Determinants of Capital Structure in

Spain
TABLE OF CONTENTS
CHAPTER 1: INTRODUCTION..............................................................................................1
1.0 Background of the study..................................................................................................1
1.1 Rationale of the study.......................................................................................................2
1.2 Aim and Objectives..........................................................................................................3
1.3 Research Questions..........................................................................................................3
1.4 Scope of the study............................................................................................................3
1.5 Structure of the study.......................................................................................................4
CHAPTER 2: LITERATURE REVIEW...................................................................................6
2.0 Introduction......................................................................................................................6
2.1 Definition of capital structure..........................................................................................6
2.2 Theories of capital structure.............................................................................................7
2.3 Determinants of Capital Structure..................................................................................12
CHAPTER 3: RESEARCH METHODOLOGY.....................................................................16
3.0 Introduction....................................................................................................................16
3.1 Research Method............................................................................................................16
3.2 Research philosophy......................................................................................................17
3.3 Data collection...............................................................................................................17
3.4 Data analysis..................................................................................................................18
3.5 Reliability and validity...................................................................................................19
3.6 Ethical consideration......................................................................................................19
3.7 Limitations.....................................................................................................................20
REFERENCES.........................................................................................................................21
CHAPTER 1: INTRODUCTION
1.0 Background of the study
Operations of a business organization, regardless of the industry it may be a part of, is
affected by the capital structure (Köksal and Orman, 2015). Essentially a capital structure
provides information on ways an organization can finance its own operations and growth.
Herein firms use different types of sources of finance to fund their functioning. It is
imperative for companies that they identify and use the most appropriate type of capital
structure. It can have a significant impact on overall functioning of the company. In this
regard Mouton and Smith (2016) rightly stated that it is the backbone of an organization. By
adequately developing the capital structure, it becomes simpler for the authorities to control
and manage the company. They can develop effective plans and implement different
strategies to ensure that the organizational goals and targets are achieved to the greatest
extent possible (Handoo and Sharma, 2014). On this basis, it can be said that capital structure
is an integral part of operations of any business organization. If a mistake is made in selecting
the right capital structure, then it can have adverse impact on the firm and may be even
jeopardise its very existence. Studies by researchers such as Li, Lu and Song (2015), Alipour,
Mohammadi and Derakhshan (2015) and Graham, Leary and Roberts (2015) have concluded
that capital structure is an aspect that gets affected by a large variety of internal as well as
external factors. Therefore, companies need to pay special attention to ensuring that they use
the right capital structure.
Many past investigations have shown that there are numerous determinants or factors
that influence the capital structure of an enterprise. Knowledge about these can help the
management to take effective decisions and enhance performance as well as sustainability of
firm in the industry (Acaravci, 2014). The importance of a well-developed capital structure
can be understood through fact that it is a reflection of the firm’s financial and investment
planning. The modern day marketplace can be characterized as very competitive in nature,
due to which it is imperative for companies that they follow a proper system and structure.
This can become a great opportunity for the organization in improving its operations as well
as sustainability. According to Baltacı and Ayaydın (2014) the capital structure provides ease
of mind to the management and enables them to effectively control the business operations.
Abdullah and Naser (2015) agrees by stating that a properly developed capital structure can
help in making the organization more competitive and make it more sustainable as well.

1
 In their study Degryse, de Goeij and Kappert (2012) argued that there are numerous
determinants of capital structure. This makes it very important for the management to
identify these factors and learn more about them. For long term existence of the firm, capital
structure can enable the firm to be more competitive and manage its operations effectively. In
the modern day hyper competitive market, this can be the difference between a successful
and unsuccessful company. A capital structure is a mixture of long term and short term debt.
Each of them have their own advantages and disadvantages (Robb and Robinson, 2014).
Thus it is imperative for the organizations that create a proper balance between them to
maximize their benefits and as a result reduce the harmful effects of uncertain economic
environments.
In this research a thorough analysis of determinants of capital structure for companies
in Spain has been provided. This study will add to the existing literature available on the
subject matter and enable the readers to gain better understanding about the research topic.
Moreover, the findings of this study can be used by business organizations to improve their
capital structure and make their operations more effective (Salim and Yadav, 2012). In
essence, it can be said that through this study the researcher explored into different aspects of
the topic and studied the various capital structure theories as well. Spain is considered as one
of the key European markets and large number of multinational as well as local companies
operate in the country. They need to learn and understand as much as they can about
determinants of capital structure.

