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Key Determinants of Capital Structure in Iran

1.1 Background
Capital structure choice is one of the important financial decisions that can affect firm's value.
Capital structure has been studied by many scholars during past five decades, which in turn
generated some theories and various finding in this area of corporate finance. Definitely,
Modigliani and Miler (1958, 1961) theorem of capital structure had a significant contribution on
developing capital structure literatures .They proposed two approaches of capital structure
under certain assumptions, based on Modigliani and Miler (1958), there is no differences
between debt and equity financing under perfect market assumptions, and so capital structure
decision is irrelevance. While Modigliani and Miler (1961) considered corporate tax and
proposed debt financing will increase value of the firm.

Since then by the end of 1990, many researchers studied potential determinant of capital
structure (in addition to taxes) and introduced new theories of capital such as trade of theory
and pecking order theory based on different models including, agency cost model (Jensen and
Meckling (1976), Chang (1987), Stulz(1990), Harris and Raviv (1990)), asymmetric information
model (Ross (1977), Myers and Majluf (1984), Brennan and Kraus (1986) ), product / input
markets interaction model (Titman (1984), Brander and Lewis (1986), Saring (1988)), and
corporate control model (Harris and Raviv (1988), Stulz (1988), Stulz (1988)). They concluded
that in addition to debt tax shield other factors including earning volatility, bankruptcy
probability, fixed assets, non-debt tax shield, research and development expenditures,
profitability, growth opportunity, free cash flow and uniqueness may effect firms capital
structure . The capital structure literatures have been evolved by endeavourer of researchers for
empirically testing new theories of capital structure.

Majority of main capital structure findings are based on data from developed countries such as
United kingdom, Germany, France, Italy, Canada, United States and Japan ( Titman and Wessel
(1988), Rjan and zingales (1995), Myers (1999), Bevan and Danbolt (2000), Antoniou, Guney, and
Paudyal (2002).

There are few outstanding studies that use data from developing countries, for instance Booth,
Maksimovic, and Demirguc-Kunt (2001) studied capital structure by employing data from Brazil,
Jordan, India, South Korea, Pakistan, Malaysia, Mexico, Turkey, Zimbabwe and Thailand,
Deesomsak, Paudyal and Pescetto (2004) utilized data from Asia Pacific Region, Tong and Green
(2005) analyzed data from China, Chakraborty (2010) used data from India.
1.2 Financial resources for Iranian companies
There are mainly two financial resources namely internal and external resources, for any
company, everywhere in the world .The internal sources of fund is almost the same for all
companies apart from geographical locations, while the availability of external fund depends on
level of capital market development and structure of banking system in each countries. As far as
Iranian companies are concerned, the available financial resources for them is consist of stock
market, bond market and bank loan.

1.2.1 Iran stock market

Tehran stock exchange (TSE) incorporated in 1967 with 6 listed companies and experienced
three different period of time as following.

1967-1978: the number of listed companies increased from 6 to 105 companies and TSE
experienced a good period of time and attracted both companies and investors.

1978-1988: In this period of time, TSE severely affected by two major events, the Islamic
revolution and Iraq's war, and the value and number of exiting companies reduced dramatically.

1988 -2009: This period is full of up and down for TSE, for example during 2001 to 2004 return
on investment in TSE increased and reached to 134 % in 2003, while it experienced very tough
situation in 2007. The numbers of listed companies increase from 88 in 1988 to 417 in 2006 and
then reduced to 337 in 2009.TSE consists of main and secondary market with own listing
requirements and regulations.

1.2.2 Iran bond market

Bond market in Iran is at an early stage of development, and in fact there is no considerable
corporate bond market. The listed companies on TSE were allowed to issue corporate bond in
2003, these bonds, which called participation paper, are short tem bond between 1 to 3 years
.fixed income instrument and shariah complaint.

