DETERMINANTS OF CAPITAL STRUCTURE, A STUDY OF

MANUFACTURING SECTOR IN PAKISTAN

A Thesis Submitted to,

SUPERIOR UNIVERSITY LAHORE
In Partial Fulfillment of the Requirements for the Degree of
Master in Business Administration

SUBMITTED BY,
Muhammad Umer
MBP 12128
Finance (2011-2014)
 DETERMINANTS OF CAPITAL STRUCTURE

DECLARATION

I hereby declare that this project is entirely my own work and that any additional sources of
information have been duly cited. My all work has been carried out under the supervision of Mr.
Muhammad Shafat, Department of Management Sciences of Superior University Lahore.
I hereby declare that any Internet sources published or unpublished works from which I have
quoted or draw references fully in the text and in the content list. I understand that failure to do
this will result in failure of this project due to plagiarism.
I hereby declare that this work has not been previously submitted to any other university for any
other examination.
I understand I may be called for viva and if so must attend. I acknowledge that this is my
responsibility to check whether I am required to attend and that I will be available during the
viva periods.

Signed……………………………………………..
Date………………………………………………..

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ACKNOWLEDGEMENT

Praise to ALLAH, the creator of the world. The most cordial and the most kind. We thank him
for given us skill and the tolerance throughout our life and especially during completion of this
project.
Above all we are indebted to almighty ALLAH, lord of our life and of everything in the universe
and his HOLY PROPHET MUHAMMAD (Peace Be upon Him) whose blessings enabled us
to perceive and pursuit higher ideas of life.
I am also heartily thankful to my supervisor Professor Muhammad Shafat Superior University
Lahore, whose encouragement, guidance and support from the initial to the final level enabled
me to develop an understanding of research. He showed me different ways to approach a
research problem and the need to be persistent to accomplish any goal.
Lastly, I offer my regards and blessings to all of my family members specially my father who
supported me in every aspect during the completion of the project. I would also like to thanks to
my class fellows Yasir Riaz, Danish Faiz, and Muhammad Ali who help me a lot for the
completion of this project.

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DEDICATION
I am dedicating my work to my parents and respected teachers who has played a vital role in my
studies and has guided me at every step with their precious ideas. No doubt this dedication is
insufficient and i can never repay for the role which they have played in our studies but i am sure
that their work will prove itself an asset in my life. I also dedicated my work to my dear friends
they always help me in doing every activity at every stage during the session of this research
thesis.

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Contents
Declaration..................................................................................................................................2

ACKNOWLEDGEMENT ...........................................................................................................3

Dedication...................................................................................................................................4

ABSTRACT ...............................................................................................................................8

Key Words: .............................................................................................................................8

Chapter 1 ....................................................................................................................................9

Introduction ................................................................................................................................9

1.1 History and Background: ...................................................................................................9

1.2 Purpose Statement: .......................................................................................................... 10

1.3 Objective of the Study ..................................................................................................... 10

1.4 Significance of study ....................................................................................................... 11

1.5 Theoretical Model ........................................................................................................... 12

1.6 Hypotheses ...................................................................................................................... 12

Hypothesis 1:..................................................................................................................... 12

Hypothesis 2:..................................................................................................................... 12

Hypothesis 3:..................................................................................................................... 12

Chapter 2 .................................................................................................................................. 13

Literature Review ...................................................................................................................... 13

CHAPTER # 3 .......................................................................................................................... 23

Data and METHODOLOGY ..................................................................................................... 23

3.1 Research Paradigm: ......................................................................................................... 23

3.2 Research Approach:......................................................................................................... 23

3.3 Population and Sampling: ................................................................................................ 23

3.3.1 Population: ............................................................................................................... 23

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3.3.2 Sampling: ................................................................................................................. 24

3.4 Data Collection and Instruments: ..................................................................................... 24

3.4.1 Data Collection ......................................................................................................... 24

3.4.1.1 Primary Data:......................................................................................................... 24

3.4.1.2 Secondary Data: ..................................................................................................... 24

3.5 Data Analysis: ................................................................................................................. 24

3.5.1 Descriptive Analysis: ................................................................................................ 24

3.5.1.1. Frequency table/ Bar Chart: .................................................................................. 24

3.5.1.2. Five Figures Summary/ Histogram: ....................................................................... 25

3.5.1.3. Scatter Plot: .......................................................................................................... 25

3.5.2. Inferential Analysis: .................................................................................................... 25

3.5.2.1. Correlation: ........................................................................................................... 25

3.5.2.2. Regression: ........................................................................................................... 26

3.6 Research Limitations: ...................................................................................................... 26

3.7 Ethical Considerations: .................................................................................................... 26

3.8 Future Research: .............................................................................................................. 26

Chapter 4 .................................................................................................................................. 28

Result and Analysis ................................................................................................................... 28

Table 1: ................................................................................................................................. 28

Table 2: ................................................................................................................................. 29

Table 3: ................................................................................................................................. 29

Table 4: ................................................................................................................................. 30

Regression: ........................................................................................................................... 31

CHAPTER 5 ............................................................................................................................. 33

DISCUSSION AND CONCLUSION ........................................................................................ 33

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5.1 Discussion ....................................................................................................................... 33

5.2 Conclusion ...................................................................................................................... 34

5.3 recommendation .............................................................................................................. 34

References ................................................................................................................................ 35

Appendix .................................................................................................................................. 38

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ABSTRACT
The aim of the study is to investigate and understanding the determinants of capital
structure in manufacturing industry of Pakistan. The model of the research shows that tangible
Assets, Profitability and Firm Size (Independent Variables) are affected on Leverage (Dependent
Variable). For this study I have manufacturing sector as population and my sample are ten
different textile manufacturing industries. I have collected data from the latest four years annual
reports of the ten different textile manufacturing companies in Pakistan. After the data collection
I have entered in E-view (seven) software and calculate the results. The short summary of the
analysis is that the capital structure is affected by all these factors and the tangible assets,
profitability and firm size have positive relationship with the leverage. Secondly if any change in
these three factors than leverage must be affected. The further result and data are discussed in
depth in this report.
KEY WORDS: Tangible Assets, Profitability, Firm Size, Leverage, Capital Structure

