8131 0.39% 14.2293 0.0700 0.2902 0.57% 18.1671 0.3100 0.0064 0.3600 0.23% 9.0120 0.1471 0.1881 0.64% 9.2360 STD/TA 0.0909 0.3353 0.87% 6.34% 27.0963 0.2267 0.5359 2.0171 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 0.5545 2.0287 0.0952 0.4216 0.1400 0.0481 0.0056 0.9281 2.1827 0.4500 0.3668 3.64% 3.1843 0.0000 0.3900 0.1148 22.43% 13.5319 1.0208 0.1500 0.2751 0.3756 0.29% 15.0100 0.1182 Prof 0.3004 0.3021 2.3142 0.1208 0.5319 0.2100 0.1960 0.0375 0.1013 0.1032 0.74% 18.00% -5.0100 0.0437 0.47% 12.94% 1.6600 0.2745 0.9800 0.2333 0.0541 0.4472 3.97% 9.0400 0.0000 0.4009 0.2098 0.2900 0.0491 0.1640 0.1499 4.1577 0.0030 0.9893 3.2421 0.1250 3.1760 0.4667 0.39% 12.0100 0.2096 0.6752 4.6800 1.0000 0.1479 0.81% 19.3170 0.8200 3.0400 0.62% 0.5396 0.0733 2.2044 0.0400 0.1351 0.0058 0.0959 0.5424 0.58% 8.2730 Div 0.3309 0.6700 3.5400 0.6800 2.1652 0.0635 0.6656 0.49% -2.2109 0.20% 31.5266 4.1600 0.7269 0.0091 0.8100 0.5040 0.0000 0.0000 0.3122 3.7706 3.2288 0.0213 0.8000 0.80% 9.0500 0.41% 8.83% 14.0921 0.7500 0.0925 0.2700 0.

6088 0.0000 0.0000 0.0894 2.27% 9.1152 0.8898 0.3118 4.4406 0.1675 0.5890 4.1928 0.4183 0.2686 0.3006 0.4168 0.1147 0.09% 4.0103 0.0094 0.2213 0.26% 8.1525 0.5509 0.1860 1.45% 63.3837 0.4168 0.2476 4.2576 0.32% 11.0039 0.1261 0.4500 0.5554 0.3821 0.7559 2.83% 40.4805 0.0056 3.1426 0.1314 0.1940 0.5820 0.4935 0.0502 0.0857 0.0405 0.1444 0.0017 0.0041 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 0.2019 0.0149 0.5040 0.1194 0.3956 0.0358 0.3001 0.1082 0.4041 80 .1672 0.4960 0.4852 0.90% -1.65% 38.21% 15.29% 77.0579 0.1040 0.0188 0.0212 0.01% 1.14% 3.0657 0.4155 0.4472 2.50% 2.0450 0.2718 1.0012 0.7457 1.33% -4.1490 0.0000 0.0003 0.4327 0.1538 2.0284 0.2719 0.1167 0.8864 0.4259 0.5205 0.0197 0.18% 3.0939 0.8422 0.0158 0.1017 0.3360 0.4874 0.5514 2.55% -4.0000 0.0600 0.2671 0.17% 77.0011 12.0251 0.1040 0.3173 0.0032 0.5774 0.3045 0.7240 0.0093 0.2422 0.0018 0.0795 0.0364 0.30% 4.8775 0.3255 0.4314 3.6047 0.1375 0.2697 0.0000 0.28% -9.4986 0.2851 0.1013 0.5354 0.1181 0.1697 0.0135 0.4392 0.7081 4.96% -2.0467 0.2558 0.0638 0.1574 0.28% 13.9934 2.0196 0.1383 0.0000 0.0057 0.0587 0.64% 20.0453 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 0.1511 0.2887 0.0017 0.0007 0.1489 0.0104 0.4750 0.0304 0.8535 3.1155 0.1993 0.4148 0.1320 0.4537 0.1599 0.0133 0.0074 0.1170 0.0000 0.5449 0.0327 0.0103 0.1318 0.8357 1.11% -4.7881 0.3407 3.0881 0.6656 0.5359 3.55% 0.0054 0.0191 2.0178 0.97% -0.2820 1.0000 0.01% 30.0000 0.1063 0.49% 26.0635 4.1813 1.0753 0.0000 0.22% 32.2486 0.1541 1.1232 0.0019 0.3231 0.0337 0.04% 11.0000 0.0000 0.1227 0.3580 0.1936 0.8192 2.1244 0.0636 0.0293 0.5959 0.4250 0.0417 0.5051 5.2098 0.4250 0.2823 0.3578 3.3120 0.11% 66.2509 0.3905 2.1629 0.4710 0.8215 2.2303 0.2651 0.0001 0.3384 0.0810 2.2862 0.0916 0.0894 3.2488 0.1346 0.0418 0.2014 2.1455 0.3648 0.22% 34.7230 0.6144 2.4280 0.