1.3 Problem Statement

Capital structure mainly studied in developed countries and still there is a lack of study for
developing countries especially Iran. Capital structure of Iranian companies influenced at least
by three main different factors from firm capital structure in developed countries .Firstly Iranian
companies rising fund based on Islamic Financial Systems which has own regulation in banking
and financial market .Secondly financial market especially bond market are less developed in
Iran compare to developed countries which limit debt financing mostly to bank loan. Thirdly
most economic activity directly or indirectly controlled by government which may affect firm
capital structure in Iran.
In the case of Iran by the time of writing this thesis, seven papers (published on international
journal) about determinant of capital structure have been found, which have own limitations and
problems, such as employing limited number of variables, using little number of firms, choosing
short horizon of time study, and even some statistical problems in running regression models.
Hence, there is still a room for studying capital structure of Iranian companies by testing more
independent variables in longer period of time with accurate and sophisticated model.

1.4 Research questions and objectives

This study aims to, firstly clarify determinant of capital structure for Iranian companies and
secondly study importance of each factors on capital structure choice, and thirdly determine
which capital structure theory, trade off or pecking order, better explain capital structure choice
of Iranian companies.

1.4.1 Research questions

In order to achieve these goals the following question marked in this study.

 Which factors determine capital structure of Iranian companies?

 What is the importance of each factor on Iranian firm capital structure?

 Do firms' capital structure choices in Iran follow trade off or pecking order theory?

1.4.2 Research objectives

In order to answer the study's questions the following objectives determined:

 To find relationship between liquidity and debt ratio

 To find relationship between profitability and debt ratio

 To find relationship between tangibility and debt ratio

 To find relationship between growth opportunity and debt ratio

 To find relationship between business risk and debt ratio

1.5 Research hypothesis

There is two set of hypothesis based on capital structure theories. First group is based on trade
off theory and second one is based on pecking order theory.

1- Trade off theory and determinant of capital structure

Trade off theory considered optimal capital structure based on balance between advantage and
disadvantage of debt financing, so firms has own optimal capital structure that maximize its
value. Based on this theory profitable, highly liquid and firm with more tangible assets should
have higher level of debt, while companies with more growth and higher earnings volatility have
lower amount of debt.

H1: There is a positive correlation between liquidity and debt ratio

H2: There is a positive correlation between profitability and debt ratio

H3: There is a positive correlation between tangibility and debt ratio

H4: There is a negative correlation between growth and debt ratio

H5: There is a negative correlation between business risk and debt ratio

2-pecking order theory and determinant of capital structure

Pecking order theory doesn't hold optimal capital structure and proposed firms should finance
with internal over external fund and debt over equity whenever external financing is
unavoidable. According to this theory firm with more tangible assets and growth opportunity
should have higher amount of debt while profitable and highly liquid firm have lower amount of
debt, also firm with higher bossiness risk should have lower amount of debt.

H6: There is a negative correlation between liquidity and debt ratio

H7: There is a negative correlation between profitability and debt ratio

H8: There is a positive correlation between tangibility and debt ratio

H9: There is a positive correlation between growth opportunity and debt

H10: There is a negative correlation between business risk and debt ratio

Table 1.Summary of predicted sign between independent variables and debt ratio

Trade off Theory

Pecking order theory












Business Risk



1.6 Research instrument

The study mainly use secondary information, in forms of annual financial information of Iranian
companies listed on Tehran stock Exchange consist of balance sheet and income statement
available online at www.codal.Ir official web site of Tehran stock exchange for company's
announcements and financial information.

