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ISSN 1744-0718

Determinants of Capital Structure
Evidence from Libya

Fakher Buferna
Kenbata Bangassa
and Lynn Hodgkinson

No. 2005/08

Research Paper Series

Management School
University of Liverpool
Liverpool, L69 7ZH
Great Britain

Determinants of Capital Structure:
Evidence from Libya

Fakher Buferna a, Kenbata Bangassa a, Lynn Hodgkinson b

a
School of Management, University of Liverpool, Chatham Street, Liverpool L 69 7 ZH, UK
b
School of Business and Regional Development, University of Wales, Hen Goleg, College Road,
Bangor, Gwynedd, LL57 2DG, UK.
_____________________________________________________________________

Abstract

This paper provides further evidence of the capital structure theories pertaining to a

developing country and examines the impact of the lack of a secondary capital market

by analysing a capital structure question with reference to the Libyan business

environment. The results of cross-sectional OLS regression show that both the static

trade-off theory and the agency cost theory are pertinent theories to the Libyan

companies’ capital structure whereas there was little evidence to support the

asymmetric information theory. The lack of a secondary market may have an impact

on agency costs, as shareholders who are unable to offload their shares might exert

pressure on management to act in their best interests.

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1. Introduction

Following on from the pioneering work of Modigliani and Miller (1958) on capital

structure, three conflicting theories of capital structure have been developed. They are

namely: static trade-off, pecking order, and agency cost theories.

The static trade-off theory of capital structure (also referred to as the tax based theory)

states that optimal capital structure is obtained where the net tax advantage of debt

financing balances leverage related costs such as financial distress and bankruptcy,

holding firm’s assets and investment decisions constant (e.g., Baxter, 1967 and

Altman 1984, 2002). In view of this theory, issuing equity means moving away from

the optimum and should therefore be considered bad news. According to Myers

(1984), firms adopting this theory could be regarded as setting a target debt-to-value

ratio with a gradual attempt to achieve it. Myers (1984), however, suggests that

managers will be reluctant to issue equity if they feel it is undervalued in the market.

The consequence is that investors perceive equity issues to only occur if equity is

either fairly priced or over priced. As a result investors tend to react negatively to an

equity issue and management are reluctant to issue equity.

Pecking order theory (also referred to as the information asymmetry theory) proposed

by Myers states that firms prefer to finance new investment, first internally with

retained earnings, then with debt, and finally with an issue of new equity. Myers

argues that an optimal capital structure is difficult to define as equity appears at the

top and the bottom of the ‘pecking order’. Internal funds incur no flotation costs and

require no disclosure of the firm’s proprietary financial information that may include

firm’s potential investment opportunities and gains that are expected to accrue as a

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may reduce the agency conflict between shareholders and managers. Debt and the accompanying interest payments. Pakistan. Bevan and Danbolt (2000 and 2002) utilise data from the UK. Pandey (2001) uses data from Malaysia. Debtholders have legal redress if management fails to make interest payments when they are due. which. Jensen and Meckling (1976) argue that agency costs play an important role in financing decisions due to the conflict that may exist between shareholders and debtholders. Antoniou et al. however.result of undertaking such investments. Omet and Nobanee (2001) use data from Jordan and Al-Sakran (2001) 3 . shareholders can encourage management to take decisions. Chen (2004) utilise data from China. Most capital structure studies to date are based on data from developed countries. Malaysia. hence managers concerned about potential loss of job. will be more likely to operate the firm as efficiently as possible in order to meet the interest payments. for example Booth et al. If companies are approaching financial distress. There are few studies that provide evidence from developing countries. Mexico. India. and France and Hall et al. Jordan. For example. Germany. Rajan and Zingales (1995) use data from the G-7 countries. in effect. The agency cost theory of capital structure states that an optimal capital structure will be determined by minimising the costs arising from conflicts between the parties involved. (2002) analyse data from the UK. Turkey and Zimbabwe). (2004) used data from European SMEs. South Korea. Sophisticated debtholders will then require a higher return for their funds if there is potential for this transfer of wealth. expropriate funds from debtholders to equityholders. (2001) analyse data from ten developing countries (Brazil. Thailand. thus aligning their behaviour closer to shareholder wealth maximisation.