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CHAPTER 1
INTRODUCTION
1.1 HISTORY AND BACKGROUND:
Determinants of capital structure have been an important area in corporate finance since Miller
and Modigliani’s work in 1958. Miller and Modigliani (1958) claims that the value of the firm is
independent of its capital structure. However, it provides a starting point that helps understand
the capital structure and its determinants. The trade-off-theory of capital structure refers to mix
of debt and equity by balancing the costs of bankruptcy and benefits of tax saving. Stewart C.
Myers (1984) presented Pecking Order Theory which states that the firms prefer to use their
internal sources of financing to equity financing. If internal financing do not meet the needs of
the firm, they use external financing, first they apply for bank loan, then for public debts and as a
last resort, equity financing is used. Thus, the profitable firms are less likely to opt for debt for
new projects because they have the available funds in the form of retained earnings.
Capital structure refers to the mix of debt and equity used by a firm in financing its assets. The
capital structure decision is the most important decision for the financial management. Capital
structure is a mid-point of many other decisions in the corporate finance. Its include dividend
policies, financing, assets management, profit enhancement and so on. Capital structure is one of
the most important tools of management to manage the cost of capital. Much of the empirical
research on determinates of capital structure has been directed largely towards companies listed
in the developed countries such as UK, USA and Western Europe (B.Prahalathan 2010).
Profitability is an important factor in capital structure. Myers and Majluf (1984) suggest that
firms prefer internal funds rather than external funds. If external finance is required, the first
choice is to issue debt and then eventually equity as a last resort (Brealey and Myers, 1991). This
behavior may be due to the costs of issuing new equity, as a result of asymmetric information or
transaction costs. All things being equal to the more profitable the firms.They will have more
internal financing and therefore we should expect a negative relationship between leverage and
profitability. However, other point of view more profitable firms are exposed to lower risks of
bankruptcy.(Bancel and Mittoo 2002).
A firm can borrow the amount for tangible assets at lower rate of interest by providing the
security of these assets to the creditors. When a firm having higher percentage of fixed assets

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than he expected to borrow on the lower rate of interest as compare to a firm whose have less
fixed assets and cost of borrowing is higher. Due to this reason we expect that there is positive
relationship between tangibility of assets and leverage. (Harris and Raviv, 1991), leading to an
expected negative relation between the importance of intangible assets and leverage.
Firm size is also effect on the leverage of the firm. Larger firms being more diversified have
lesser chances of bankruptcy (Titman and Wessels 1988). According to this we expect that there
is positive relationship between size and leverage of a firm. According to Rajan and Zingales
(1995) argue that there is less unbalanced information about the larger firms. This reduces the
chances of undervaluation of the new equity issue and, thus, encourages the large firms to use
equity financing. This means that there is a negative relationship between size and leverage of a
firm.
Textile sector plays very important role in the national economies and providing support to
economic growth indicators like GDP, exports, employment and foreign exchange earnings.
Pakistan is a major producer of textile. Pakistan’s textile sector provides the best production in
hosiery, garments, clothing and other value added items. The exports of textiles, including
apparel, from Pakistan grew by 6.5 percent year-on-year to US$ 11.437 billion in the first ten
months of fiscal year 2013-14, according to the latest data released by the Pakistan Bureau of
Statistics.Minister for Textile Industry Abbas Khan Afridi has said The new textile policy for
financial years 2014-19 currently being designed by the Ministry of Textile Industry will aim at
increasing Pakistan’s textile exports to US$ 26 billion over the next five years.
1.2 PURPOSE STATEMENT:
The purpose of this study is to analyze the determinants of capital structure in manufacturing
industry of Pakistan in which my independent variables are tangible assets, profitability, and firm
size and dependent variable is leverage. The focus of my study is that how the factors affect on
the capital structure in manufacturing industry.
1.3 OBJECTIVE OF THE STUDY
The objective of this study is to examine the effect of factors that are contributed in the capital
structure in manufacturing industry of Pakistan. To conclude the answer of this question that
what factors and how these factors affect the capital structure. I have conducted this study. In our
study three independent variables and one dependent variable is selected. I examine the effect of
these three independent variables on the capital structure in Pakistan. These independent

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variables are Firm Size, Profitability and Tangible Assets and the dependent variable is
Leverage. Another purpose of this study is to examine the relationship among the variables
between one another and between the dependent and independent variables.
 To examine the relationship between firm size and leverage.
 To analyze the effect of tangible assets on the leverage.
 To examine the effect of profitability on the leverage.
 To also examine the combine effect ofFirm Size, Profitability and Tangible Assets on the
leverage.
 To suggest the appropriate strategy for financial policy makers.
1.4 SIGNIFICANCE OF STUDY
The significance of my study is that study is helpful for the manufacturing industry of our
country. This study is more helpful for researchers, students and other interested peoplewho want
to further study about this topic or on this sector in future. This research also helpful and direct
beneficiary for those people who involves in the textile industry development and work for the
growth of textile manufacturing industry in Pakistan.
 This study is helpful for the manufacturing industries of Pakistan
 This study will helpful for the textile sector that which factor should be effect on capital
structure.
 Management of the manufacturing industries can also get help from this study for the
purpose of assets management.
 This study is helpful for the Management of manufacturing industries for the purpose of
making the strategies and policies about financial and capital.
 With the help of this study manufacturing companies can make better policies and
strategy for the capital investment.
 This study has been a body of knowledge on that particular topic which can be helpful in
future for those who wants to further work on this particular sector.
 Manufacturing companies can increase their profitability with the help of this study.

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1.5 THEORETICAL MODEL

Independent Variable Dependent variable

Tangibility Assets

Profability Leverage

Firm Size

1.6 HYPOTHESES
To evaluate the effect of tangibility of Assets, profitability, and firm size on the capital structure
(leverage) in manufacturing industry of Pakistan these hypotheses are tested.
HYPOTHESIS 1:
H1: There is relationship between tangible assets and leverage.
HO: There is no relationship between tangible assets and leverage.
HYPOTHESIS 2:
H1: There is relationship between profitability and leverage.
HO: There is no relationship between profitability and leverage.
HYPOTHESIS 3:
H1: There is relationship between Firm Size and leverage.
HO: There is no relationship between Firm Size and leverage.