1.7 Research approach and methodology

The research approach is based on quantitative approach, since the study deal with numbers in
form of financial ratio. Research methodology is based on OLS regression model with five
independent variables and one dummy as following:

Yit=α +β1LIQit + β2PROit + β3 TANit + β4GROit + β5BUSRit+ β6DUM+e

Y =Total debt over total asset

LIQ=Current asset divided by current liability

PRO=Earnings before interest and tax divided by total asses

TAN= Fixed asset divided by total assets

GRO=Percentage change in total earnings

BUSR= Absolute difference between the annual percentage change in earnings before interest
and taxes and the average of this change over the sample period

1.8 Justification of study

The importance of capital structure and firm's value widely accepted by both scholars and
financial managers, since capital structure affect cost of capital or expected earnings, however
there is still debate about how companies rising fund. In recent years, the number of listed
companies on Tehran stock exchange increase and the issue of capital structure choice became
important for both firm's owner and investors. As there is lack of study about capital structure of
Iranian companies, this study tries to clarify firm's capital structure in Iran and expand frontier of
knowledge in this area, furthermore it provides some insight for financial and executive

1.9 Structure of the Research

The following chapter organized in this thesis as following; Chapter 2 introduce summary of
literatures on capital structure theory and determinant of capital structure based on trade off
and pecking order theory, furthermore it presents selected article in both developed and
developing countries and discussed main articles in Iran. Chapter 3 presents research
methodology, data sampling, regression equation and assumptions. In chapter 4 regression
assumptions and final result are demonstrated. And finally in chapter 5 main findings and
conclusions are discussed.

Chapter 2: Literature Review

2.1 Introduction
Capital structure is one the arguable area of financial research and the mystery of debt and
equity equation in firms' capital structure is not completely clarified. However, the tax shield
benefit of debt financing obviously accepted and understood by both financial managers and
researchers. There are mainly three approaches of capital structure. At on extreme, net income
(NI) approach (Durand, 1952) states that firm can lessen its cost of capital and thus increase its
value by debt financing. In contrast, net operating income (NOI) approach, also proposed by
Modigliani and Miller (1958) claims that firm's value and capital structure are independent and
debt and equity financing create the same value.

Solomon (1963) introduced intermediate approached of capital structure, also known as

traditional approaches, which explains that the firm's value increase when financial leverage rises
and it becomes constant on designated level of debt and finally the firm's value decrease. In fact
this approach holds the concept of optimal capital structure. In other word, the companies
should have a target capital structure and follow it in order to increase firms' value. Various
theories of capital structure have been developed during past five decades that mainly tried to
illustrate relation between capital structure and firms value, and also find important factors of
effect capital structure selection. At the same time, vast amount of empirical studies have tried
to test and confirm capital structure theories, however, they have shown various results
regarding effectiveness of these theories.

The aim of this chapter is to introduce the primary theoretical themes that have evolved to
explain capital structure vagueness. It is also intended to review the main empirical research that
have been studied to test correlation between firms characteristics and capital structure to
present some of the evidence that have been collected. The structure of this chapter is as
follows. Main capital structure theories are explained in section 2.2, in section 2.3 firms'
characteristics and capital structure are discussed, and results of selected empirical studies are
reviewed in section 2.4.

2.2 Capital structure theories

Modigliani and Miller (1958) introduced modern theory of capital structure known as MM theory
that basically considered as a foundation of modern corporate finance. Modigliani and Miller
theorem consist of two distinct propositions under certain assumptions. The two propositions
declared under assumption of perfect capital market and in the absence of bankruptcy cost,
transaction cost, symmetry information and the world without tax.

MM Proposition I: argue that the firm' value and capital structure are independent, it means that
whatever capital structure selected for the firm the value would be the same. In other word
under this proposition, the value of levered firm (VL) is the same as unlevered one (VUL) and
managers should not worry about the firm capital structure and they can freely choose whatever
composition of debt and equity.


MM Proposition II: claims that cost of equity increase with leverage because risk to equity rise as
well, so weighted average cost of capital remain constant as lower cost of debt compensate with
higher cost of equity. In other world, cost of equity remains constant with any degree of
leverage, and it is a linear function of debt equity ratio.

However, Modigliani and Miller (1963) evolved their propositions under presence of corporate
tax rate (t) while keeping other assumptions. They argue that the value of firms increase with rise
of financial leverage as they do not pay tax on their interest paid (D) to debt holders.
Furthermore, weighted average cost of capital is not constant and result of linear function of
debt to equity ratio. Because, firm do not pay tax on interest paid to debt holders, weighted
average of cost of capital decreases as financial leverage rises.