Of the capital structure studies. However. there are systematic differences in the way these ratios are affected by country factors. inflation rates. The data. p 118) state that. and development of capital markets.” This paper provides further evidence of the capital structure theories pertaining to a developing country and examines the impact of the lack of a secondary capital market.analyses data from Saudi Arabia. Deesomsak et al. and the hypotheses examined in this study. (2004) analyse data from the Asia Pacific region. Section 6 concludes the paper. as it has no secondary capital market which potentially switches the focus of company financing from a short-term investment to a long-term investment. Libya differs from the developing countries previously studied. For example. research methodology and the explanatory variables are described in section 4. This study attempts to reduce the gap by analysing a capital structure question from a Libyan business environment. Section 3 presents a review of the relevant literature on capital structure. 4 . Section 2 provides an overview of the Libyan economy pertaining to firms’ capital structure decisions. (2001. some have used cross-country comparisons based on data from particular region. The results are presented and discussed in section 5. 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. This paper is organized as follows. such as GDP growth rates. “In general. Booth et al.

was to reduce public spending and gradually withdraw government subsidies. the capital structure of companies might be affected due to the shortage of financing from the state. Although firms can obtain funds from external sources such as banks and new issues on the stock exchange. In 1992 the government passed Act number 9 of 1992 to enhance and regulate the private sector activities in the nation. In this regard. The act permits the establishment of private business activities owned and managed by families and individual entrepreneurs. several attempts have been taken by the state recently to allow individuals to take part in the national economy and to privatise the state owned (public) business organisations in an attempt to gradually move the Libyan economy towards a market economy.2. and. many companies are exposed to high levels of debt. and/ or internal resources (retained earnings). The overall aim of these measures. and to encourage private sector initiatives in different sectors. Alqadhafi (2002) argues that the shortage of cash flow in most Libyan public companies has led those companies to borrow from commercial banks to cover their expenses. as stated by Saleh (2001). An Overview of Enterprise Financing in Libya Although the Libyan economy is described as a socialist-oriented economy. In addition there was a move to encourage foreign investments in the Libyan market as evidenced by Act number 5 of 1997. the absence of a secondary market might deter investors 5 . The absence of a secondary market may present a major barrier for Libyan companies to raise capital needed for investment. The act also allows the selling of publicly held companies to private investors which has resulted in the emergence of some private companies. as a result. Keister (2000) argues that during economic transition.

1 The nominal figures are LD 3053. point out that the choice of suitable explanatory variables is potentially contentious. Libyan companies will therefore. The selected explanatory variables are: tangibility. As a result. The nominal figures were converted to the real figures by using GDP deflator (144.5 million Libyan Dinner (LD) in 1990 to 2224. to identify which of the capital structure theories is relevant in the Libyan context. 3. The total amount of credit provided by the commercial banks to various sectors has slightly increased from 2111. we concentrate on four key variables identified in studies by Rajan and Zingales (1995). Therefore. and Bevan and Danbolt (2002). This might be attributed to the policy that has been adopted by the government to provide credit to different economic activities aiming at reducing public spending and government subsidies. size. there is a need to study the capital structure of Libyan companies. As a result of these studies. Capital Structure Theories Both theoretical and empirical capital structure studies have generated many results that attempt to explain the determinants of capital structure. tend to finance their investment opportunities externally from banks and internally from their retained earnings (for more details see annual report of People’s Board for follow-up. 2000). have borrowed large amounts of debt from commercial banks to cover their expenses. however. and Harris and Raviv (1991). Titman and Wessels (1988). Libyan companies. some broad categories of capital structure determinants have emerged.7 million LD in 20011. profitability. and the level of growth opportunities. as stated by Alqadhafi (2002). In this study. 6 .3 million and LD 5584 million in 1990 and 2000 respectively.from taking up new issues.6 and 251 for 1990 and 2000 respectively).