0006 0.1517 0.7380 0.1253 0.3577 0.8638 3.0000 0.6591 2.95% -1.1278 7.1386 2.8100 0.0000 0.3003 0.2259 0.0400 0.1608 0.0051 0.3294 0.0500 0.3345 3.2600 1.4044 23.7052 0.4118 0.8700 2.0400 -0.30% -4.0142 0.1226 0.16% -5.2500 0.44% 47.7846 4.7700 3.41% 7.0200 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 1.20% 14.95% -4.8197 0.1796 4.3400 27.0800 0.1325 0.2400 0.3100 0.04% 2.3201 0.0242 0.1157 STD/TA 0.3426 0.0600 0.0322 0.56% -1.0300 0.5108 4.4138 3.1300 0.2092 Div 1.3045 0.4153 4.8858 81 .0020 0.0738 0.0282 0.27% -1.0300 0.0204 0.Thus Vanco Vodafone Carphone Warehouse Universe Emap Arriva British Airways Carnival EasyJet Ryanair Labrokes Marston's Luminar Alexon Findel Lookers HMV Beale Greggs 0.0253 0.1292 0.1177 3.0827 0.0445 0.3743 3.1220 0.0683 0.0300 -3.1729 0.85% 28.2300 1.54% Siz 4.0100 0.1709 0.5842 0.5951 0.1136 0.2598 0.1693 TanAss 0.0902 0.88% 13.2912 0.5863 0.4200 0.0419 0.0053 0.0243 0.6145 3.3300 0.7774 0.3264 0.1495 0.1800 0.3220 0.1357 0.9132 0.08% 11.0501 0.2960 0.8636 0.4000 0.0019 0.1000 0.1100 0.0199 0.0585 0.0200 0.1089 0.5479 0.2400 0.1206 0.30% 11.3500 0.4208 0.3900 3.0623 0.3900 0.0761 0.2900 0.3390 0.74% -8.1304 0.36% 21.5361 0.1600 0.1676 0.7739 0.2404 0.2760 0.19% 47.0100 0.3192 0.7709 4.1365 0.1916 0.1676 0.4851 0.22% 0.38% -7.0900 0.0000 0.0126 0.9765 4.6709 4.2277 0.68% 4.1633 0.99% 26.0400 0.3749 3.2652 2.1864 0.1409 0.3000 0.1524 -0.2212 0.1750 0.4600 0.0128 0.0608 0.0142 0.0918 0.7320 4.02% 30.8477 0.1800 0.25% 4.5092 3.0265 0.1300 0.4760 0.2300 0.3401 14.36% 6.0351 0.0789 0.5700 3.6628 0.0649 0.8500 2.3579 2.1629 0.70% 4.6833 0.0081 0.0000 0.0508 0.2848 0.0279 0.1274 0.0123 0.3255 0.1493 0.5124 4.26% 32.0045 0.0335 0.0443 0.0840 3.0000 0.5051 0.2500 4.3815 0.1400 0.0000 3.1300 0.0489 0.0300 0.0714 Prof 0.0000 0.7900 3.1058 0.0652 0.0359 0.1388 0.0212 0.3775 1.2796 2001-2004 Company GKN Torotrak Carclo Croda ICI JOHNSON MATTHEY Porvair Treatt Victrex Zotefoam Elementis SMITH & NEPHEW LTD/TA 0.3343 0.9255 3.1403 0.3298 0.4797 34.3568 Gro 1% -4.5840 0.3464 0.2108 0.8397 0.2149 2.0837 Ind Automobiles Automobiles Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals Chemicals TaxS 0.55% 7.4200 0.7015 0.53% 3.0228 0.81% -9.93% -8.6457 0.0000 0.0287 0.0835 0.0746 0.1938 0.0316 0.0630 0.