Friend and Lang (1988) states that there is a negative relation between profitability and Debt
which is inconsistent with MM theory as the more profitable firm should use more debt in order
to increase tax shield benefit of debt. Modigliani and Miller propositions are difficult to test
directly (Myers, 2001).Furthermore, Fosberg and Paterson (2010) points out MM theory have
been rarely tested by researchers in an exact form described by MM; however there has been
some testing of application of theses propositions. Fosberg and Paterson (2010) tested MM
equation in the exact form specified by MM and concluded that:

“…neither the MM tax nor the no-tax valuation equations are accurate predictors of firm value.
Specifically, the value of the unlevered firm accounts for much less of firm value than predicted
and the sign of the coefficient of the interest tax shield variable is negative, instead of positive as
MM predict.”

However, MM theory is not applicable in real world with transaction and bankruptcy cost.

2.2.1 Pecking order theory

The pecking order theory (Myers and Majluf, 1984) is a capital structure model based on
asymmetry of information between insiders and outsiders that first introduced by Donaldson
(1961). The main idea of this theory is that managers have private information about firm's
performance, projects and prospective which are not available for outsider investors, so the
selection of firm's capital structure shed light on outside investors about information of insiders.
Consequently, investors will perceive investment decision without issuing securities as a positive
signal, while they considered issuing share as negative sign that reduce share price which they
willing to pay. The information asymmetry may bring about manager give up positive NPV
projects in order to avoid share price falling, since they assume to act in interested of
shareholders. To eliminate this underinvestment problem, managers try to finance new projects
in a way that is not undervalued by market.

According to this theory (Meyer, 1984), there is no specific target capital structure for the firms.
It states that in pecking order model firms adopt hierarchical order of financing, which means
that managers prefer internal financing over external financing and debt over equity whenever
external funding is unavoidable; also mangers prioritize short debt over long term debt. Internal
funds compel no floatation cost and need no disclosure of financial information and firm
prospects including firm's potential gain and investment opportunities. The pecking order
theory envisages that amount of debt goes up when investment exceeds internal funds and
decrease when amount of investment is fewer than internal financing resources. So as long as
firm‘s cash inflow exceed firm's capital expenditure, there is no need for external financing.

Since introducing pecking order theory in 1984, some empirical studies have been conducted to
test this theory, Shyam-Sunder and Myers (1999) studied small sample of firms from 1971 to
1989 and find supporting result for pecking order model. Frank and Goyal (2003) used a large
sample of the firm and find less supportive result for pecking order theory .However, they point
out that larger firms show better pecking order model performance than smaller firms which is
in line with to pecking order theory. Since smaller firms have higher potential for information
asymmetry than larger firms, which is main deriver of pecking order theory. De Jong et al (2010)
studied US firm over 1971-2005 and find that small firms do not behave according to pecking
order theory that support notion of asymmetry information in pecking order model.

Vidal and UGED (2005) describe limitation for Myers and Majluf (1984) model of pecking order
theory. Firstly, they claim that Myers and Majluf model refers to American market which firms
offered their share mostly through firm commitment underwriting and not right issue .Hence,
when the share price is undervalued, the wealth shift form current share holder to new share
holders, while in right offering current share holder can benefit from priority of buying share
which reduce probability of wealth transfer. Secondly, they argue that this theory mainly
describes listed companies and relinquishes non listed companies. Basically small –medium
enterprise (SME) have limited access to capital market (Holmes and Kent, 1991) and financing
choice for them is restricted to retain earning and loan.

Fama and French (2005) challenged pecking order theory as they find companies issue equity
frequently and issue equity even when the internal funding is available or they can issue debt.

2.2.2 Trade off theory

This theory holds (DeAngelo and Masulis, 1980) an optimal capital structure based on balance
between advantage and disadvantage of debt financing. In other word the optimal capital
structure is a debt equity ratio that benefits of debt compensate with financial distress arising
from marginal debt.