1.1 Rationale of the study

In this study the researcher has presented a thorough analysis about different
determinants of capital structure. The main reason for conducting this study is to study the
various aspects of capital structure in Spanish companies. Many studies have shown that
capital structure is among one of the most important aspects of operations of a business
organization (Öztekin and Flannery, 2012). Considering the fact that Spain is one of the most
important European markets, it is all the more important for companies that they develop and
implement a proper structure. This way the firms can perform in a better manner and also be
safe from the uncertainties prevailing in the economic environment.
A capital structure is important because it limits risks for the firm by a great margin. It
essentially indicates the risk zone for the company. Therefore, it can be considered as an
effective tool to identify the risks and reduce them by a great margin. Capital structure can
enable the Spanish companies to find ways to limit and reduce their risks while also focusing

2
on improving their operations. Ramjee and Gwatidzo (2012) stated that it can be a very
effective way through which managers and leaders can improve sustainability of the
enterprise as well. But there are a large variety of factors and forces that influence capital
structure of a company. The Spanish companies can use the findings of this study to learn
more about these factors and use this information as a base for taking effective decisions
(Jõeveer, 2013).
Another reason for selecting this topic for the current study was the fact that Spanish
economy is maintaining its momentum and is growing at a very rapid pace (Spain Economic
Outlook, 2018). New opportunities as well as threats are emerging for the business
organizations. According to Morellec, Nikolov and Schürhoff (2012) the current research
work has put more focus on identifying and understanding these various determinants so that
the Spanish companies can operate effectively and also take advantage of the latest
opportunities emerging in the environment.

1.2 Aim and Objectives

The aim of this study is “To Study the Determinants of Capital Structure in Spain”.
To achieve this aim, the following objectives had to be fulfilled:
 To explore the role and importance of capital structure for companies in Spain.
 To evaluate the theories of capital structure.
 To study factors affecting capital structure in Spain.

1.3 Research Questions

By answering the following questions, the researcher was able to achieve aim and
objectives of the current research investigation:
 What is the role of capital structure for firms operating in Spain?
 What are the different theories that support capital structure?
 What factors influence the capital structure of companies in Spain?

1.4 Scope of the study

This study is important due to a wide variety of reasons. One of the most important
reasons is the fact that the Spanish economy is growing at a very healthy rate. New
opportunities are emerging along with their own set of threats. Thus, this study adds to the
existing knowledge and literature available on the subject matter (Li, Lu and Song, 2015).
But this research investigation is different from the past scholarly work because it sheds light

3
on the factors that affect the choice of a capital structure and helps managers to determine
effective ways to improve firm’s performance. Through the findings of this study can be used
by Spanish companies in order to enhance their performance as well as position in the
market. Such knowledge can enable the managers and leaders in Spanish companies to take
effective decisions (Acaravci, 2014). The researcher in this study has presented some very
interesting aspects about the determinants of capital structure and their overall influence on
company’s capital structure and the organization as well.
Apart from this, the current study can also be used by future scholars who wish to
further expand the research topic. In the future, topics such as impact of capital structure in
limiting risks for companies or relationship between capital structure and performance of a
business entity can be explored. This study can be considered as a base by the future
researchers. Findings of the current research will help them to get a better understanding
about the research topic and the various aspects pertaining to it.

1.5 Structure of the study

The following points consist a description about contents of each of the chapters. By
developing a proper structure, the researcher can conduct the study in an efficient and
effective manner.
 Chapter 1 Introduction: This part provides an introduction to the research study. This
chapter can be termed as the beginning of a new investigation. It is an important part
of any research study. As the name suggests it introduces the readers to the research
topic. One of the key aspects of this chapter is that it consists of an explanation for the
reasons for selecting the research topic. Through this section the scholar also presents
aim and objectives of the investigation and ensures that the readers are able to
understand reasons for evaluating the topic.
 Chapter 2 Literature Review: In this section the researcher provides a thorough and
critical analysis of different aspects pertaining to the subject matter. This is an
important chapter in context of the current study because it enabled the researcher to
learn more about the topic and thus ensure that its aim and objectives are fulfilled.
Over the years many studies have explored the topic of determinants of capital
structure. Through this chapter the researcher was able to critically analyse findings of
different studies that have been carried out on the topic.
 Chapter 3 Research Methodology: This chapter provides information about different
tools and methods used by the research to conduct the study in an efficient and

4
 effective manner. It is a very important chapter. The information shared and presented
through this section enabled the researcher to control the study and thus ensure that its
aim and objectives are fulfilled. Aspects such as research philosophy, approach, data
collection instruments, data analysis, etc. have been discussed in this chapter. One of
the main purposes of this section is to enable the researcher to set the boundaries and
conduct the study within those.
 Chapter 4 Data Analysis: As the name suggests, in this part the researcher presents a
thorough analysis of the data collected through different sources. Essentially there are
two ways to analyse the data – qualitative and quantitative. In this study the
researcher has used qualitative approach for data analysis. Through this approach the
scholar was able to thoroughly analyse the subject matter. By using qualitative
methods of data analysis, the researcher was able to comprehensively evaluate the
data and identify as well as evaluate the various determinants of capital structure for
companies operating in Spain.
 Chapter 5 Conclusion and Recommendation: This section provides an overview of
the whole research study. It is an important chapter for the current research because it
would enable the reader(s) to get a better understanding about the topic and also the
findings. It will be the first chapter that majority of the readers would read and
therefore, it may be said that this will be the point of attraction for the readers.