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CHAPTER 2
LITERATURE REVIEW
The objective of literature review is to examine existing research on capital structure and its
determinants with relative emphasis on the manufacturing sectors of the Pakistan. This is so as to
discover and provide an insight on the theoretical models used to clarify capital structure and its
determinants. The literature review seeks to offer clear understanding on the theories of capital
structure and to look at its determinants, how they can be influenced by these theories and how
they are related to gearing. The theoretical foundation for this research will be established
through literature review of relevant research. Priority will be given to the most modern work.
The equity and debt value used by the company in its process will constitute its capital structure.
The capital structure decision is therefore a very important one because of the impact such a
decision has on the firm’s ability to deal with its competitive environment. It is often debated
whether commonly perceived "good industry” is defined by its determinants that can point
towards the right mixture to be used to achieve optimum capital structure. Capital structure ratios
of specific industries have been documented and their results are in broad agreement and show
that highly geared industries have consistently high capital structure.Debt is borrowed money
that a fixed payment in the future is made. Equity on the other hand is the leftover after debt
payments have been made. Combining debt with equity gives the gearing or capital structure
position of the company. Debt can be short term or long term. Equity financing entails
issuingcommon stocks or preferred shares to investors. In return for the money paid,
shareholders receive ownership interest in the corporation. This is referred to share capital.
The modern work on capital structure theory began by Modigliani and Miller (1958). M&M
proof that the value of the firm is independent from its capital structure. It’s provides a starting
point that helps understand the capital structure and its determinants. They stated that increasing
debt level can lead to the increase in bankruptcy risk of a firm as the borrowing cost rises. On
one hand, debt financing provide tax shield to firms but on the other hand chances of bankruptcy
for a firm increase due greater portion of firm's debt. Hence, the credibility and value of firm
reduces making it unattractive for investors to invest in the firm.
According to Scott(1976) the use of the capital in such a manner can have negative implications
on a firm value because it fails to consider the effects of increaseddebt on a firm. Stewart C.

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Myers(1984) presented Pecking Order Theory which states that the firms prefer to use their
internal sources of financing to equity financing. If internal financing do not meet the needs of
the firmthey use external financing, first they apply for bank loan then for public debts and as a
last resort and equity financing is used. Titman and Wessels(1988) analyzed the explanatory
power of some of the recent theories of optimal debt equity ratio. They found that financing with
debt was negatively related to firm’s uniqueness regarding its type of business. Transactions
costs might be an influencing determinant of capital structure decision and the results were
consistent with existing theories.
Hatfield(1994) who suggest that firms prefer an optimum level of debt and they increase or
decrease that level to enhance their value in the market. The firms want that level of debt where
they can beat other industry in battle of market value. There are many variables which can
influence the firm’scapital structure ratio and can have a positive or negative impact on the value
of the firm. Harris and Raviv(1995) identify variables that are considered to influence the firm’s
capital structure ratio such as: size, tangibility, growth and probability.
Booth(2001) the more tangible the firm’s assets, the greater its ability to issue secured debt.A
firm with large amount of fixed asset can borrow at relatively lower rate of interest by providing
the security of these assets to creditors. Having the incentive of getting debt at lower interest rate,
a firm with higher percentage of fixed asset is expected to borrow more as compared to a firm
whose cost of borrowing is higher because of having less fixed assets. Thus a positive
relationship between tangibility of assets and capital structure is expected.A study on testing the
static trade off theory and pecking order theory was done by Cassar and Holmes(2003) and the
results of regression analysis showed that the asset structure, profitability and growth were
important factors which affected the debt equity ratio of the firms. Size and risk showed weaker
influences on the debt financing of the firms.

Booth(2001) analyzed data from ten underdeveloped countries including Pakistan and
empirically proved that some of the characteristic capital structure of modern finance theory
wastransferable across countries. He also found that debt ratios varied substantially across
developing countries, but overall were not out of line with comparable data for industrial
countries. According to them,

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“In general, debt ratios in developing countries seem to be affected in the same way and by the
same types of variables that are significant in developed countries. However, there are systematic
differences in the way these ratios are affected by country factors, such as GDP growth rates,
inflation rates, and development of capital markets.”
MittonT(2007) explained the tendency of firms in the emerging market for debt financing.
Jong(2008) analyzed that the debt equity ratio was related to a number of country specific factors
such as bond market development, protection of creditor’s right and growth rate of gross
domestic product. Although many foreign researchers have studied the attributes affecting the
choice of debt and equity of firms in developed countries, few of them researched on firms in
developing countries.Cespedes(2009) explained the behavior of firms in Latin America covering
seven countries. They experienced that ownership oriented firms preferred equity financing due
to lower tax shields and higher bankruptcy costs.
In the perspective of Pakistan, Rahman(1990) studied the Industry and Size as determinants of
Capital Structure decisions and the results showed that Engineering and Tobacco industries were
heavily geared. Focusing on the factors affecting capital structure decisions of firms of Japan,
Malaysia and Pakistan, Mahmood(2003) found that firms in Japan and Pakistan showed very
high capital structure ratios because of Japanese developed market status and underdeveloped
capital market of Pakistan which forces firms to opt for bank loan rather than raising equity.
Qureshi and Azid(2006) identified that the public sector preferred financing through debts due to
low corporate governance, favorable terms and conditions of commercial banks and lesser
accountability than private sector. Shah and Khan(2007) examined that there was highest capital
structure ratio for textile industry and the average profitability of textile industry was negative
due to understatement of profit by family controlled firms. Hijazi(2006) examined the cement
sector of Pakistan and the results, except for firm size, were found to be highly significant and
rejected the static trade off theory.
Joshua(2008) stated that large size firms as well public sector firms require debt financing while
small medium enterprises require equity financing to generate optimal performance and results.
Furthermore, he elaborated that equity financing should be encouraged in the initial stages of a
firm's existence which will provide a sound baseto firm in order to expand by debt financing. In
the study related to size and capital structureof the firm Titman and Wessels(1988) explained that
debt financing might be small forlarge firms and large for small firms. This phenomenon can