i. (2000) argue that the legal environment. Antoniou et al. by incorporating the institutional differences between countries when specifying the theoretical models. Firstly. the deterioration or the improvement in the state of economy. but also by its surrounding environment. The surrounding environment may affect the firm’s capital structure for different reasons. and technological capabilities influence the capital structure in the fourteen European community member countries examined in their study. and secondly. have reported conflicting results. however. Korajczyk and Levy (2003) argue that both macroeconomic conditions and firm-specific factors have an effect on firm’s financing choices. Other empirical studies at the international level. Um (2001) suggests that a high profit level gives rise to a higher 7 .. Static Trade-off Theory The static trade-off theory of capital structure states that optimal capital structure is obtained where the net tax advantage of debt financing balances leverage related costs such as bankruptcy. as well as in ten developing countries (Booth et al. the economic system. the existence of a stock market and/or the size of banks sector.These four explanatory variables are identified as important factors in the G-7 countries (Rajan and Zingales. 1995). 2001). Furthermore. (2002) find that the capital structure decisions of firms are not only affected by its own characteristics. by continuing to develop the relationship between theoretical models and empirical findings by widely applying the models to different situations. the tax environment. Gleason et al. Rajan and Zingales (1995) suggest that future research should proceed in two ways. such as.

and work of Um (2001) in Korea report a positive relationship between tangibility and leverage. Bevan and Danbolt (2000 and 2002) also find a positive relationship between tangibility and long-term debt. and Huang and Song (2002) in China. that companies with high levels of tangible assets are less likely to default and will take on relatively more debt resulting in a positive relationship between tangibility and financial leverage. 1988. Nuri (2000) argues that companies with a high fixed asset ratio tend to use more long-term debt. find that tangibility is negatively related to leverage. the empirical studies in developing countries find mixed relationship. among others) find a positive relationship between tangibility and leverage. It is argued. (2001) in ten developing countries. other studies such as Booth et al. Hence. Rajan and Zingales. It is expected. While the majority of empirical studies in developed countries (Titman and Wessels. Antoniou et al. whereas a negative relationship is observed for short-term debt and tangibility in the UK. therefore. Firms with high levels of tangible assets will be in a position to provide collateral for debts. 1995. If the company then defaults on the debt. whilst the work of Wiwattanakantang (1999) in Thailand. (2002) argue that several studies find that the size of a firm is a good explanatory variable for its leverage ratio. Bevan and Danbolt (2002) also argue that large firms tend to hold more debt. because they are regarded as being ‘too big to fail’ 8 . it is expected that a positive relationship should exist between profitability and financial leverage.debt capacity and accompanying tax shields. the assets will be seized but the company may be in a position to avoid bankruptcy. that this relation depends on the type of debt. For instance. however.

In an attempt to explain some financing behaviour that is not consistent with the prediction of static trade-off theory (such as a negative relationship between profitability and leverage). ii. (1994) argue that large firms are able to hold more debt rather than small firms. Wiwattanakantang (1999). and Huang and Song (2002) find a significant positive relationship between leverage ratios and size in developing countries. On the other hand. Hamaifer et al. The alternative hypotheses to test whether the static trade-off theory is relevant in the Libyan context are as follows: H1: There is a positive relationship between leverage ratios and profitability. Empirical studies find mixed evidence. H2: There is a positive relationship between leverage ratios and tangibility. While Rajan and Zingales (1995) find a positive relationship between size and leverage in G-7 countries.and therefore receive better access to the capital market. because large firms have higher debt capacity. Al-Sakran (2001). Bevan and Danbolt (2002) report that size is found to be negatively related to short-term debt and positively related to long-term debt. Information Asymmetry Theory (Pecking Order Theory) The information asymmetry theory of capital structure assumes that firm managers or insiders possess private information about the characteristics of the firm’s return stream or investment opportunities. which is not known to common investors. Pandey (2001). (2001). H3: There is a positive relationship between leverage ratios and size. Titman and Wessels (1988) report a positive correlation between the size of the firm and the total debt ratio and the long-term debt ratio. Booth et al. Myers (1984) emphasises that internal funds and external funds are used 9 .