5
CHAPTER 2: LITERATURE REVIEW
2.0 Introduction
In this chapter the researcher conducts a thorough and extensive analysis about
different aspects of capital structure and its determinants. A critical evaluation of the past
studies helped the researcher to learn more about the research topic and thus was able to
conduct the study in an efficient and effective manner.

2.1 Definition of capital structure

Focusing in relation with the capital structure, it is being determined as the funds
being used by the business to finance their operations by a certain combination of owner
equity as well as liability. Normally, leverage ratio is being referred as the ratio of debt to
total financing. From the practical point of view, various other meanings of capital structure
decisions is being applied in the literatures. Near about all the studies scrutinise some of the
substitutes of leverage ratio. According to Abor (2008), capital structure decisions are
considered by long term debt to total assets and short-term debt to total assets. On the other
hand, Faulkender and Peterson (2006), investigated the decision related to the capital
structure in the definition of total debt to book value of total assets and total debt to total book
value of assets minus book value of owner equity plus market value of equity (Adedeji,
2008). All these definition of decisions about the capital structure differs in whether short
term and long term debt and total debt. Further, they are also according to the market value or
book value of the assets.
In the recent years, Welch also suggested that to measure the leverage, financial debt
to asset ratio is being regarded as a flawed. The concerned ratio increases with the increase in
the financial debt which is right, however it decreases with the extension in non-financial
liabilities which is not correct. Therefore, it is crucial to avoid financial debt to asset ratio in
the future research. To overcome this issue, another ratio was being introduced such as total
liabilities to total assets and the balance sheet leverage which has better reasonably common
substitute measure of leverage (Ferranda and Serrasqueiro, 2017). In addition to this, total
liabilities to total assets rightly stipulate higher leverage when the financial and non-financial
liabilities of the firm are higher. Additionally, when the creditors evaluates their clients for
the purpose of offering them the loan they generally takes into account leverage of the firm as
total liabilities. Consequently, corporate debt capacity is being impacted by the long term
debt as well as from the other liabilities too. Other than this, the trade credit which is
regarded as the vital aspect of the current liabilities is important source of short term debt.

6
Thus, it is essential to include account payable in leverage measures. Underpinning the
discussion, total liabilities to total asset is being regarded as the most suitable proxy of capital
structure decisions (Akdal, 2010).

2.2 Theories of capital structure

It is a well-known fact that capital structure is one of the most important aspects of
operations of business entities (Li, Lu and Song, 2015). A properly developed capital
structure makes the firm more resilient to economic changes and uncertainties and also
contribute in making operations of the firm more sustainable. Over the years various theories
have been developed by different experts and researchers that help in understanding the
capital structures in a better manner. The study of Lemmon and Zender (2010) focused on
debt capacity and tests of capital structure theories. One of the key findings of this study was
that the internally generated funds are the preferred source of funding and finance for
companies. This means that organizations generally tend to prefer using the internal sources
for arranging the necessary funds and thus realize its goals and objectives. But the researchers
also found that in absence of any concerns regarding deb capacity, it is the most preferred
option by the business organizations (Salim and Yadav, 2012). This was a major limitation of
the study, as this finding is more suited for publicly traded companies. Thus it can be said
that debt capacity might not be a major concern for private firms. Through the current study
the researcher has explored the determinants for both public and private companies.
Lemmon and Zender (2010) further found that profitable companies with low
leverage and minimum transaction costs for issuing new securities generally tend to rack up
on their debt capacities. This means such types of organizations prefer using the debt as the
primary aspect of their capital structure. These companies use debt as the key source for
arranging the necessary funds and as a result ensure that operations for the firm are managed
in an efficient and effective manner (Abdullah and Naser, 2015). But finding of this study
was consistent with the pecking order theory. The authors further stated that it is very
difficult to use the trade-off theory as the primary way of explaining the debt capacity of an
enterprise.
Margaritis and Psillaki (2010) in their study evaluated the relationship between capital
structure, ownership structure and firm performance in different French manufacturing
companies. Productive efficiency was considered as the key measure by the researchers to
analyse performance of the firms. The researchers further used non-parametric Data
Envelopment Analysis (DEA) methods to empirically construct the industry’s ‘best practice’

7
production frontier and measure firm efficiency as the distance from that frontier. During the
study Margaritis and Psillaki (2010) stated that concentrated ownership can help in improving
the performance of a business organization by a great margin. This means that according to
the two authors ownership structure is a much effective way of managing the business
operations. But the findings of Jõeveer (2013) contradict. Their findings clearly argue and
state that a capital structure can help the managers in determining more effective ways to
oversee as well as control the business operations. According to them, capital structure
provides greater flexibility to the management and also enables them to take tough decisions
that can have a significant impact on firm’s performance. Bae, Kang and Wang (2011)
explored the stakeholder theory of capital structure. The focus of this study was on
relationship shared by an organization with its employees. According to their findings,
companies with better relations with the employees are able to maintain low debt ratios. This
means that they have less debtors. It is a clear indication that such firms area able to perform
a lot better than their counterparts and are in a much better position to face the market
conditions as well (Acaravci, 2014).
Practically, the decision in regards with the capital structure is quite complicated.
There are five important theories which can be used to describe the capital structure decisions
such as static trade-off theory, agency theory, dynamic trade-off theory, market timing theory
and the pecking theory (Cassar and Holmes, 2003). All the above defined theories are being
dependent on the tax benefits of debt financing, agency cost, bankruptcy, asymmetric
information, issuance cost etc. The explanation of five theories of capital structure is being
performed in the subsequent paragraph:

The static trade-off theory

The basis for contemporary approach of capital structure was being founded since
Modigliani and Miller (1958) developed the original MM prepositions. Both have executed
the MM prepositions which suggested that in an efficient market having no taxes, symmetric
information and bankruptcy costs on the prospects of the firm amid corporate insiders and
outsider’s investors, the capital structure of the firm is quite irrelevant to its value. Pertaining
to this, the value of un-levered and levered firm is similar. In addition to this, it was also
stated in the basic of MM prepositions 2 that the cost of equity capital is a linear increasing
function of the debt of the organization to equity ratio (Shyam-Sunder and Myers, 2009). The
advancement in debt will increase the needed return on equity. The raising risk from the
financial leverage is indeed reimbursed by increase in the needed return. Thus, irrespective of

8
the capital structure, the weighted average cost of the capital remains constant for a given
company. Other than this, Modigliani and Miller also introduced preposition 3 which stated
that the cost of capital will be exercised as a cut-off point for the investment decision of the
company and it will not be influenced by the source of financing. One of the most vital
prediction of this theory is the positive relationship amid the profitability and leverage of the
firm. Companies which are more profitable are going to benefit more from the tax savings
and decrease in the bankruptcy costs. Moreover, those firms which possess more tangible
assets which can be utilized as collateral and bankruptcy costs are supposed to be lesser (Ang,
Chua and McConnell, 2002).

Dynamic trade-off theory

In the year 1984 Myers specified that those organizations who follow the trade-off
theory set their target capital structure and gradually move ahead in regards with their target
leverage. Years later, Fischer et al. (1989) developed dynamic trade-off theory. This theory
grants the optimal dynamic capital structure of the company to rely in the advantages and
cost of debt financing underlying the asset variability, costs of recapitalizing and the riskless
interest rates (Castanias and DeAngelo, 2001). Further, the dynamic trade –off theory also
suggests that the actual leverage ratio can vary from the optimum level and the company need
to rebalance their activities related to finance in order to take the leverage ratio back to the
ideal level. This will happen only when the benefits prevail over the costs of adjustment. The
process of adjustment is dependent on the costs and benefits of equity as well as debt
financing. Therefore, it can be said that the corporate leverage might not blend with their
target capital structure always and the organization to some extent meet out to their target
capital structures (Jõeveer, 2013).

The agency theory

There is another theory related to the capital structure i.e. agency theory. Their theory
is being divided into two parts. One part pays attention to the conflicts amid the equity as
well as debt holders and the next part pays attention on the conflicts between the shareholders
and the managers of the organization. The last part of the agency theory needs to deal with
the conflicts amid the shareholders and the managers of the firm because of the differences in
motivation as well as interest on the way money should be spent. According to Jensen (1986),
the main problem is findings ways to motivate the managers so that they spend cash instead
of investing the same at below the cost of capital (Ang, Chua and McConnell, 2002). This

9
theory is also being known as free cash flow theory. Increasing debt can be considered as the
prevention against this problem as suggested by Jensen. With debt, the free cash flow of the
company will decrease due to the interest that needs to be give off. Talking in reference with
the free-cash flow, it is being referred as the excess amount of cash available with the
organization after investing the money in all positive net present value projects.
Further, the conflicts amid the managers and shareholders arise because of several
reasons. Firstly, the shareholders of the company holds an assumption that the managers does
not spent money in a correct manner. This is being assumed by them because of diverse level
of interests. The main aim of the manager is to search for those investment that offers them
growth and success (Ang, Chua and McConnell, 2002). If the firm will achieve greater
heights than it will also increase their power, as resource will also increase. Another reward a
manager can get from good work is promotion. Thus, the managers on a prior basis
investigate the ways of increasing their own wealth before thinking in regards with the
interests of the shareholders. On contrary, the shareholders of the firm desires that the
manager spend money in such a manner that they in return get highest amount of dividend for
their investment in the share of the organization. for making the organization grow, there is a
need of investment and thus, the managers makes use of some of amount which can be give
off as dividends to shareholders considering their own interests to expand the value of the
company (Castanias and DeAngelo, 2001).
To see whether the managers are not investing money in no-profitable projects,
agency costs need to be formulated. For decreasing the agency costs, debt can be utilized.
Speaking in relation with the agency costs, it is being defined as the costs which are required
to monitor as well as control the managers of the firm. Further, the management is considered
as an agent for the shareholders for investing their amount in the correct manner. Thus, to
control that their money is being invested in the correct manner costs needs to be made.
There is one more threat that results in agency costs is underinvestment. This situation takes
place when the firm had a no choice instead of investing the amount in a low risk assets by
means of debt covenants (Ogden, Jen and O'Connor, 2003). The main problem is that even if
the asset has positive net present value, the debt provide will only get their money because of
the low profit that has been offered with the asset. Pertaining to this, conflicts are more likely
to happen amid the debt providers and the shareholders. For the purpose of controlling the
managers to invest money in risky projects agency costs needs to be established.