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only be true if debt for shortterm can be borrowed by small firms thus enabling them to reduce
the overall borrowingcost.
Assets tangibility was considered as the determinant ofcapital structuring in many researches by
scholars like Ross(1977),Harris and Raviv(1990),Ozkan(2001) and Khrawish&Khrawesh(2007-
08) wherein they concluded that fixed assets structure is directly related to capital structure of a
firm but in case of Pakistan, the study conducted by Shah and Hijazi(2004)elaborated that fixed
assets structure or tangibility has no or negative impact on the capitalstructuring of firms in
Pakistan. Hence, the outcome was in contradiction with the earlierresearches carried out by
various researches of different countries. Fixed assets structurehas a direct relationship with long
term debts while a negative relationship with the shortterm debts (Loof H,2004).
Capital structure has a positive relation with profitability because debt financingwill provide tax
shield to firm and hence improve its profit. Myers and Majluf(1984) contradicted with the above
statement and said that firms select internal financingdue to asymmetry information and show an
inverse relationship between profitability andcapital structure. A study by Rajan and
Zingle(1995) also showed the result similar tothe outcome earlier provided by (Myers and
Majluf,1984).
Teker(2009) and Chen(2003) Capital structuring of the firms in developed countries have been
the subject of most research by scholars and very lessresearch has been conducted in developing
countries and emerging markets Sukkari(2003). Those few research works that have been
conducted on developing countries showedthat firms' capital structure depends on various factors
such as interest rate, tangibility,size and inflation Lima M(2009). According to Myers(1984)
growth of the economyhas a positive impact on capital structure and investment increases for
firms with thegrowth of economy Huang, S. and Song(2002). Hence, a positive relationship
betweencapital structure and growth of economy exist.
Asymmetric information has always been the major concern for debt financingas it created
hurdles for firms with the potential to grow and succeed by not financing theiroperations with
external debts Myers and Majluf(1984). The research is mainly based on"Pecking Order Theory"
which states that "firms will rely more on internal financing dueto information asymmetry" and
if enough information will be available then firms can bepersuaded to external financing i.e.
borrowing. Few policies allow firms to cover debtfinancing by deducting interest from profit and
increasing tax rates also lead to increase in debt financing. Miller(1977) also endorsed this view.

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According to TalatAfza and Amer Hussain(2011) The financing behavior of firms of

Automobile, Cable and Electrical Goods, and Engineering Sectors depend on the tax provision,
asset structure, size and profitability of the firms The study indicates some policy implications
for the managers and investors of firms in these sectors. The large firms of Automobile Sector
having good asset structure should finance their growth and current operations by debt financing
and the firms with increasing cost of debt should use retained earnings and then equity financing
if further funds are required. The large firms of Cable and Electrical Goods Sector may use debt
financing even the cost of debt increases as they do not have any other option to survive in the
market due to worse economic conditions.
Berger, A. N(2002) findings are consistent with the agency cost higher capital structure, or a
lower equitycapital ratio is associated with higher profit efficiency, all else being equal. The
relationship between performance andcapitalstructure may be reversed when capital structure is
very high due to the agency cost of outside debt. Profit efficiency is responsibleto ownership
structure of the firm consistent with agency theory and their argument that profit efficiency
embeds agencycosts. Hung(2002) found that high gearing reflects more of low equity base than
high level of debts, which indicates thatcapital gearing is positively related with asset but
negatively with profit margins.
Pandey(2002) findings vindicated the saucer-shaped relationship between capital structure and
Profitability because of the interplay of agency costs, costs of external financing and interest tax-
shield, and proved that the size and tangibility have a positive influence and growth, risk and
ownership have a negative influence on capital structure. Bhaduri(2002) stated that the optimal
capital structure choice can be influenced by factors such as growth, cash flow, size and product
and industry characteristic capital structure, and confirmed the existence of restructuring costs in
attaining an optimal capital structure. Voulgaris, Asteriou and Mirigianakis(2002) found that the
growth of asset utilization, gross as well as net profitability, and total assets have a significant
effect on the capital structure. Ronny and Clarirette(2003) supported the pecking order theory
and rejected the trade-off theory of capital structure. Further, the small role played by the
Mauritian capital market as a source of long term finance is evident from the results with respect
to a number of explanatory variables including age, growth, risk and profitability. The strong and
positive results for the size variable are consistent with the findings of other studies and with the
trade-off theory.

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Strebulaev(2003) argued that even though a positive relation between profitability and the
optimal capital structure ratio can be expected, there is a negative relation between profitability
and the actual capital structure ratio. Be- cause of transaction costs, firms do not rebalance their
capital structure ratios constantly; instead, they allow them to move within a range surrounding
the optimal capital structure ratios. Mesquita and Lara(2003) stated that the choice between the
ideal proportion of debt and equity can affect the value of the company, as much as the return
rates can.
The results indicate that the return rates present a positive correlation with short-term debt and
equity, and an inverse correlation with long-term debt. Azhagaiah and Premgeetha(2004)
suggested that the rapid ability to acquire and dispose of debt provides the desired financial
flexibility of firms with a goal for growth. The non-debt tax shield and growth rate are
statistically significant, which means that these variables are the major determinants of the
capital structure of Pharmaceutical Companies in India.
Hennessy and Whited(2005) develop a dynamic trade-off model with endogenous choice of
capital structure, distributions, and real investment in the presence of a graduated corporate
income tax, individual taxes on interest and corporate distributions, financial distress costs, and
equity flotation costs. The study explains several empirical findings inconsistent with the static
trade-off theory and show that there is no target capital structure ratio, firms can be savers or
heavily levered, capital structure is path dependent, capital structure is decreasing in lagged
liquidity, and capital structure varies negatively with an external finance weighted average.
Using estimates of structural parameters, they find also that simulated model moments match
data moments.
Chen and Zhao(2004) suggested that dynamic tax considerations are unlikely to be the main
reason for the negative relation between profitability and capital structure either.
Deesomsak(2004) suggested that the capital structure decision of firms is influenced by the
environment in which they operate, and finds a significant but diverse impact on firms’ capital
structure decision. Loof(2004) found the ideas that the more unique a firm’s asset is the thinner
the market are for such assets. Hence one may expect that uniqueness be negatively related to
capital structure.
Voulgoaris, AsteriouandMirigianakis(2004) found that the profitability is one of the major
determinants of capital structure for both SMES and LSES size groups. However, efficient assets