3028 0.3775 0.81% 1.2167 0.59% 2.096 0.0822 0.2466 0.2301 0.0353 0.5118 0.39% 12.7182 0.2357 0.0566 0.1581 0.0540 0.7101 2.1392 3.8834 3.229 0.0005 0.1339 0.0366 0.6624 0.39% 1.3141 0.4309 0.0431 0.0002 2.83% 6.2689 0.0596 0.0910 0.5614 3.4001 2.0567 0.1889 0.0807 0.5292 625.0263 0.2124 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 0.3913 0.0602 0.1190 -0.55% -11.315 0.2139 0.1232 0.394 2.1939 0.0668 0.2082 0.3968 2.2053 0.84% -8.6909 3.2648 0.9878 0.8515 3.3695 0.5502 2.0000 0.0539 0.0746 1.7709 2.1701 4.1414 7.6964 0.1536 0.0001 0.3239 0.01% -9.0893 0.02% -6.37% 30.1581 0.05% -7.52% -2.2685 0.3286 0.3158 0.5755 4.0183 0.60% 33.0262 0.2464 0.0003 0.7392 3.24% 12.0263 0.0184 0.8794 3.6918 0.3692 3.0609 0.8800 0.2199 0.0148 0.0472 0.0564 0.1305 0.0000 0.0047 0.0825 0.78% 13.7779 3.1173 0.0000 0.1379 0.71% 26.6604 3.0390 0.2363 0.0204 0.0310 0.2367 0.2228 0.323 0.1520 10.1594 0.0824 0.0123 0.0000 0.0496 0.1450 0.8599 0.79% 0.1090 0.1441 0.0000 0.7170 0.0681 0.0899 -0.12% 2.0052 0.4614 0.4637 4.0000 7.96% 224.02% -2.0947 0.0735 0.0590 -0.1754 0.3960 0.4128 0.1714 0.2919 0.34% -1.3997 3.8147 0.59% 82 .6266 1.68% -16.0265 625.7186 0.1827 0.5684 0.3688 0.0369 0.0468 0.7785 0.3975 3.1391 0.0605 4.0069 0.0661 -0.0430 0.1339 0.1488 0.0214 0.0165 3.3225 0.0843 0.1386 0.3470 0.66% -6.1080 0.1418 0.2554 0.0843 0.7794 0.2798 0.0844 0.0427 0.1785 3.2266 0.0756 0.53% -8.83% -21.0028 0.6588 3.2921 0.3878 3.1795 0.2009 5.3275 0.9037 0.1920 0.1683 0.1160 0.0533 0.3150 0.07% 9.1941 0.92% 16.1904 0.0237 0.9986 3.0788 0.508 0.1785 3.677 1 0.1772 0.0672 0.1597 0.0643 0.0591 0.1014 0.6566 0.0000 0.7232 0.41% 12.89% -2.69% 45.0288 0.0788 0.0871 0.1418 0.6032 0.0430 0.8838 0.0000 0.2449 0.7688 0.8328 1.2560 0.5917 0.3449 0.6038 0.0768 0.5639 4.5568 0.1000 4.0258 0.1397 0.0382 0.3666 3.0929 0.0089 0.3707 0.0282 0.2774 0.1948 0.1405 0.0746 0.0662 0.82% 185.0379 0.53% 250.3027 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 0.2765 0.