10
The Pecking order theory
This theory is being proposed by Myers & Myers and Majluf (1984) which explains
the ways firms takes decisions regarding how to finance and its influence on the capital
structure of the firm. The pecking theory has a major role to play when the organization is
probing for incremental financing. Because of the shortage of financing the firm is required
to think in regards with different types of financial resources that can be used to fill up the
gap (Morellec, Nikolov and Schürhoff, 2012). Companies which are quite large have more
alternatives for different financing. As they have better image in the market and thus, it
becomes easier for them to borrow money as compared to the smaller firms. The pecker
theory is dependent on the fact that there is irregularity in data amid the managers of the
company and their investors. Thus, it can be noticed from this theory, that companies prefer
internal financing above external financing. If firms makes use of external financing than it
will definitely favour debt above equity (Hall, Hutchinson and Michaelas, 2004).
Asymmetry in data takes place when the managers know more in regards with the
value of the firm in comparison to the investors in the market. However, according to Hiller
(2011), managers are not better in identifying the value of the firm than the investors. This
statement signifies that with the present of the same data investors can perhaps make more
reliable estimations of the value of the firm (Ogden, Jen and O'Connor, 2003). Companies
always favour those method of financing in which they need to offer less data. Further, if this
is not possible than they utilizes debt wherein relevant data only needs to be offered to the
suppliers of debt and through issuing stock information it must be offered to all the investors
on the market.

The market timing theory

In recent time, the idea in regards with the market timing has become more popular
due to the reality that the financial condition of the company alters with the passage of time.
Baker and Wurgler (2002) has suggested this theory and it is being implemented to elucidate
the ways companies settle on the issue pertaining to finance their outlays with equity or debt
instruments. The market timing theory stated that the existing capital structure is nothing but
the collaborative influence of standard applications to time the equity market. Other than this,
it also suggests that corporate executives are rationale managers which are capable enough to
time the current conditions in both equity markets and debt markets (Jensen and Meckling,
2006). Furthermore, the executives also takes into account that the investors are also illogical.
Consequently, they issue equity when share price is quite higher and repurchase the same

11
equity when the stock prices is quite low. Between this processes, the fund raising might be
delayed because of the unfavourableness of either equity markets or debt markets. Companies
prefer to have equity when the relative cost of equity is low and goes for debt when the
relative cost of debt is low.

2.3 Determinants of Capital Structure

Previously in the above section theories that are major elements to judge the capital
structure of a firm had been discussed. Since most of the impacts are unnoticed, to understand
impact of these theories on capital structure accounting practices need to be analysed. In
subsequent section specific features which influence the capital structure of the firm to be
discussed (Hall, Hutchinson and Michaelas, 2004). It must be kept in consideration that
change in a factor can give firm incentive to have slightly more/less, or slightly more/less
funds for lending. Primarily introduction of the authors work and effect of the element had
been motivated. Same had been measured by a short presentation of the chosen delegation,
how it is made and lastly, the probable affiliation between the factor and the capital structure
measures. Factors had to be presented in the subsequent order: effective tax rate, non-debt tax
shields, risk, asset structure, size, age, growth opportunities and profitability (Jõeveer, 2013).

Effective Tax Rate

According to the static trade off theory the major advantage are the tax benefit of
debt. As interest payments on debt are taxable these benefits happen, while dividend payment
to equity owners are not taxable. As a result debt is cheaper than equity and due to high tax
rates, tax benefits of the debt are also high. The substitute of interest tax shields are being
defined as tax dividend by earnings prior taxes that is the effective tax rate as well as to
expect to find a positive relationship to all of the leverage ratio (Homaifar, Zietz and
Benkato, 2004). This is also being reinforced by many other earlier studies related to
Homaifar (1994) as well.

Non-debt Tax Shields

In the year 1963, Miller and Modigliani has stated that companies possess strong
incentive in regards with increasing the leverage because of the deducible interest tax shields
(Salim and Yadav, 2012). On contrary to this, sizeable amount of non-debt related corporate
tax shields like tax deductions, tax credits for research and development might depict that
there is inverse relationship between the debt and non-debt tax shields. Further, DeAngelo
and Masulis (1980) presented an argument that higher amount of tax shields is the indication

12
of higher probability of non-taxable income and therefore, the expected corporate tax rates
and the expected pay off from the interest tax shields decreases significantly (DeAngelo and
Masulis, 2000). Hypothetically, this is being backed up by the static trade-off theory which
foresees that companies having larger amount of non-debt tax shields have low expected tax
rates and thus, they have less amount of book leverage. All these estimates are being
empirically underpinned by De Miguel and Pindado (2001), while on the other hand Titman
and Wessels (1988) explored that there is no statistical proof for an effect on debt ratios being
ascending from the non-debt tax shields. For the substitute of non-debt tax shields, the ratio
related to annual depreciation expense over sales is being used. As per the argumentation
being described above, there is a negative relationships amid the all the leverage ratios as
well as substitute is being expected (Baltacı and Ayaydın, 2014).