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management and assets growth are found essential for the debt structure of LSES as opposed to
efficiency of size, growth and high fixed assets, which were found to affect substantially the
credibility of SMES. Joshua(2005) revealed a significantly positive relationship between the
ratio of short term debt to total assets and ROE. Abor(2005) seeks to investigate the relationship
between capital structure and profitability of listed firms on the Ghana and find a significantly
positive relation between the ratio of short-term debt to total assets and ROE and negative
relationship between the ratio of long-term debt to total assets and ROE.
Gill(2011) seeks to extend Abor’s(2005) findings regarding the effect of capital structure on
profitability by examining the effect of capital structure on profitability of the American service
and manufacturing firms. A sample of 272 American firms listed on New York Stock Exchange
for a period of 3 years from 2005 – 2007 was selected. The correlations and regression analyses
were used to estimate the functions relating to profitability with measures of capital structure.
Empirical results show a positive relationship between short-term debt to total assets and
profitability and between total debt to total assets and profitability in the service industry. The
findings of this paper show also a positive relationship between short-term debt to total assets
and profitability, long-term debt to total assets and profitability, and between total debt to total
assets and profitability in the manufacturing industry. Due to the tax advantage inherent in debt
financing, many companies prefer debt financing to equity financing asset results in increased
profits becoming available to the shareholder. However, debt must be used with extremecare
because of the risk of possible financial distress when firms are unable to pay their debts. An
associated cost of financial distress such as legal and administrative costs reduces profits
available to shareholders.
There are two conflicting viewpoints about the relationship of size to capital structure of afirm.
First, large firms don’t consider the direct bankruptcy costs as an active variablein deciding the
level of capital structure as these costs are fixed by constitution and constitutea smaller
proportion of the total firm’s value. And also, larger firms being morediversified have lesser
chances of bankruptcy. One may expect a positive relationship between size and capital structure
of a firm.Rajan and Zingales(1995) argue that there is lessasymmetrical information about the
larger firms. This reduces the chances ofundervaluation of the new equity issue and thus
encourages the large firms to useequity financing. This means that there is negative relationship
between size andcapitalstructure of a firm.

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Marsh(1982) indicates thatlarge firms more often choose long-term debt, while smallfirms
choose short term debt. The cost of issuing debt andequity is negatively related to firm size. In
addition, larger firms are often diversified and have more stable cashflows, and so the probability
of bankruptcy for larger firmsisless, relative to smaller firms. This suggests that size couldbe
positively related with capital structure. The positive relationshipbetween size and capital
structure is also viewed as support of asymmetric information. Larger size firms enjoy
economies of scale and creditworthiness in issuing long termdebt and have bargaining power
over creditors. Thesearguments suggest that larger firms have tendency to use higher capital
structure.Smith(1977) indicates that because small sized firms bearhigh costs of new equity and
long term debt issuance, theymay prefer to rely on short term debt and more capital structure
thanlarger sized firms. Rajan and Zingales(1995) argue that largerfirms tend to disclose more
information to outsiders, operateunder less asymmetric information and may tend to use
moreequity than debt. Overall, these arguments suggest a negativerelationship between capital
structure and firm size.Empirical studies generally support the positive relationshipbetween firm
size andcapital structure hypothesis. In contrast, Kester(1986) and Titman and Wessels(1988)
find anegative albeit weak and insignificant relationship.
Modigliani and Miller(1958) found a positive relation between growth opportunities and a firm’s
preference for the debt, while making a capital structure decision. Modigliani and Miller asserted
that after discovering a major growth opportunity, owners of firms may not prefer to finance it
using common stock at the then ruling price, as this price may not succeed to make the most of
new venture. Firms may finance the project initially with debt, and once the project has proved
itself profitable by reflecting increased actual earnings, the debt could be paid back either by
issuing equity at much better prices or through retained earnings.Omet and Nobanee(2001)
variables identified, period of this study and number of companies and selected explanatory
variables in this study are: size, tangibility, profitability, long-term debt and short-term debt, but
explanatory variables in Omet and Nobanee's study are Age of company, cash flows, size and
growth.
For creditors and investors risk is the main concern in debt financing and according to Kraus and
Litzenberger(1973) if a firm's financial debt is higher than its earning then the firm would
probably lose it value in the market and the creditors and investors might lose their confidence in
the firm and become reluctant to investment. Hence, the firm will lose major portion of capital

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structure and will lead to decline in sales,growth and operations of the firm. According to
Hussain(2011) Pakistani firmscapital structure has received very limited attention from scholars
and other stakeholders and according to him, in Pakistan discussion on determinants capital
structure of Pakistani firms started with the study conducted by (Shah and Hijazi(2004) followed
by Tariq and Hijazi(2006), Shah and Khan(2007) and Rafiq(2008))).
Sbeiti(2010) found a negative relation between growth opportunities and leverage and it was
consistent with the predictions of the agency theory that high growth firms used less debt, since
they did not wish to be exposed to possible restrictions by lenders. His explanation was that
growing firms had more options of choosing between risky and safe sources of funds and
managers as agents to shareholders went for risky projects in order to maximize the return to
their shareholders. Creditors, however, would be reluctant to provide funds to such firms as they
would bear more risk for the same return. They would thus demand a higher premium from
growing firms. Faced with this prospect and in order to avoid the extra cost of debt, growing
firms will tend to use less debt and more equity. Hence, the relatively large magnitude of the
growth coefficient may be indicative of a higher degree of information asymmetries in these
markets, restricting the ability of managers to raise external debt capital. He further explains that
it is also important to note that the firm specific coefficients are almost identical. Variables such
as market to book ratio reflect the capital market valuation of the firm, which in turn is affected
by the conditions of the capital market.
Um(2001) argues that growing companies funding pressure for investment opportunities is likely
to exceed their retained earnings and, according to the ‘pecking order’ are likely to choose debt
rather than equity. Thus, if the information asymmetry theory is pertinent in Libya, a positive
relationship is expected between financial leverage and growth. Pandey(2001) finds a positive
relationship between growth and both long-term and short-term debt ratios in Malaysia. The
multivariate-pooled OLS regression results showed that the coefficient of investment opportunity
variable was insignificant throughout. Jani, Hoesli and Bender(2003), found the negative sign of
growth and confirmed the hypothesis that firms with growth opportunities were less levered. To
analysis this relationship further, they divided their sample in two sub-samples using the median
growth as cut-off. The negative sign and significance of the coefficient remained irrespective of
the leverage measure for the high growth firms. Concerning the low growth firms, which were
typically no growth firms as the market-to-book ratio was below one, they observed a negative