according to the ‘pecking order’ are likely to choose debt rather than equity. Myers (1984) refers to this as a ‘pecking order theory’ which states that firms prefer to finance new investment. work of Titman and Wessels (1988). Pandey (2001). Rajan and Zingales (1995). Pandey (2001) finds a positive relationship between growth and both long-term and short-term debt ratios in Malaysia. (2001) argue that this relation is generally positive in all countries in their sample. Bevan and Danbolt (2002) state that the more profitable firms should hold less debt. (2001). Um (2001) argues that growing companies’ funding pressure for investment opportunities is likely to exceed their retained earnings and. Booth et al.hierarchically. Chen (2004) and Al-Sakran (2001) in developing countries all find a negative relationship between leverage ratios and profitability. Wiwattanakantang (1999). a positive relationship is expected between financial leverage and growth. because high levels of profits provide a high level of internal funds. debt secured by a collateral may 10 . and finally with an issue of new equity. Antoniou et al. (2002) and Bevan and Danbolt (2002) in developed countries. first internally with retained earnings. Thus. if the information asymmetry theory is pertinent in Libya. Myers (1984) suggests that issuing debt secured by collateral may reduce the asymmetric information related costs in financing. then with debt. Consistent with the pecking order theory. except for South Korea and Pakistan. Booth et al. Hence. Um (2001). The difference in information sets between the parties involved may lead to the moral hazard problem (hidden action) and/or diverse selection (hidden information).

causes the moral hazard problem. The use of short-term sources of debt. as any attempt by shareholders to extract wealth from debtholders is likely to restrict the firms’ access to short-term debt in the immediate future. In addition. 2 Scapens (1991) contends that lack of direct observation or imperfect understanding of outsiders. regarding manager’s effect. iii. however. H6: There is a positive relationship between leverage ratios and tangibility. may mitigate the agency problems. whilst Wiwattanakantang (1999) and Um (2001) report a positive relationship between tangibility and leverage for Thailand and South Korea. The alternative hypotheses used to test whether the information asymmetry theory is relevant in Libyan context are as follows: H4: There is a negative relationship between leverage ratios and profitability. Titman and Wessels (1988) and Rajan and Zingales (1995) report a positive relationship between tangibility and leverage for developed countries. a positive relationship between tangibility and financial leverage may be expected. 1976). Agency Cost Theory Debt agency costs arise due to a conflict of interest between debt providers on one side and shareholders and managers on the other side (Jensen and Meckling. respectively.mitigate asymmetric information related cost in financing2. because if the investment fails. Scapens (1984) argues that the adverse selection problem appears when the outsiders can observe the manager’s action but do not know the basis of manager’s decision. Therefore. 11 . H5: There is a positive relationship between leverage ratios and growth. the lenders are likely to bear the cost as the shareholders have limited liability. Managers have the motivation to invest funds in risky business for shareholders’ interest.

H9: There is a positive relationship between leverage ratios and size. however. 12 . The alternative hypotheses used to test whether the agency cost theory is pertinent in Libya are as follows: H7: There is a negative relationship between leverage ratios and growth. Jensen and Meckling (1976) argue that the use of secured debt might reduce the agency cost of debt. Titman and Wessels (1988). Um also argues that firm size may proxy for the debt agency costs (monitoring cost) arising from conflicts between managers and investors. a negative relationship between debt and tangibility is consistent with an equity agency cost explanation (Um. Um (2001) emphasises that the monitoring cost is lower for large firms than for small firms. Consistent with these predictions. the management for monitoring cost reasons may choose a high level of debt to mitigate equity agency costs. larger firms will be induced to use more debt than smaller ones. Um (2001). 2001). H8a (equity cost explanation): There is a negative relationship between leverage ratios and tangibility. Therefore.Titman and Wessels (1988) point out that the costs associated with the agency relationship between shareholders and debtholders are likely to be higher for firms in growing industries hence a negative relationship between growth and financial leverage is likely. suggests that if a firm’s level of tangible assets is low. Chung (1993) and Rajan and Zingales (1995) find a negative relationship between growth and the level of leverage on data from developed countries. H8b (debt cost explanation): There is a positive relationship between leverage ratios and tangibility. Therefore.

(2002) argue that public companies differ in terms of choice of social and political goals over profit maximization. Data The data set used in the analysis is constructed by merging companies’ balance sheet and income statement information obtained from the Tax Offices in the capital city of Tripoli and Benghazi city. The criteria used for choosing the companies were the availability and quality of data for a time period of 5 years (1995-1999). In this regard. The public companies are defined as companies where the state owns more than 50 percent of their shares. Sun et al. There are some differences between private and public companies in terms of goals. and twenty-three private companies. families and/or institutions. as the probability of bankruptcy may have a significant impact on a firm’s financing decisions. whereas. Data and Methodology i. also provide empirical support that public ownership is less efficient 13 . The data were averaged over the five years to smooth the leverage and explanatory variables. The sample consists of thirty-two public companies. from 1995-1999 is used resulting in a panel database of 257 cases for 55 companies. The sample includes both financially sound companies and companies in financial distress to avoid survival bias. employment of staff. (2002) and Dewenter and Malatesta (2001). the private companies are where the companies majority is owned by individuals. Sun et al. and receipt of the government subsidies. among others. In an attempt to make the database of Libyan companies as complete as possible.4. For inclusion in the sample 5 years data. companies from both the public and the private sectors were selected.