2737 0.7244 0.8979 0.0127 Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Pharmaceuticals and Biotech Real Estate 0.7506 0.0066 -0.1700 0.2247 0.0107 4.61% 13.4851 4.788 0.0021 0.7163 4.15% 37.4249 4.0000 0.0950 0.4988 0.1084 -0.0019 0.2002 0.0617 1.96% 4.0165 0.5106 0.5107 0.1645 0.4532 0.5255 0.0161 0.1874 0.0685 0.5720 0.0745 0.0305 0.2064 0.0034 0.1829 0.1597 -0.0077 0.6229 0.0829 0.2640 0.3224 0.3436 0.5797 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 0.3113 0.5764 0.9302 4.1904 0.59% 6.0481 0.0000 1.0448 0.8307 0.0297 0.4220 2.0130 0.0202 0.0759 0.3175 0.3200 0.0736 0.49% 24.0804 0.83% 1.6769 0.1143 0.0494 0.4226 0.98% 34.0775 0.1909 0.0842 0.0212 0.0361 0.2785 0.0185 0.5893 -0.0142 0.28% -3.1045 0.61% -2.9186 2.2015 7.01% 11.1527 0.1590 0.4344 0.0054 0.1038 0.7685 1.1879 0.0294 0.3428 3.47% 4.0000 0.35% 22.3465 3.0732 0.0874 0.42% 13.1031 0.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 0.3880 0.0440 1.7665 4.0735 1.0000 0.6605 0.70% 14.3717 0.3924 0.2089 0.6534 0.7911 3.4843 5.2169 0.0101 0.0203 0.0093 0.4124 4.277 2.0560 0.0710 0.5115 2.0430 0.1153 -0.0290 0.0583 0.0310 0.0616 2.58% 5.1168 0.16% 2.44% -4.16% 16.05% 17.2599 0.2350 -0.3227 0.06% 6.7877 0.4232 0.5688 0.15% 43.5404 0.62% 39.5527 0.5104 0.68% -1.1118 0.1176 0.0259 0.3909 3.8275 0.2484 0.2695 0.0000 0.2300 0.44% 11.0401 -0.1987 0.3524 0.0170 0.2161 0.2273 1.0769 0.0164 -0.0942 3.4227 0.0638 0.74% 4.0001 0.0131 0.1874 0.0227 0.0467 0.1824 0.01% 21.4066 0.03% 4.8638 3.3341 0.1952 0.1845 1.0000 0.4723 0.0552 0.1045 0.4705 1.1754 0.3687 0.0482 2.3122 0.0000 0.0000 0.1975 0.4074 0.0962 0.8948 3.7256 0.18% 16.4040 0.5061 0.5172 0.6628 0.62% 1.2404 0.9040 0.7485 -1.4741 0.53% 2.9138 2.0430 0.2973 2.7439 2.0440 3.9073 0.19% 5.4379 3.70% 15.3754 0.1808 0.2630 0.9129 0.0626 0.4172 0.8771 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 .0814 0.8788 0.0119 0.5012 4.7427 1.8858 2.0538 0.3032 0.1350 0.0594 0.4847 0.0000 0.0853 0.0019 0.3544 0.4202 3.3184 0.2382 0.3757 0.8131 0.1062 0.1330 0.0944 0.1803 0.4114 0.3105 0.0727 0.1390 0.0606 0.5365 0.9345 0.28% 33.0886 0.