Advantage of debt financing: Debt financing reduce amount of tax revenue as a portion of
interest paid to creditors (Modigliani and Miller, 1963), moreover it lessen agency cost between
shareholders and mangers. This kind of agency problem refers to interest conflict between
owners of firms and managers (Jensen and Meckling, 1976). This theory state that corporate
manager, agents, will follow their own interest, they looking for high salary, job security,
prerequisites, better facility and may even assets and cash flows of the companies. Furthermore,
managers tend to increase investment and develop the size of the company even if there is no
benefit for the shareholders. This behavior of manager is known as empire building. However
investors can control agent by methods of monitoring and controlling, but these methods are
more costly and subject to decreasing return. Based on Free cash flow theory(Jensen, 1986) debt
can reduce this kind of agency cost, in a way that company must pay interest to creditors which
reduce available cash flow to the managers. So, instead of inefficient use of money by managers
part of cash flow is given to creditors.

Disadvantage of debt financing :The disadvantage of financial leverage comprise of bankruptcy

cost and agency cost occurring between shareholders and debt holders (Jensen and Meckling,
1976) .This sort of agency cost arising from interest conflicts between share holders, or their
agents, and debt holders. If investors perceive this kind of risk, they demand higher return for
their investment which consequently increase cost of debt financing.
There are three types of conflicts happen between bond holders and share holders. The first
conflict is asset substitution problem (Jensen and Meckling, 1976) .in which manger has
incentive to take riskier projects when amount of debt increase. it is simply because if project
succeed, share holders obtain benefits and, if project fail debt holder get disadvantage since
shareholders have limited liability. The second conflict is wealth transfer from debt holder to
shareholders (Smith and Warner, 1979) in a way that board of directors, as representative of
shareholders, increase amount of dividend as expense of debt holders. Third conflict between
shareholders and debt holder is underinvestment problem (Myers, 1977) that mainly occur
under financial distress .Since under this situation gains from new projects is taken by bond
holders, shareholders have less incentive to undertake these projects even with positive present

According to trade off theory profitable firms should use interest tax shield as they have more
taxable income (Myers, 2001). In other word, trade off theory doesn't support negative relation
between profitability and debt. Moreover this theory is consistent with some clear fact, for
instance, the companies with moderately safe, tangible assets tend to use more debt than
companies with variable and intangible assets.

Figure 1

2.3 Determinant of capital structure

There are different factors that can affect firm's capital structure. These factors can be classified
in two groups as external and internal factors (Antoniou et al, 2002). The external factors arising
from firm's environment and basically could not be controlled by firm's mangers such as
country's economical, institutional factors. Rajan and Zingales (1995) find that institutional
factors including tax code, bankruptcy law, and development of capital market affect firm capital
structures. Holmstrom and Tirole's (1997) argue that small firms have tougher constrain than
larger firms for external financing, and so, macroeconomic and institutional factors have higher
impact on their leverage .

Demirg and Maksimovic (1995) investigate relationship between domestic capital market
development and firm leverage and find significant negative relation between domestic market
development and leverage. Schmukler and Vesperoni (2001) studied relation between counry's
financial liberalizations and leverage .They find that financial librization do not change leverage
ratio, but it change debt structure and rises portion of short term debt. Deesomsak et all (2004)
studied determinant of capital structure among Asian pacific countries and find that capital
structure is affected by firm environment. They show that 1997 Asian economic crisis have had a
significant effect on firm's capital structure . .Voulgaris et all (2004) studied determinant of
capital structure of Greek companies and find that strict monetary and fiscal regulation have
more impact on small firms than large firms. De Jong et al (2008) studied determinant of firm
capital structure across the world and demonstrate that specific determinant of capital structure
vary across the counties and also shows country's specific factors have indirect effect on firm
specific determinant of capital structure.
Internal factors are those attribute that can be controlled, may not completely, by firm's
managers such as firm's characteristics. This study focus on important factor of capital structure
in both developed (Rajan and Zingales, 1995) and developing (Booth et al, . 2001) countries
including asset structure, profitability, growth opportunity, liquidity, and business risk.