Risk
Many authors argues that the unpredictability in income is a measure of operating risk
possess negative influence on the leverage of the company. Myers (1984) debates that those
which are risky firms are more likely to borrow less as a higher discrepancy rate in net
income can increase the probability of default (Myers, 2014). In addition to this, companies
with unstable earnings are provided incentives that should not make fuller utilization of their
tax benefits as they are more chances that might be exposed to agency and bankruptcy costs.
On contrary to this, numerous types of counter hypothesis have also been offered such as
Jaffe and Westerfield, 1984, Castanias and DeAngelo, 1981 etc. (De Miguel and Pindado,
2001). Further, empirical research being carried out by Titman and Wessels and Cassar and
Holmes was also not successful in searching a statistical relation for small and medium firms
and large firms. Additionally, Wald (1999) originated contradictive outcomes as the influence
was seen to be dependent on nation. More astonishingly, there has been limited amount of
research being carried out on small and medium enterprise still it suggested a, affirmative
relations amid the leverage as well as risk (Titman and Wessels, 2008).

Asset Structure
The kind of assets being owned by the company is being regarded as one of the most
vital determinant of capital structure as per most of the theories related to the capital
structure. Further, the liquidation value of the organization is being affected by the extent to
which the assets of the company are generic and tangible (Jensen and Meckling, 2006).
Moderately larger proportion of tangible assets will augment the liquidation value of the

13
organization as the value of the assets which are tangible can be evaluated more easily.
Consequently, there are more chances that tangible assets will be accepted as a collateral
security in comparison with the intangible assets. Through collateralization of debt, funds
being offered to the borrower are constrained to a particular kind of a project (Gilson, 2007).
If there is presence of no such guarantee in a project than the creditors will need more
favourable terms. Significantly, this will compel the organization to make use of equity
financing. Other than this, making use of tangible assets as a collateral security will help in
preventing the risk related to shifting as it will be challenging for the company to shift their
investment to riskier projects. Thus, it can be said that high large fraction of the tangible
assets helps in increasing the willingness for supplying finance by lenders and helps in
augmenting the firm’s leverage as well (Castanias and DeAngelo, 2011).

Size
An extensive number of authors such as Fama and French (2002) have proposed that
there is a positive relation between the leverage and size of the firm. Further, Warner (1977)
stated that with the increase in the value of the organization, the ratio of bankruptcy costs to
the firm also decrease. Moreover, the influence of all these expected bankruptcy costs is also
minimal for firms which have large borrowings decisions and also allows them to have more
amount of leverage (Barclay, Morellec and Smith, 2006). On the other side, those firms
which are small need to face varied reality in terms of acquiring long term debt. This
situation does not pertains because of the unevenness of the information however it is mainly
due to strong negative cooperation amid the probability of bankruptcy and size of the firm. A
conceivable elucidation is that comparatively organizations which are large tend to be more
diversified and therefore, there are less chances related to bankruptcy. But, Fama and Jensen
(1983) recommended that companies have to fight with less asymmetric information
problems, if the transaction costs are being reduced for the large firms. This should increase
the preferences of the larger corporations for equity over debt in comparison to the smaller
and medium enterprise (Fama and Jensen, 2003).

Age
The capital structure can be affected by the age both in terms of the pecking order
theory and static trade-off theory. As per the former, organization which are old have track
record which is being considered as a base for the long term lenders for taking their lending
decisions (Alzomaia, 2014). Pertaining to this, the firms which are new such as SMEs and not

14
large companies, are compelled to depend on short term financing. The pecking order theory
supports this hypothesis that those corporations which are old have more accumulated funds
which helps in eliminating the need for external lending in short period of time. As the
marginal influence of an additional year of track record will reduce with age, there is
utilization of natural logarithm of age for the purpose of controlling the possibility of non-
linearity. On the basis of the above arguments, it is expected that age and long term debt are
positively related whereas age and short term debt are negatively related with each other
(Adam and Goyal, 2008).

Growth Opportunities
It is also being regarded as the possible factor that helps in determining the capital
structure which is being enclosed by uncertainty in terms of its effect on leverage of the firm
and the ways of measuring it in an optimal manner. Those organizations who have higher
growth opportunities generally have higher demand for funds. Further, the firms are required
to turn towards external financing if in case the retained earnings cannot offer desirable
amount being required to fund the growth opportunities (Warner, 2007). This also advocates
there is a positive relationship amid growth opportunities and firm leverage.