572 .234 -.147 .041 3.983 .862 .048 .978 .874 1.047 1.980 .33E-005 .704 .849 1.174 .430 .001 Std.491 .898 .0019 0.015 -.208 .4847 0.704 .080 -.004 -.524 -.956 .001 .692 -1. Error .028 -.683 .381 .050 . Collinearity Statistics Tolerance VIF 84 .000 Std.004 .002 .048 .439 -.970 .197 Standardized Coefficients Beta 2.120 1.219 .985 .047 1.000 Standardized Coefficients Beta .031 1.0000 Retailers Retailers 0. Collinearity Statistics Tolerance VIF Regression on Short-term Debt 2001-2004 Model 1 (Constant) Tax Shield Profitability Growth Rate Unstandardized Coefficients B .001 .1726 4.978 .040 .902 .001 . Error .330 .023 1.310 Std. Error .850 .1121 0.952 -1.009 .144 t Sig.005 .101 . 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 1.874 .094 -.034 .019 .925 .019 .017 -.178 t Sig.860 .014 .002 .956 .017 1.008 .0000 0.742 .793 -.479 .0232 0.Beale Greggs 0.2358 Appendix Two: Tables of Coefficients Regression on Long-term Debt 2001-2004 Model Unstandardized Coefficients B .020 -.025 .251 .881 .178 -.0865 0.023 1.171 .127 .159 1.394 -.44% 3.010 .915 .108 1.497 .967 .001 .950 1.144 1.863 .7085 8.061 Standardized Coefficients Beta .0533 0.33% 10.556 .030 -.2021 0.177 1.0887 0.893 .137 .178 .712 -.177 -1.092 1.584 .042 .028 -2.129 -.039 .163 -.936 .110 1.956 .077 -.000 -.3490 -1.053 t Sig.

Error of the Estimate Model 1 R R Square .92E-005 . Tangible Assets. Growth Rate 2005-2006 Model Summary Adjusted R Square Std.402 .081 -. Dividend.512 .389 85 .063 -.863 . Tangible Assets.408(a) R Square .392 . Growth Rate Model 1 R R Square Inclusion of dummy variables Model Summary Adjusted R Square .108 1.250 .912 1.017 .849 1. Error of the Estimate . Profitability.68E-005 Std.271 Std.047 .307 .120 1.125 -.205 .343 .312 -1.4706778 a Predictors: (Constant).022 .017 t Sig. Error .032 -.008 .970 . Tax Shield.159 1. Dividend.219 .076 . Collinearity Statistics Tolerance VIF Appendix Three: R2 Summary • Regression on Long-term Debt 2001-2004 Model Summary Adjusted R Square Std.659 -.013 .331(a) . Profitability.987 -.950 .064 . Size.178 2005-2006 Model 1 (Constant) Profitability Tangible Assets Growth Rate Size Tax Shield Dividend Unstandardized Coefficients B .915 .861 2.000 Standardized Coefficients Beta 1.799 .095 .003 .092 1.000 .983 1.312 -.817 .850 .031 1.002 -.177 1.053 1.5671772 a Predictors: (Constant).295 -. Tax Shield.180 .Tangible Assets Dividend Size -.893 .401(a) .228 .4350471 Model 1 R .201 .029 .005 5.026 -1.006 -.078 .689 .040 4.302 .055 .902 .114 -.727 .295 -.110 1.232 . Size.127 . Error of the Estimate .

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

552 79 -.01 level (2-tailed). (2-tailed) N Tangible Assets Pearson Correlation Sig.143 79 80 -.962 79 -.035 .204 .278(*) .143 79 -.448 80 -.005 .204 . (2-tailed) N Profitability Pearson Correlation Sig.320 80 .320 80 -.305 80 .825 79 -.758 80 -.006 80 80 80 1 Tangible Assets .053 .097 . (2-tailed) N Dividend Pearson Correlation Sig.589 80 -.448 80 79 -.072 79 -.065 .018 .972 80 1 Dividend -.875 80 -. (2-tailed) N Size Pearson Correlation Sig.025 .581 80 -.086 .113 .166 . (2-tailed) N Growth Rate Pearson Correlation Sig.061 .278(*) .552 79 1 Industry Industry Pearson Correlation Sig.381 80 .085 80 .304(**) .116 .035 .589 80 .086 .053 .134 .063 .061 .006 80 1 80 80 * Correlation is significant at the 0.013 80 -.875 80 80 -.962 79 .134 .235 80 .758 80 -.825 79 .305 80 .065 .972 80 .005 .085 80 1 Growth Rate .018 .004 .099 .567 80 -. (2-tailed) N Tax Shield Pearson Correlation Sig.113 .004 .381 80 -.05 level (2-tailed).193 .099 .072 79 1 Size .304(**) .638 80 -.025 .235 80 -.567 80 .397 79 .013 80 .Appendix Four: Correlations between Independent Variables Correlations Tax Shield -. ** Correlation is significant at the 0. (2-tailed) N 1 Profitability .193 .397 79 -.581 80 .063 .166 .068 .116 . 87 .638 80 -.097 .068 .