2.3.1 Growth
According to pecking order theory growth and leverage have positive relationship. The main
idea behind this relationship is that growth firms need more fund than lower growth firms, and
hence, they probably require external financial recourses, and preferably debt financing, for new
projects ( De Jong, 1999). Jung et al. (1996) argue that firm with growth opportunity should use
equity financing in order to reduce agency cost between managers and shareholders. Whereas
companies with less growth opportunity should use debt financing (Stulz, 1990).

Organizational life stage theory is another explanation for growth opportunity and debt
financing. In fact organizational life stage theory design for strategic management field, but
there is a rational link between this theory and capital structure . The simple premise of
organizational life stage theory is that firms, the same as living creature, have different life
phases and pass through startup, growth, maturity and decline stage (Black, 1998). It states that
business risk reduce over firm life stage as firm become more stable and it allow financial risk
rises (Bender and ward, 1993). In other word there is a negative relation between business risk
and financial risk which is mainly concluded from trade off theory of capital structure. Hence,
based on organizational life stage theory, firms should finance with equity in earlier stage and
use more debt as they develop. Chang et all (2009) studied determinant of capital structure and
find that growth is the most important determinant of firm's capital structure.

Relationship between growth opportunity and debt has been studied by many researchers. Long
and Malitz(1985), Titman and( Wessels 1988) Chung (1993), Rajan and Zingales (1995), Barclay
and smith (1999) find that there is a negative relation between firm growth opportunity and
leverage. While Hall et al. (2000) demonstrate that growth opportunity is positively related to
short debt ratio and negatively related to long term debt ratio.

2.3.2 Asset structure

Asset structure is another determinant of capital structure. There are mainly two groups of asset,
tangible and intangible, and each group of assets has own effects on firm capital structures. As
tangible asset can be used as collateral, companies with more tangible assets can use debt as
financial resources with lower cost . Furthermore, tangible assets reduce moral hazard risks,
because tangible assets convey a positive signal to creditors in case of firms default and selling
of firms assets. According to trade off theory, when tangible assets use as collateral, reduce
bankruptcy cost which turn increase credibility and accessibility to debt market . Also based on
pecking order theory tangibility reduce asymmetry information between insider and outsider.
Pecking order theory predicts positive relation between tangibility and debt financing. However,
Berger and Udel (1994) ague that firms who have close relationship with creditors need less
collateral, because they convey more information to creditors and reduce asymmetry
information risk.

While majority of studies show positive relation between tangibility and leverage ( Rajan and
Zingales, 1995; Frank and Goyal, 2003;Niu.2008;Liu et al 2009), some studies demonstrate
negative relation between tangibility and leverage (Booth et al, 2001; Huang and Song, 2002). It
is state that relationship between tangibility and leverage affected by type of debt. Hall et all
(2004) studied determinant of capital structure among European companies and find that
tangibility negatively related to short term debt while positively correlated to long term debt.
Also, Sogorb-Mira (2005) find supportive result for negative relation between tangibility and
short term debt, and argue that negative relation between tangibility and short term debt may
explain with maturity matching principle, where firms try to finance fixed assets with long term
debt and working capital needs with short term debt.

2.3.3 Profitability
Profitability can effects debt financing in two directions .Based on pecking order theory there is
a negative relation between profitability and debt financing. Since, profitable companies
generated enough cash which turn can be used as source of internal financing. Shyam-Sunder
and Myers (1999) argue that avers relation between profitability and leverage is consistent with
pecking order theory. On the other hand trade off theory predicted positive relation between
profitability and leverage. As profitable company generates more available cash for
management opportunities for using cash inefficiency and unnecessarily manners that increase
agency cost between managers and shareholders. So, Debt financing is the best remedy for
overcoming this problem (Jenson, 1986).