The cross-sectional regression used in this study is based on models used in Rajan and Zingales (1995). The debt ratios considered are: total debt to total assets. that tangibility of assets. Explanatory Variables To test the hypotheses. the relationships between the level of debt and four explanatory variables representing profitability. due to government involvement in public companies’ ownership. (2004) argue that. growth. with some modifications in both the 14 . (2004). liquidity. earnings volatility and company size have less important role in capital structure decisions of public companies. Deesomsak et al. To examine for differences between public and private companies’ capital structure we analyse two sub samples (private and public companies). and Bevan and Danbolt (2002). tangibility and size are examined using ordinary least square regressions. ii. Dewenter and Malatesta (2001) report that the leverage of public companies tends to exceed that of private companies. Therefore. They added that this is because public companies may borrow at favourable rates due to loan guarantees that are provided through government ownership. This may imply. these companies have better access to capital market and less potential for problems of financial distress. in line with Bevan and Danbolt (2002) and Michaelas (1998) this study decomposes debt into long-term and short-term debt. short-term debt to total assets. and long-term debt to total assets. Furthermore.than private ownership. according to Deesomsak et al. Bevan and Danbolt (2002) point out that capital structure studies examining the determinants of leverage based on total debt may disguise the significant differences between long-term and short-term debt.

The ratio of total debt on average is 53. and Um (2001) a company’s growth is measured by the percentage change in the value of total assets. [insert Table 1] The public companies have. but due to the lack of a secondary stock exchange market in Libya. private and public firms. higher tangible assets than private companies. on average. Rajan and Zingales (1995) use the market to book ratio to proxy for growth. and the two sub-samples. Table 1 summarizes the statistics for the various explanatory variables and leverage measures for the entire sample of Libyan companies. however. Contrary to the suggestions of Dewenter 15 . hence. In line with Rajan and Zingales (1995) tangibility is measured by the ratio of fixed assets to total assets. Rajan and Zingales use the natural logarithm of sales to proxy for size but there were more observations for total assets than sales. The ratio of profit before tax to the book value of total assets is used to proxy for profitability in this paper. it can be seen that Libyan companies have a low rate of profitability (1. of a short-term nature (46. and private companies tend to have a higher average growth rate than the public ones. the market value of equity is unavailable. the public companies are bigger than the private companies. From these results. in line with Al-Sakran (2001).leverage and explanatory measures due to lack of data availability as discussed below.7 percent). The vast majority of the debt is.48 percent. The growth rate on average is 13. Hence.7 percent on average). The absence of a secondary stock market may deter shareholders and long-term debtholders from investing in companies. As expected. following Al-Sakran (2001) and Cassar and Holmes (2003) size is measured by the natural logarithm of assets.9 percent of total book value of assets.

This implies that larger companies and growing companies tend to have higher profitability. This implies that (1) Growing companies and companies with high levels of tangible assets tend to use short-term debt rather than long-term debt. [insert Table 2] The results show that growth and size are positively related to profitability. as follows: Z i = α i + β1n X n + β 2 n D + β 3n X n D + ε i (1) 16 . results reported on Table 1 show that private companies have higher levels of short-term debt than public companies. and a negative correlation with long-term debt. while tangibility has a negative relationship with profitability. The regression model adopted is. Despite the fact that this correlation matrix ignores joint effects of more than one variable on leverage.and Malatesta (2001). (2) Large and profitable companies are less likely to use short-term debt and tend to use less debt overall. profitable companies tend to have less tangible assets. the tangibility and growth variables have a positive correlation with short-term debt. whereas. which results in private companies having higher average debt ratios than the public ones. The level of long-term debt is very similar for both private and public companies. who suggest public companies will have higher levels of debt than private companies due to government guarantees. Table 2 presents a correlation matrix of the leverage and explanatory variables. Profitability and size have a negative correlation with short-term debt and total debt ratios.