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relationship between growth and leverage when market values were used, and a positive relation
when leverage was measured with book values.
Focusing on the factors affecting capital structure decisions of firms of Japan, Malaysia and
Pakistan, M(2003) found that firms in Japan and Pakistan showed very high leverage ratios
because of Japanese developed market status and underdeveloped capital market of Pakistan
which forces firms to opt for bank loan rather than raising equity. Qureshi and Azid (2006)
identified that the public sector preferred financing through debts due to low corporate
governance, favorable terms and conditions of commercial banks and lesser accountability than
private sector. Shah and Khan (2007) examined that there was highest leverage ratio for textile
industry and the average profitability of textile industry was negative due to understatement of
profit by family controlled firms. Hijazi(2006) examined the cement sector of Pakistan and the
results, except for firm size, were found to be highly significant and rejected the static trade off
theory.
Kanwar(2007) explained the attributes of Capital Structure in Sugar industry of Pakistan and the
results depicted that return on assets, asset tangibility, market to book ratio and size were found
to be significant except tax rate. The developed provinces of Pakistan showed highest debt ratios.
Rafiq(2008) examined the chemical industry of Pakistan regarding capital structure choice and
suggested that chemical sector preferred more equity financing than the debt financing. Size and
growth variables showed static trade off behavior of the firms. On the basis of theoretical frame
work of Ranjan and Zingales(1995) and previous empirical results, they have developed analyze
the impact of tangibility, size of firm, tax, profitability, liquidity, non-debt tax shield and cost of
debt on leverage.

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CHAPTER # 3
DATA AND METHODOLOGY
3.1 RESEARCH PARADIGM:
In this research I used (positivism paradigm) quantitative research approach because on this topic
already researches have been conducted by different researcher. I verified the old study. Other
reason for selecting quantitative technique is that it is economical. In my study I select the
positivism research paradigm for my research purpose. Positivism research paradigm is well
known and used in universities internationally. Positivism research paradigm assumes that the
knowledge is based on experiences and my study also based on experiments and experiences.
Positivism approach is also called Scientific Method, Empirical Science, Post Positivism and
Quantitative Research. The words that are mostly used in positivism paradigm are the
Determination, Reduction, empirical Observation and Measurement and Verification of the
theory. (Creswell J. W. 2003)
3.2 RESEARCH APPROACH:
In this research I have used quantitative approach. Quantitative approach is proper, impartial and
systematic process of research in which numeric data is used. In quantitative approach researcher
point of view are preferred. A Quantitative research approach is one which the mostly uses as the
investigator and developing knowledge about cause, variables, hypotheses and questions. It’s
also used for measurement, observations and tests the different theories. The reason for selecting
quantitative technique is that it is economical and inexpensive.
3.3 POPULATION AND SAMPLING:
3.3.1 POPULATION:
Population means the group of people in which we select the sample for the purpose of research.
This study employs descriptive research in investigating the determinants of capital structure in
Pakistan. In our study our population is all the manufacturing industries that are working in
Pakistan and other side our population are whole data of all years of the manufacturing
industries. Our population for this study is particularly not very large. The populations which
have we select the manufacturing firms that are listed in the Karachi Stock Exchange.

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3.3.2 SAMPLING:
The group of population that is selected for research is called sample. Sample is a subset of
population. We took all textile firms which are listed in KSE then we got 10 textile firms
randomly as our sample. We use a technique in selection of the firms for research. To achieve
the sampling, the names of companies write down on the equal pieces of paper, picked ten pieces
of paper and these industries use as sampling. We select the 4 years 2010-2013 annual reports of
selected ten textile industries we use in the study.
3.4 DATA COLLECTION AND INSTRUMENTS:
3.4.1 DATA COLLECTION
3.4.1.1 PRIMARY DATA:
I will not use primary data collection approach in my research because there is not any data exist
in primary data approach and don’t have past study on the selected research topic.
3.4.1.2 SECONDARY DATA:
My study depends on secondary sources of data collection because data is available for the
further research. I collected the data from firm’s website in the shape of past four year’s annual
reports where I collected data to calculate Tangible Assets (TA), Profitability (PA), Firm Size
(FS), Risk (R) and Leverage (L) which used for the data collection.
3.5 DATA ANALYSIS:
“Data analyses are the process of systematically applying statistical and/ or logical techniques to
describe and illustrate, condense and recap, and evaluate data”.
3.5.1 DESCRIPTIVE ANALYSIS:
In data analysis firstly we used descriptive analysis in this many tests like frequency used for the
determine percentiles, measures the central tendency, five figure summary and for the graphical
presentation we used bar chart and histogram.
3.5.1.1. FREQUENCY TABLE/ BAR CHART:
A frequency is a distribution of data. Frequency is a table with all possible values the variable
could take on and the frequency with which each of those values occurs. For example, if we
wanted to know the gender distribution for the sample than we can use the frequency table for it.
The graphical presentation of frequency table is called Bar chart. Bar charts can be used to
display the frequency of nominally scaled variables or the mean value of the levels.In a specific

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bar chart the bars of the each chart are separate from each of them and all these bars represent the
frequency of each category. (Bryman, A. and Bell, E. 2003)
3.5.1.2. FIVE FIGURES SUMMARY/ HISTOGRAM:
Five figure summary is used to obtain the simple numerical summaries of the numerical values
of the variables. If the data is converted into numerical order then the results of five figure
summary can be extracted. There are five different figures that are explained below.
 Minimum Value: The smallest value of the data.
 Maximum Value: The largest value of the data.
 Median: The middle value of the data.
 Lower Quartile: The middle value of the first half.
 Upper Quartile: The middle value of the second half.(Bryman, A. and Bell, E. 2003)
Histogram is a graphical presentation of five figures summary.
3.5.1.3. SCATTER PLOT:
A scatter plot gives a visual idea of what is happening with the data. Scatter plots are similar
to line graphs. The only difference is a line graph has a continuous line while a scatter plot has a
series of dots. Scatter plots in statistics create the foundation for linear regression, where we take
scatter plots and try to create a usable model using functions. In fact, all linear regression is
doing is trying to draw a line through all of those dots. Scatter plot is more useful for examining
the insight relationship between two variables. (Bryman, A. and Bell, E. 2003)
3.5.2. INFERENTIAL ANALYSIS:
Inferential analysis are most useful for the purpose of getting the conclusion from the about a
population from the sample. The conclusions are derived on the basis of statistical relationships.
Inferential analyses are used to differentiate the two or more variables on the basis of statistical
tests with the assumption that the sample is selected on the random basis. This work is done for
the purpose to generalize or for the purpose of make predictions in future. (Creswell J. W. 2003)
3.5.2.1. CORRELATION:
Correlation is a measure of the degree of linear relationship between two variables. A positive
correlation means that the value of one variable increase, the value of other variable increase. As
one decrease than other variable’s value also decrease. A negative correlation indicates that’s as
one variable increase than other decrease. The absolute value of the correlation coefficient
measures the strength of the relationship.