Effect of profitability on leverage has been studied by many researchers . Morri and Cristanziani
(2009) studied capital structure of UK Property companies and assert that profitability is the
most important determinant of capital structure for UK property companies, and it aversely
related to leverage.Many studies (Titman and Wessels 1988; Rajan and Zingals, 1995;Fama and
French 2002;Hovakimian et al 2004) find negative relation between profitability and debt level .
Whereas some researchers argue there is positive relation between profitability and leverage.
MacKay and Phillips (2001) state that leverage positively correlated with profitability. Gaud et all
(2007) studied debt equity choice among European firms and find that ROA, as proxy of
profitability, positively correlated with “debt issue versus Equity issue”. They argue that for
European profitable firms, debt financing use as a disciplinary device for controlling mangers

2.3.4 Liquidity
Liquidity is another determinant of capital structure which has been described in many capital
structure literatures. Based on pecking order theory firm ‘s liquidity has negative impact on
leverage. The rationale behind this relationship is that liquidity reduce need for debt financing as
more liquid firms have more cash to use and vice versa. Also trade of theory predict negative
relation between liquidity and leverage, since shareholder of firm with more liquid assets can
easier use them at the expense of bondholders which create interest conflict for both parties.
Myers and Rajan (1998) state when out side creditors face agency cost arising from high
liquidity, they limit amount of debt available to the firm.

2.3.5Business risk
Business risk can be considered as an influential factor on the firm capital structure choice.
Business risk will increase financial distress cost and so rise cost of external financing. According
to both trade off and pecking order theory, there is a negative relationship between business
risk and debt ratio.

2.4 Review of selected article

2.4.1 Review of main articles in developed countries
The capital structure theories mentioned in the perviuos sections relate to effects of firm
characteristics on capital structure. The empirical studies regarding determinant of capital
structure started in 1980s and one the major studies was performed by Titman and Wessels in
1988 that studied determinant of capital structure among US companies from 1974 to 1982.
They introduced an analytical model regarding important factors of capital structure selection
and studied impact of firm's size, uniqueness, asset structure, growth, profitability, volatility and
non debt tax shield on the firm's capital structure and find that firm past profitability and
uniqueness negatively related to debt equity ratio, while firm size positively related to long term
debt and aversely correlated with short term debt. They also indicate that firm's asset structure,
future growth, volatility and non debt tax shield have no impact on capital structure choice.
Another study which widely cited in capital structure literatures comes from Rajan and zingals
(1995) research. They studied determinant of capital structure among G7 countries ( United
states, Japan, Germany, United Kingdom, Canada, Italy and France) and analyze institutional
differences and impact of firm's size, growth opportunity, profitability and asset structure on
capital structure choice across theses countries . Rajan and zingals (1995) find that firm's size
and tangibility positively correlated with leverage, while firm's profitability and growth
opportunity negatively related to leverage across G7 countries, except Germany where firm's
size negatively and profitability positively related to leverage. Their findings are consistent with
capital structure theories, however in the case of Firm's size and leverage in Germany, they do
not find any rational explanation for their result.

Bevan and Danbolt (2002) studied determinant of capital structure among UK firms from 1987
to1990.They extended Rajan and zingals analysis of UK Firms by investigating impact of firm's
size, growth opportunity, profitability and tangibility on level of gearing and find the same result
as previous Rajan and zingals did. Their study find that short term debt negatively correlated
with tangibility, while long term debt show positive correlation. Furthermore, they find firm size
aversely correlated with short term bank borrowing, and positively relate to long term debt and
short term paper debt.
Hovakimian and Tehranian (2004) studied determinant of capital structure by investigating dual
equity and debt issuers from 1992 to 2000. They tested theoretical theories of capital structure
including trade off theory, pecking order theory and market timing theory by examining impact
of market and operating performance factors on firm optimal capital structure. Their result imply
that firm with high growth opportunity have a low target debt ratio which is consistent with
pecking order theory. On the other hand, in line with market timing theory, their result
demonstrate that high stock return amplify possibility of equity issuing, but possibility of debt
issuing is not influenced by stock return. They also find that unprofitable firms tend to issue
equity in order to counterbalance excessive leverage arising from cumulative losses.