Xn denotes the explanatory variables as following (n=1. and 4. Analysis and Results To control for potential heteroscedasticity problems the variables are deflated by the book value of total assets in accordance with Bevan and Danbolt (2000 and 2002). and εi is the random error term. As can be seen from Table 3.Profitability is proxied by the ratio of profit before tax to the book value of total assets. As a result. long-term debt to total assets. 2. 5. and 0 if the firm is a public firm. and short-term debt to total assets. They argue that the ordinary least square (OLS) results are very similar to those results that are obtained using the alternative techniques. This study also uses White (1980) heteroscedasticity-consistent standard errors and covariance for mitigating heteroscedasticity in calculating the t-statistics. 2. D denotes a dummy variable which takes the value of 1 if the firm is a private firm. in alternative estimations. α is the intercept.Size is measured by the natural logarithm of total assets.Growth is measured by the percentage change in the value of assets. Bevan and Danbolt (2002) have confirmed these findings. 3.Where: Zi denotes leverage and is computed as the ratio of total debt to total assets. Rajan and Zingales (1995) estimate their regression by using maximum likelihood and a censored Tobit model.Tangibility is measured by the ratio of fixed assets to total assets. the independent variables 17 . we present and discuss the OLS results only. 3 and 4): 1.

[insert Table 3] The interaction coefficients in Table 3 indicate whether there is a significant difference between the gradients of the slopes for the private and public companies. short term debt and long term debt. the implied coefficients for the explanatory variables for private companies given the regression output in Table 3 are shown in Table 4. there is fairly strong support for the static trade-off theory.51 for total debt. To determine whether the slopes for the private firms are significantly different from zero.provide high explanatory power as indicated by adjusted R2 values of 0. Wald tests are then used to determine whether the combined coefficients in Table 4 are significantly different from zero. tangibility and size explanatory variables.88 and 0. [insert Table 5] Discussion of Results If the static trade-off theory holds.95. 0. significant positive slope coefficients are expected for the profitability. Given that the vast majority of debt in Libyan companies is from short- term sources (see Table 1). respectively. For both the private and public companies there is strong evidence for the static trade-off theory for total and short-term debt as evidenced by the coefficients for profitability and size coefficients. Table 5 sets out the expected signs of the coefficients for the four explanatory variables. This may imply that larger companies with higher profits will have a higher debt 18 . [insert Table 4] To aid identification of the pertaining capital structure theories.

The high proportion of short term to long term debt used by Libyan companies also gives support for the agency cost theory as the conflict between shareholders and debtholders is less of a problem when short term debt is used. as a negative relationship is evident between financial leverage and growth for total and short-term debt. The conflicting results to the static trade-off theory are that although the slopes for the tangibility variable are positive they are not significantly different from zero. The inability to offload shares in a secondary market may encourage shareholders to exert pressure on management to expropriate funds from debtholders to themselves. The agency cost theory predicts a positive significant and a negative significant slope for size and growth variables. therefore. The positive relationship between profitability and leverage. and take advantage of any tax deductibility. There is little support for the information asymmetry theory that predicts a positive significant slope for the growth and tangibility variables and a negative significant slope for profitability variables. be able to borrow more. The results suggest that none of these relationships exist for either the public or the private companies. respectively and either a significant positive or negative slope for the tangibility variables. coupled with the regression results. This. suggests that agency costs may be a real problem for Libyan firms.capacity and will. also supports the 19 . Furthermore. The results support the findings of Titman and Wessels (1988). which gives support for the static trade-off theory. the static trade-off theory does not predict a relationship between growth and leverage whereas a negative coefficient is observed suggesting that the static trade-off theory is not the only relevant capital structure theory for Libyan companies.