Deviation Std.0552174 .167259 2.480821 .085903 .0151859 .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 .0080319 .0142 .853433 .Appendix Five: Descriptive Figures from ANOVA Test 2001-2004 N Mean Std.0313867 .220550 .055849 .621092 .107390 .2400 .0264657 .0000 .0836918 1.240000 .0019 .0019 .0000000 .0328932 .240000 .0000 .0788 .019362 .1968117 .0134286 .025278 .3822477 .0000 .0047 .361333 .049763 .0199900 .0992534 .4741 .346367 .915759 .0587010 .62262 6 .011247 .1590 .2689 .240000 .114019 .255011 .1351450 .067422 .175215 .0506710 .2900 .1511528 .0300 .088531 .0000 .0085773 .0710983 .2633523 .0736 .0799386 .2464 4.2400 .005499 .301525 .0837 .018042 .2599 .019511 .0056652 . Error 95% Confidence Interval for Mean Lower Upper Bound Bound .195084 -.0538 .364919 .149548 .497650 .0200 .0513118 .6229 1.0745 .038531 .0252788 .204450 .0816634 .6882458 .1451316 .0489653 .062633 .118667 -.071921 .6858511 .0207539 .0000 .051383 .0052 .069275 .037680 .0503658 .240000 .2689 .025000 .098300 .0050000 .0000 .045057 .056951 .139601 .0001 .0253990 .0253 .0000000 .0257319 .0068396 .016864 .0216289 .252855 .3960 .1176 .1038 .088740 .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 .0288724 .145104 -.0000 .117513 .1939 .045675 .064464 .1829 .051950 .047521 -.137547 .0070711 .118030 .0455743 .030627 .0656039 .1075131 .6769 4.068438 .0123 .151309 .0000 .0000 .036478 .0440 .060845 .4938795 .037879 .0224833 .1772 .001003 .291552 .3775 .

094036 2.085650 .1594941 .0002 .0900622 . Deviation Std.108822 .003864 -1.113989 .793912 .120403 .0334830 .0424264 .1784974 .4208 12.0500 .122963 .082850 2.0158 .0872437 4.316917 .0000 .0149 .0300000 .0000 .1500 .083331 -.484945 .045367 .5396 .0630265 1.232795 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 .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 .207344 .1787124 .1525 4.0275889 1.1629 4.0179414 .9886292 .2700 .0200000 .0000 .795017 .0629325 .308163 .772417 .1860 .030000 .143568 -1.023951 .5965297 .028141 .7094239 .224124 -.1633571 1.119298 .0538243 .149150 .225304 .2158549 2.059233 .055856 .3580 .0246850 .118155 .0719516 .2005-2006 N Mean Std.438621 . Error 95% Confidence Interval for Mean Lower Upper Bound Bound -.5050481 .2029418 .129201 .1827 .2215263 .186130 -.67403 4 .066534 .0282843 .230826 .145260 7.207440 .0480893 .6600 .0000 .0395585 .7230 7.0018 .294155 .0666903 .0683 .41097 3 .145838 .131600 .9579260 .201186 .011005 .8711268 .283633 .088645 .062238 -.000391 -.0100 .4710 .1227 .1860 .0199010 .1058824 .2333 .0199307 .044811 .0000 .0000 .7052 .0631844 .1676 .335538 .309489 1.475410 3.0641758 .033463 .1444 .42885 1 .7397616 .0383327 .284124 .0000 .2100 .0783214 .112200 .059526 .0000 .0271548 .003438 .0000 .020440 -2.086184 .120725 .2719 12.018088 .8477 .1212187 .0042 .008010 .0139860 .6628 .0564661 .0000 .180000 .0000 .0604657 .048950 .8120385 .0006 .0000 .561186 .068970 .