Chang and Lee (2009) extended study of Titman and Wessels (1988) by applying “Multiple
Indicators and Multiple Causes (MIMIC)” model and find more rigorous result than Titman and
Wessels. They find that firm growth opportunity is the most important determinant of firm's
debt and equity choice which followed by profitability, tangibility, volatility, non debt tax shield
and uniqueness. However, firm size excluded from their study due to unmet statistical criteria
needed by MIMIC model .Their study demonstrates growth opportunity and profitability have
both negative and positive impact on leverage depending on measurement of growth
opportunity and profitability. Also they find mixed result regarding relationship between
uniqueness and leverage based on applying different proxy for firm uniqueness.

2.4.2 Review of main articles in Iran

Bagherzadeh (2004) studied determinant of capital structure of Iranian listed companies based
on main capital structure theories . financial information of 158 out of 252 companies listed on
Tehran stock exchange from 1999 to 2003 employed in this study.

Four independent variables including profitability, tangibility, growth opportunity and size
against one dependent variable based on book and market value were used in this study.
Findings show that leverage has a positive relationship with profitability, tangibility and size,
while it has a negative relationship with growth opportunity. Results didn't support capital
structure theoris.

Salehi and Biglar (2009) impact of firm performance on capital structure of Iranian listed
companies by applying different theory of capital structure .Financial information of 117
companies listed on Tehran stock Exchange for the period of 2002 to 2007 selected in this study
.Five independent variable selected in this study including return on investment (ROI), return on
equity (ROE), resturn on stock (RET), earning before tax to sale ratio ( EBT/sale), operational
profit to sale (OPR/sale). Three measures of leverage used in this study based on book value,
market value and adjusted market value.The results show negative relation between ROI and all
three measure of leverage and ROE and RET have positive relation with book value, while they
have negative relation with market value and adjusted market value .Both EBT/sale and OPR/sale
have negative relation with all three measure of leverage .The Reasons behind using of debts by
Iranian companies may be constant interest rate in any level of debt and risk. Totally, with
respect to observed link between capital structure and performance, the conclusion is that
company that has high profitability and good performance have less debt.

Shahjahanpour, Ghalambor and Aflatooni (2010) examines capital structure of Iranian listed
companies based pecking order and trade off theory of capital structure. Financial information
of 248 out of 449 compnies listed on Tehran Stock Exchange for the period of 2007 to 2008 and
follwing regression model were used in this study.

Y=β0 + β1(Liq) + β2 (Etr) + β3 (Pr) + β4 (Ndts) + e

Four indepndet variables used in this study including liquidity (LIq), Effective tax rate (Etr),
Payout ratio (Pr), Non debt tax shield ( NDTS) and firm Uniqueness which which has been
excluded due to data limitation . Moreover two proxies as Short term debt ratio (STDR) and long
term debt ratio (LTDR) employed in this paper.

Findings show that 79 percent of variation in short term debt ratio and 49 percent of variation in
long term debt ratio were explained by independent variables .Results demonstrate that
liquidity, payout ratio and effective tax rate have significant effect on both short term and long
term debt, while non debt tax shield has non significance effect.

In line with pecking order theory reverse significance relation between liquidity with both short
and long term ratio observed, Also positive significance relation between payout ratio and long
term debt observed . Furthermore positive relation between effective tax rates observed. All in
all, 60% of the results are in line with the pecking order theory, and the 40% are consistent with
the static trade off theory. So, Iranian capital structure decisions are better explained by pecking
order theory over trade off theory.

Essays, UK. (November 2013). Key Determinants of Capital Structure in Iran. Retrieved from