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3.5.2.2. REGRESSION:
Regression analysis is most important analysis to check the relationship between two or more
variables. In the regression analysis one variable is called dependent variable and the second
variable is called independent variable. Regression analysis is used to check the relationship that
due to one unit changes in independent variable how much will be occurring in the value of
dependent variable. (Creswell J. W. 2003)
3.6 RESEARCH LIMITATIONS:
Although this research was carefully prepared, I am still aware of its limitations,
 I take only four years data from research but not taken many years data.
 Research will be conduct on both way qualitative and quantitative but me use only
quantitative research approach
 My research is only on textile sector but there are so many firms in Pakistan.
 We follow all the norms and values of society that’s relate to my topic
 My research is mostly work on private sectors but not in Government sectors
 We work only on secondary source of data it is also limits of my topic.
 We not work on primary source because this is limit about my topic of my studies.
3.7 ETHICAL CONSIDERATIONS:
The subject of this study will be briefed about the nature of study before collecting data. The data
provided by respondents will be kept confidential. Further, a permission from will be signed by
the participant before they engage in research in order to protect the participant right.
The permission will include the following:
 The purpose of this study, so that individual understands the nature of the research and
impact on them.
 Comprehensive information will be provided to respondents in order to make them clear
about aspect, objectives purpose and outcomes of research.
 Information must be used for only research purpose.
 Insure that the right use of the information and privacy of the respondents information.
 There is no risk for the people of any kind of physical, psychological, social or legal harm
3.8 FUTURE RESEARCH:
I am study about Determinants of Capital Structure and my variables are “Tangible Assets (TA),
Profitability (PA), Firm Size (FS), Risk (R) and Leverage (L)” but there are also many variables
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which are effect on capital structure and can be used in future for research for example “Growth,
Tax Shied, Uniqueness and income variability”. In my research I just used data about textile
sector there are many manufacturing sector in Pakistan for further research. My study will help
researcher in future for achieving their objectives.

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CHAPTER 4
RESULT AND ANALYSIS
In results and analysis chapter we conduct the analysis on the data that are collected from the
annual reports of 10textile companies which are listed in Karachi Stock Exchange in Pakistan.
We enter the collected data into E-view Seven software and get the results of that the relationship
between dependent and independent variable individually. We also examine the relationship of
all the variables collectively on the leverage in Pakistan. After applying the test we also check
the normality of the data.
TABLE 1:

TEST NAME Prob Value

Levie, Lin &Chut 0
Breitung t-test 0.4895
Firm Size
Im, Pesaran and Shin W-stat 0
ADF- Fisher Chi-Square 0.0006
PP- Fisher Chi-square 0
Hadri Z-stat 0.0004

Interpretation:
This table show the Levie Lin &Chut,Breitung t-test ,ImPesaran and Shin W-stat, ADF- Fisher
Chi-Square, PP- Fisher Chi-square and Hadri Z-stat values of Firm Size. In above table Levie
Lin &Chut value is 0, its show that data is stationary because it’s less than 0.05. The value of
Breitung t-test is 0.4895, its mean data is not stationary because value is also more than 0.05.
The ImPesaran and Shin W-stat test shows that data is stationary because its vale is 0 and less
than 0.05. The value of ADF- Fisher Chi-Square shows that data is stationary because its value
equal to 0.0006 and its less than 0.05. The value of PP- Fisher Chi-square equal to 0 its less than
0.05, its mean data is stationary and Hadri Z-stat value is 0.0004 it’s also show that data is
stationary because value is less than 0.05.

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TABLE 2:
Test name Prob Value

Levie, Lin &Chut 0

Breitung t-test 0.05

Profitability
Im, Pesaran and Shin W-stat 0
ADF- Fisher Chi-Square 0.0056
PP- Fisher Chi-square 0.0053
Hadri Z-stat 0.0026

Interpretation:
This table show the Levie Lin &Chut ,Breitung t-test , ImPesaran and Shin W-stat, ADF- Fisher
Chi-Square, PP- Fisher Chi-square and Hadri Z-stat about the stationary values of Profitability.
In above table Levie Lin &Chut value is 0, its show that data is stationary because it’s less than
0.05. The value of Breitung t-test is 0.05, its mean data is stationary because value is equal to
0.05. The ImPesaran and Shin W-stat test shows that data is stationary because its vale is 0.0056
and less than 0.05. The value of ADF- Fisher Chi-Square shows that data is stationary because its
value equal to 0.0056 and its less than 0.05. The value of PP- Fisher Chi-square equal to 0.0053
its less than 0.05, its mean data is stationary and Hadri Z-stat value is 0.0026 it’s also show that
data is stationary because value is less than 0.05.
TABLE 3:
Test name Prob Value

Levie, Lin &Chut 0

Breitung t-test 0.0341

Tangible Assets
Im, Pesaran and Shin W-stat 0

ADF- Fisher Chi-Square 0

PP- Fisher Chi-square 0

Hadri Z-stat 0.007

Interpretation:
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This table show the Levie Lin &Chut,Breitung t-test ,ImPesaran and Shin W-stat, ADF- Fisher
Chi-Square, PP- Fisher Chi-square and Hadri Z-stat values of stationary data of Firm Tangible
Assets. In above table Levie Lin &Chut value is 0, its show that data is stationary because it’s
less than 0.05. The value of Breitung t-test is 0.0341, its mean data is stationary because value is
also less than 0.05. The ImPesaran and Shin W-stat test shows that data is stationary because its
vale is 0 and less than 0.05. The value of ADF- Fisher Chi-Square shows that data is stationary
because its value equal to 0.000 and its less than 0.05. The value of PP- Fisher Chi-square equal
to 0 its less than 0.05, its mean data is stationary and Hadri Z-stat value is 0.007 it’s also show
that data is stationary because value is less than 0.05.
TABLE 4:
Test name Prob Value