Profitability
Pecking order theory states that organization likes to have internal financing than debt
and debt over equity. Those corporations which are more profitable are likely to have more
access to internal finance and they will make use of less external financing for the purpose of
funding their investment opportunities and operations. Several authors have empirically
tested the negative relationship amid the profitability and leverage and they always remains
clearly uncontested both for small and medium and large firms (Abdullah and Naser, 2015).
Wald (1999), in fact also originated that profitability impacts the debt of the firm to asset
ratio negatively.

15
CHAPTER 3: RESEARCH METHODOLOGY

3.0 Introduction
Throwing light in relation with the research methodology, it is being referred as a set
procedure to investigate the outcome of a particular given issue on a specified research
problem which is also being defined as a research problem. The current section of the
dissertation helps in reaching towards the aims and objectives and thus, varied approaches as
well as techniques are being adopted to achieve the same. For the purpose of reaching
towards the end results, the researcher is required to take into account effectiveness of all
methods techniques and approaches (Simon, 2011). In addition to this, this section of the
dissertation helps the researcher to explain the approaches as well as research design being
considered for the present study. It is rather an attempt in relation with the process of
explaining and vindicating the appropriate mode of design in regards with the problem of the
research. Therefore, this chapter of the dissertation is being segregated into two sections such
as methods of the research as well as implications of the kinds of data and the detained
evaluation of the collected information. The final part of this section will provide ephemeral
insight about the ethics being considered, various limitations being faced, reliability and
validity and importance of accuracy headed the same. All these techniques are being
elaborated in the subsequent section.

3.1 Research Method

Focusing in relation with the research methods, it is being defined as a tool that is
being used by the researcher to perform the study. There are mainly three types of research
methods such as qualitative, quantitative and mixed. Speaking about the quantitative research
methods, it mainly pays attention on examining numerical data and often needs utilization of
statistical tools and methods to evaluate the information being accumulated. Further, with this
research method, measurement of variables and their relationships can easily be developed.
Additionally, the data being gathered can also be represented in graphs and tables formats.
On the other hand, in case of qualitative research method, the focus is being done on patterns
(Ong, 2003). It is qualitative in nature and generally includes thematic analysis to evaluate
the accumulated data. And finally, in case of a mixed research method, both the methods i.e.
qualitative as well as quantitative methods are being adopted. It also allows the explanation
of unexpected results.

16
 In order to fulfil the current aims and objectives of the study, quantitative research
method is being adopted by the researcher. This method is being selected as it is suitable for
large sample and in the current research, the population is quite large i.e. various companies
in Spain. Furthermore, the result being gathered can be quantifiable and measurable. Other
than this, quantitative research will help in describing the phenomenon numerically will
accurately reflect the population.

3.2 Research philosophy

Research philosophy is being linked with the clarification of assumption in regards
with the source and nature of knowledge. In other words, it is nothing but a belief in relation
with the ways wherein information concerning a phenomenon is being accumulated,
evaluated and utilized. Each and every stage of the research process is dependent on the
belief about the nature and source of knowledge (Younus, 2014). This part of the dissertation
will showcase the vital assumptions of the researcher and these norms will going to serve as a
foundation for the strategy of the research. Normally, research philosophy incudes numerous
branches in regards with variety of disciplines. However within the scope of business studies
there are majorly four main research philosophies such as pragmatism, positivism,
interpretivism and realism.
Throwing light in relation with the pragmatism research philosophy, it takes concepts
to be germane only when they are being supported by action. Positivism research philosophy
follows the viewpoint that only factual knowledge being acquired by observation is reliable.
In such type of studies, the researcher’s role is restricted to accumulate the information and
its interpretation in an objective manner. Moreover, in such type of research, results are
generally quantifiable as well as observable (Pedhazur and Schmelkin, 2011). On contrary,
realism research philosophy is dependent on the notion of independence of reality from the
intellects of human. Finally, interpretivism research philosophy assumes that reality can only
be accessed through social constructions like shared meanings, instruments, language and
consciousness. Further, this philosophy mainly focusses on qualitative analysis over
quantitative analysis. In the current research study, the researcher has selected positivism
research philosophy because of the involvement of large sample of population and the
gathered data needs to be evaluated in quantitative manner.

3.3 Data collection

Data plays a crucial role in serving the starting points of many fields of study or
discipline whether it is marketing, physical science, humanities and social science. Thus, in