The same relationship for long-term debt is more negative resulting in a significant negative relationship between tangibility and long term debt for private companies. Whilst there is little evidence of which theory drives companies to issue long-term debt for public companies. they prefer to use less debt. The relationship between short-term debt and tangibility is stronger for private companies as shown in Table 3 although the relationship is still not significantly different from zero as shown in Table 4. This may imply that growing companies have enough internal funds for their financing needs but. it may imply that as growing companies tend to be more risky. A significant negative relationship between tangibility and leverage is observed for private companies when the long-term measure for the level of debt is the dependent variable (as shown in Table 4). more likely. The lack of a significant relationship between 20 . Perhaps shareholders in public companies are less affected by the lack of a secondary market for their shares. private companies. as they expect public companies to continue due to government support.agency cost theory. appear to be influenced by the agency cost theory. as discussed above. which provides further support for the agency cost theory and the existence of conflict between debtholders and shareholders. The significance of the dummy interaction coefficients in Table 3 indicate whether the relationship between leverage and the explanatory variables differ depending on whether the company is public or private. The negative signs for the growth variables in both the public and the private companies indicate that growing companies do not rely on debt to finance their new investment opportunities.

The lack of a secondary market may have an impact on agency costs as shareholders. based on comparing the relationships between long and short term debt and four explanatory variables that represent profitability. will be more of a problem for private companies and indeed the relationships supporting the agency cost theory were stronger for private companies. The relationship between growth and leverage is slightly less negative for private companies where short-term debt is the dependent variable. might exert pressure on management to act in their best interests. Hypotheses. who are unable to offload their shares. The relationship between short-term debt and size is less positive for private companies whereas the relationship between long-term debt and leverage is more positive. 6.tangibility and short or long-term debt for public companies suggests that public companies do not use their fixed assets as collateral for obtaining more debt. The latter may be due to investors having more confidence in larger private companies (as they are less likely to fail) and are therefore more willing to lend long-term. It is likely that equity agency costs. arising due to conflict between debtholders and shareholders. Conclusions The findings of this paper contribute towards a better understanding of financing behaviour in Libyan companies. This may imply that as the state has the majority of ownership in these companies. 21 . The results suggest that both the static trade-off theory and the agency cost theory are pertinent theories whereas there was little evidence to support the information asymmetry theory. tangibility and size. growth. were developed to test which capital structure theories best explained Libyan companies’ capital structure. the debtholders take government involvement as collateral instead of the firms’ fixed assets.

The lack of high-quality databases might constitute the major barrier on conducting capital structure research in Libya. there is a need to develop validated databases as more data becomes available in future. 22 . Consequently. Using such databases can help examining and identifying additional variables that could influence the financing behaviour of Libyan companies.

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683 0.589 1.244 0.372 71.830 0.676 0.451 Median 0.187 15.149 2.640 1.034 Std.000 19.344 0.587 0.491 0.662 Median 0.072 0.150 17.334 Maximum 0. Dev.546 Minimum -0.130 -29.470 0.220 0.381 0.003 11.181 -33.017 0.467 0.329 Private Firms Mean 0. Growth is measured by the percentage change in total assets. 0.034 Std.160 0.770 0.560 1.084 30.508 Maximum 0.170 13.266 0.141 15.100 0.000 0.072 38.485 0.674 15.760 0.231 Std.881 0.003 11.539 Median 0.279 0.149 1.491 0.372 114.208 0.017 13.044 0.680 Maximum 0. 0. Total debt ratio refers to the ratio of total debt to total assets.074 0. Size is measured by the natural logarithm of assets.220 0.546 Minimum -0.199 17.627 0.181 -33.135 0.092 19.019 Minimum -0.941 0.151 1.073 0.466 0.000 0.875 0.005 0.005 0.005 0.539 0. 27 .610 0.010 0.563 0. Tangibility is defined as the ratio of fixed assets to total assets. Dev.589 1. Long-term debt ratio refers to long-term debt to total assets.000 8.379 0. Dev.Table 1 Summary of Descriptive Statistics Profitability Growth Tangibility Size Short-term Long.640 1.073 0.133 0.012 13.770 0.374 Note: Profitability is defined as the ratio of earnings before tax to total assets.515 0.683 0.101 0. 0.000 0.002 7.026 5.978 0.141 0.520 0.723 19.133 13.723 19.410 0.204 Public Firms Mean 0.005 24.201 0. Short-term debt ratio refers to the ratio of short-term debt to total assets. Total debt ratio term debt debt ratio ratio Entire Sample Mean 0.108 114.032 0.