Levie, Lin &Chut 0

Leverage Breitung t-test 0.4078

Im, Pesaran and Shin W-stat 0

ADF- Fisher Chi-Square 0.0014

PP- Fisher Chi-square 0.0016

Hadri Z-stat 0.004

Interpretation:
This table show the Levie Lin &Chut ,Breitung t-test , ImPesaran and Shin W-stat, ADF- Fisher
Chi-Square, PP- Fisher Chi-square and Hadri Z-stat values of stationary data of Leverage. In
above table Levie Lin &Chut value is 0, its show that data is stationary because it’s less than
0.05. The value of Breitung t-test is 0.4078, its mean data is not stationary because value is more
than 0.05. The ImPesaran and Shin W-stat test shows that data is stationary because its vale is 0
and less than 0.05. The value of ADF- Fisher Chi-Square shows that data is stationary because its
value equal to 0.0014 and its less than 0.05. The value of PP- Fisher Chi-square equal to 0.0016
its less than 0.05, its mean data is stationary and Hadri Z-stat value is 0.004 it’s also show that
data is stationary because value is less than 0.05.

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REGRESSION:
Dependent Variable: L?
Method: Pooled Least Squares
Date: 05/12/14 Time: 00:27
Sample: 2010 2013
Included observations: 4
Cross-sections included: 10
Total pool (balanced) observations: 40

Coefficie
Variable nt Std. Error t-Statistic Prob.

-
C 360.8818 329.5949 -1.094925 0.2808
-
FS? 5.362857 18.88117 -0.284032 0.7780
PB? 2161.288 748.1084 2.889004 0.0065
TA? 527.5531 322.7714 1.634448 0.1109

R-squared 0.201263 Mean dependent var 53.02250

Adjusted R-squared 0.134701 S.D. dependent var 319.6441
S.E. of regression 297.3375 Akaike info criterion 14.32225
Sum squared resid 3182746. Schwarz criterion 14.49114
-
Log likelihood 282.4450 F-statistic 3.023714
Durbin-Watson stat 1.044339 Prob(F-statistic) 0.042073

Interpretation:
In above table Prob (F-statistic) and Durbin-Watson stat show the relationship of Firm Size,
Profitability, tangible assets on leverage and R-squared show the percentage change in leverage
due to Firm Size, Profitability and Tangible assets. The value of Prob is 0.042073 its show that
there is relationship between leverage and Firm Size, Profitability and tangible assets because it’s
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less than 0.05. The value of Durbin-Watson stat is 1.044339 its less than 2 due to this there is
relationship between leverage and Firm Size, Profitability and tangible assets. R-square value
shows that there is 20% change in leverage due to Firm Size, Profitability and tangible assets.

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CHAPTER 5
DISCUSSION AND CONCLUSION
5.1 DISCUSSION
The purpose of this study checks the effect and relationship in the determinants of capital
structure in manufacturing industry of Pakistan. In this study tangible assets, firm size and
profitability are independent variables and dependent variable is leverage. The capital structure
of the firms hasrelation with profitability because debt financingwill provide tax shield to firm
and hence improve its profit. Myers and Majluf(1984) contradicted with the above statement and
said that firms select internal financingdue to asymmetry information and show an inverse
relationship between profitability andcapital structure. A study by Rajan and Zingle(1995) also
showed the result similar tothe outcome earlier provided by (Myers and
Majluf,1984).Teker(2009) and Chen(2003) Capital structuring of the firms in developed
countries have been the subject of most research by scholars and very lessresearch has been
conducted in developing countries and emerging markets Sukkari(2003).
The capital structure decision is the most important decision for the financial management.
Capital structure is a mid-point of many other decisions in the corporate finance. Its include
dividend policies, financing, assets management, profit enhancement and so on. Capital structure
is one of the most important tools of management to manage the cost of capital. Those few
research works that have been conducted on developing countries showedthat firms' capital
structure depends on various factors such as interest rate, tangibility,size and inflation Lima
M(2009).
According to Myers(1984) growth of the economyhas a positive impact on capital structure and
investment increases for firms with thegrowth of economy Huang, S. and Song(2002). Hence, a
positive relationship betweencapital structure and growth of economy exist.Asymmetric
information has always been the major concern for debt financingas it created hurdles for firms
with the potential to grow and succeed by not financing theiroperations with external debts
Myers and Majluf(1984).My data is secondary and it’s collected through annual reports of textile
companies. First of all prepare the literature review, for this purpose data collection of literature
review I read more than 30 articles and after reading the summery of all articles write down in
the literature review. After this define the research objectives & hypothesis. For the research

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purpose we collect the data from company’s website and collect the latest four years annual
reports.
5.2 CONCLUSION
As a conclusion of our whole study I can say that the, I conduct this study is to examine the
relationship between tangibility of assets, firm size and profitability on the capital structure.
Using a quantitative method I have used the 4 years data (2010-2013) from annual reports of
different textile companies. In this studytangibility of assets, firm size and profitability used as
independent and leverage as dependent variable. After collecting the data I put into eview seven
software and apply different tests on collected data. After applying the adjusted R Square test on
data the results have been concluded.
I found the result that the value of Prob is 0.042073 its show that there is relationship between
leverage and Firm Size, Profitability and tangible assets because it’s less than 0.05. The value of
Durbin-Watson stat is 1.044339 its less than 2 due to this there is relationship between leverage
and Firm Size, Profitability and tangible assets. R-square value shows that there is 20% change
in leverage due to Firm Size, Profitability and tangible assets.
5.3 RECOMMENDATION
There are some essential recommendations regarding this subjects are mentioned below,
 Tangible assets should be reviewed.
 Develop criteria how to estimate tangible assets value.
 Tangibility of assets must be used like enhance firm’s good will.
 Profitability of the firms must be checked
 Trace new methods to enhance profitability
 Minimize cost to boost profitability
 Leverage should be measured accordingly
 Leverage must be reviewed periodically
 Firm size should consider in decision making
 Firm should be manage according to its size

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APPENDIX

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