17
all these processes if utilization of information as well as knowledge is being involved than
accumulation of data is being regarded as the first step. This part of the research methodology
section is considered as the most vital and crucial for the study. In this section, the researcher
is required to focus on varied sources from which useful information or data related to the
topic of the study can be collected (Jick, 2009). Thus, data collection is nothing but a set
process through which information is being collected and measured on variables of interest in
a systematic manner. Dependent on the objective and goals, discipline and nature of data
sought, data collection approaches differs significantly. In addition to this, varied approaches
for the application of the methods will also differ.
Mainly there are two types of data that researchers finds while carrying out the study
i.e. primary and secondary data. Talking about the primary data, it is being defined as data
which is never being existed before in any form and thus, it is not published previously by
any authors or researchers. Furthermore, primary data is being accumulated for a particular
purpose such as they are critically being evaluated to discover answers to research questions
(Bartunek, 2007). On contrary to this, secondary data is being defined as that kind of data that
has been published in newspapers, articles, magazines, books and online portals and many
other sources. Furthermore, primary data collection methods can be of two types i.e.
qualitative and quantitative. The former one can stated in generalization as well as motives.
And the later one can generally be expressed in the form of variables. In the current research
report, the researcher has adopted secondary method to collect relevant information, facts and
figures. For this purpose, various articles, journals, magazines, online sources, books and
newspaper have been evaluated significantly on regards with the capital structure and its
various aspects.

3.4 Data analysis

Under this part of the research methodology section, methods being used to analyze
the data is being explained. There are two types of analysis takes place in the research i.e.
qualitative and quantitative analysis. In qualitative analysis methods such as focus groups,
experiments, interviews and many more is utilized. Further, it involves determining the
common patterns within the response and afterwards evaluating those patterns for the purpose
of achieving the objectives of the study. On the other hand, quantitative analysis takes into
consideration critical evaluation as well as interpretation of numbers and figures and make
efforts to investigate rationale behind the occurrence of the major findings (Agresti and
Finlay, 2006). Data analysis section is being considered as the most vital and complex part of

18
the research study wherein findings of the study are being assessed with a view to depict the
facts and figures being accumulated from the respondents. Thus, in the current research
study, the researcher has adopted quantitative analysis technique wherein data will be
assessed by using statistical analysis.

3.5 Reliability and validity

Talking in relation with the reliability, it is being defined as an extent to which the
similar responses can be attained by making use of same instruments more than one time. In
simple words, it can be said that if the study is being related with high level of reliability than
it other researcher are also able to obtain same result by adopting same methods in alike
situations. As per Wilson (2010), issues related to reliability many a times is closely linked
with subjectivity and at times when the investigator makes use of subjective approach in
regards with the study the level of reliability of the work will be sacrificed (Whittemore,
Chase and Mandle, 2001). On contrary to this, validity of the research is being elucidated as
an extent at which the requirements of the scientific research method is being adhered in the
whole research process. According to Oliver (2010), validity is being regarded as an essential
element for all kinds of studies. In addition to this, there are numerous forms of research
validity such as construct, internal, concurrent, external, face and criterion-related validity.
Some of the measures to ensure validity are as follows:
 It is important to ensure that proper time scale is being selected for the study
 As per the features of the study, suitable methodology should be selected
 It is vital to make sure that all the participants are not pressurized in any manner to
choose among the sets of answers
Further it is also crucial to comprehend that threats to validity and reliability of the
research cannot be eliminated completely but the researcher is required to make efforts to
minimize the threats as much as possible. The current research work is being performed and
made by seeking support from the reliable sources. This will surely going to help other
researchers and readers in their piece of work. Furthermore, since in the current study
secondary data has been gathered, it is ensured by the researcher that authorized websites,
books, articles have been reviewed. Moreover, the techniques and approaches being used in
the research methodology section are feasible as well as reliable to use.

3.6 Ethical consideration

Ethical consideration is being identified as one of the vital component of the research
study. The whole dissertation even doomed to failure if this section is not included in the

19
study (Miller and Salkind, 2002). Some of the ethical considerations that needs to be adhered
by the researcher while carrying out the study and these are as follows:
 The participants of the study should not harm to anyone in any manner
 Prior to the study, it is vital to take the consents of all the respondents
 The privacy of the participants should be ensured by the researcher
 Communication should be done while considering the aspects of honesty as well as
transparency
 Finally, any type of misleading information should be avoided by the researcher
Seeking help from all the above defined dimensions, the researcher has boosted the
value of the research work. Considering the importance of ethical consideration, the
researcher has not copied any of the content from the study of another investigator or
websites. The current work solely belongs to the researcher’s own thinking as well as level of
knowledge. Any type of misleading information is not used in the present study. All the
concepts as well as theories are being used in a suitable manner by keeping in intellect all
ethical considerations.

3.7 Limitations
It is quite normal that when any type of research study is being performed by the
researcher than it will have some or the other limitations. But, it is vital on the part of
investigator to make efforts in order to minimize the range of scope of limitations during the
whole process of the research. Further, it is also critically important to provide
acknowledgement of the research limitations in the research methodology section fairly
(Lynda, 2001). Additionally, it is always better to determine and concede the shortcomings of
the study instead of leaving them in the dissertation. Furthermore, it is also significant to
understand that only that shortcomings should be included that has affected the findings of
the study. Some of the limitation of the current research study are being defined underneath:
 The aims and objectives of the research are formed too broadly
 Because of the short time period, the research was not conducted extensively
 Since the research was quantitative in nature, the outcomes of the research was
limited
 Lack of resources for collecting the data

20
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