118 -0.025 0.051 Size 0. Short-term debt ratio refers to the ratio of short- term debt to total assets. 28 . Tangibility is defined as the ratio of fixed assets to total assets.919 0.026 -0.066 0.304 debt ratio Total debt -0.242 -0.096 -0.Table 2 Correlation Matrix Variables Profitability Tangibility Growth Size Short-term Long-term debt ratio debt ratio Tangibility -0.417 debt ratio Long-term 0.424 0. Size is measured by the natural logarithm of assets. Growth is measured by the percentage change in total assets.073 0.002 -0.039 -0.093 ratio Note: Profitability is defined as the ratio of earnings before tax to total assets.039 -0. Long-term debt ratio refers to long-term debt to total assets. Total debt ratio refers to the ratio of total debt to total assets.082 0.102 -0.085 -0.227 Growth 0.180 Short-term -0.

057*** 0.33*** 46.018** -0. 29 .002*** 0.91) (11.45) (0.072*** 0. significant at the l0. 5.158) (1.606 -0.301) (-1.32) (-1.001 (-4.0002* -0.83) (-2.0005*** (-3.19) D*Tangibility -0.88 0.0001*** -0. *.710*** (-0.061 0.026*** 0.99) D*Size -0.705*** 3. and ***.0004** (-1.108 (8.004*** -0.551 (0. D denotes a dummy variable.12) Tangibility 0.26) (2.813*** -0.0001 0.01) (-0.29) Growth -0.89) (-2.623*** -0. Tangibility is defined as the ratio of fixed assets to total assets.55) (2.70) Profitability 3.087 0. **.95 0.038** (-2. Total debt ratio refers to the ratio of total debt to total assets.Table 3 Results of OLS Analysis over Different Measures of Leverage The Variables Total debt ratio Short-term debt Long-term debt ratio ratio Intercept -0.072*** 0. respectively. and 1% level.0003 (12. Size is measured by the natural logarithm of assets.58) (-4.002 (4.028 0.0002*** -0. t-statistics are in parentheses.93) (-4.49*** Obs 55 55 55 Notes: All dependent and independent variables are scaled by total assets.07) (0. Long-term debt ratio refers to long-term debt to total assets.01) (7.33) Adj R2 0.018 0.00) (3.04) (0.77*** 7.28) D -0.90) D*Growth 0. Growth is measured by the percentage change in total assets. Profitability is defined as the ratio of earnings before tax to total assets.11) (2.009 (0.07) D*Profitability 0.26) (-4.53) (1.15) Size 0.29) (1.025*** -0. Short-term debt ratio refers to the ratio of short-term debt to total assets.51 F 133. which takes a value of 1 if the company is a private company and a value of 0 if the company is a public company.

Short-term debt ratio refers to the ratio of short-term debt to total assets.22) Tangibility -0.63) (4.641 -0.69) (1. 5.71) (11.Table 4 Coefficients for the explanatory variables for private firms The Variables Total debt Short-term debt Long-term debt ratio ratio ratio Intercept -0.0009** (3. Long-term debt ratio refers to long-term debt to total assets.02) (1.59) Note: All dependent and independent variables are scaled by total assets. Wald tests were used to compute F-statistics.426*** -0.26) Profitability 3.054*** 0.766*** 4.659 (38.023*** -0. Growth is measured by the percentage change in total assets.022** -0.10) Size 0. F-statistics are in parentheses.33) (2.93) (1. respectively.015 0. 30 .0001 -0. and 1% level.14) Growth -0. and ***.041** (84. Profitability is defined as the ratio of earnings before tax to total assets.83) (30.90) (8. Total debt ratio refers to the ratio of total debt to total assets. **.701*** (0.0003*** 0. significant at the l0.92) (0.001 (16.59) (5. *. Size is measured by the natural logarithm of assets.059 0. Tangibility is defined as the ratio of fixed assets to total assets.

Table 5 The expected signs of the coefficients for the three capital structure theories Proxy Definitions Trade-off Asymmetric Agency cost Theory information Theory Theory Profit before tax + . ? Profitability to the book value of total assets Tangibility Fixed assets to + + + (Debt cost) total assets . “?” means that there is no clear prediction. 31 . whereas a negative sign “-“indicates that the theory suggests a negative relationship between the variable and the measure of leverage.(Equity cost) Growth The percentage ? + - change in the value of assets Size The natural + ? + logarithm of total assets A positive sign “+” indicates that the theory suggests a positive relationship between the variable and the measure of leverage.