1.

1 Introduction

Capital structure is considered as one of the most important factors for an organization
because it can affect the financial position of the company and the stakeholders’ value. As the
organizations try to maximize their benefits or profits, the managers are expected to choose
the optimal level of debt and equity. When the firm chooses to use the high debt financing, it
might face high interest payment obligation. On the other hand, using more equity can be a
cause of less profitability because debt financing has tax deductibility feature unlike equity
financing. So, identifying the optimal capital structure is an important area of research.

One of the major objectives of a firm is to maximize the wealth of owners or shareholders of
the firm. The wealth of shareholders in turn is defined as the current price of the firm’s
outstanding shares. In order to achieve this objective firm’s management should take rational
financing decisions regarding optimal capital structure which in turn would minimize its cost
of capital (Goyal,2013). Capital structure refers to several alternatives that could be adopted
by a firm to get the necessary funds for its investing activities in a way that is consistent with
its priorities. Most of the effort of the financial decision-making process is centered on the
determination of the optimal capital structure; where the cost of capital is minimized, and
firms’ value is maximized. Capital structure theory suggests that firms determine what is
often referred to as a target debt ratio, which is based on various trade-off between the costs
and benefits of debt versus equity. The theory of capital structure was first established by
Modigliani and Miller in 1958. Following the seminal work of Modigliani and Miller (1958),
a vast theoretical literature developed, which led to the formulation of alternative theories,
such as the static trade off theory, pecking order theory and agency cost theory. The trade- off
theory states that the optimal debt ratio is set by balancing the trade-off between the benefit
and cost of debt. According to this theory, the optimal capital structure is achieved when the
marginal present value of the tax shield on additional debt is equal to the marginal present
value of the financial distress cost on additional debt (Myers, 1984). The pecking order
theory emphasizes the information asymmetry between the firm insiders and the outside
investors suggesting that firms use debt only when the internal financing is not available
(Myers & Majluf, 1984). Besides, the agency cost theory predicts the capital structure choice
based on the existence of agency cost. Therefore, given the unique features of banks financial
structure and the environment in which they operate, there are strong grounds for a separate
study on the determinants of optimum capital structure of State-Owned commercial banks in
Bangladesh with due focus on the profitability of core business operations of State-Owned
commercial banks.

1.2 Background of the Study

The internship experience was a way to get a flavor of the corporate scenario which will
definitely help me to transition into the next phase of my career. This report is a necessary
part of doing an internship in any organization. A report of this sort shows the learning
achieved through a formal venture. The financial analysis part was most important as I am
interning in the Finance department. The analysis has many parts such as capital structure
analysis. The analysis that I have done in this report is part of the work to show the effect of
optimum capital structure of state-owned commercial Bank in Bangladesh.

1.3 Problem Statement

In the study the researcher tries to find out what should be the best combination of a capital
structure. There are so many factors have to be considered while deciding on debt ratio and
the whole capital structure. Low business earnings may occur due to the chances of default
and bankruptcy. Risk and other so many factors must be considered at the time of taking the
capital structure decision. In view of this, researcher has undertaken the present study aiming
at examining the relationship and influence of some important factors like Tangibility,
Profitability, Size, Growth as well as Tax on the optimal capital structure of the respective
industry.

1.4 Significance of the study

This study has significant role to play in filling gap in understanding of the determinants of
optimum capital structure decisions of State-owned Commercial bank of Bangladesh. And
hence will serve as reference for financial managers to equip them with applied knowledge of
the potential problems in financing decisions / capital structure and profitability, as well as
determining their optimal level of capital structure to achieve optimum level of firm’s
profitability so that to meet wealth maximization goal of firms. In addition, it will serve as a
base reference for other researchers in the area of corporate finance.
1.5 Scope of the study

As the report is entitled as " Determinants of optimum capital structure: An Empirical Study
on State-owned Commercial Bank in Bangladesh", so it will mostly focus on capital structure
of State-owned Bank as well as the followings:

 Sources of long-term fund.

 Cost of collecting fund.

 Amount of equity.

Each of the above areas would be critically analyzed in order to find out the determinants of
optimum capital structure of State-owned commercial Bank.

1.6 Research Questions

The problem of the research can be summarized through answer the following questions:
What are the determinants of optimum capital structure of State-owned Commercial bank of
Bangladesh during the time period between (2012-2021)?

In the light of this problem the study asks some of the following sub-questions:

1. What is the position of capital structure of State-Owned Commercial Banks in

Bangladesh?

2. What is the position of profitability in State-Owned Commercial Banks?

3. Is there any impact of firm specific variables on the optimum capital structure in State-
owned Commercial Banks?

4. What factors should be determined to formulate optimum capital structure in State-owned

Commercial Banks?

1.7 Objectives of the study

General Objective of the study

The general objective of this study is to examine the determinants of optimum capital
structure of State-owned Commercial banks of Bangladesh, with an emphasis on performance
of core business operation of the bank.

Specific Objectives of the study

Based on the above main objective of this study and the problem statement, the study has the
following specific research objectives:

 To review the existing literature on capital structure and identify the key determinants
of optimum capital structure for banks.
 To analyze the capital structure of state-owned commercial banks in Bangladesh and
determine their current level of leverage.
 To identify the factors influencing the capital structure decisions of state-owned
commercial banks in Bangladesh, including firm size, profitability, tangibility,
liquidity, growth, and firm age.
 To explain the relationship between leverage and the determinants of capital structure.
 To provide recommendations for state-owned commercial banks in Bangladesh on
how to optimize their capital structure based on the identified determinants and their
specific business needs.

1.8 Limitations of the study

Though I have given utmost effort to prepare this paper but there are some limitations of the
study. Such are as follows-

 Time Constraint: The tenure of the Practical Orientation program is only three months.
So, limited time factor in writing this report is the main hindrance.

 Confidentiality: Since credit is very sensitive department, as a result bank employees

don’t want to provide all necessary information due to security and other corporate
obligations.

 Pressure on Workplace: The officers of Janata Bank Limited have been very helpful but
very busy with their works. They don’t have enough time to provide, as they are busy
with their assigned work. So, in some cases, observation was needed.
 Lack of Update Information: Since Bangladesh Bank (BB) regularly changes their
policy towards banks. So, to adjust with Bangladesh Bank, State owned Bank also has
changes rules & regulation according to BB. As a result, in all cases, I can't collect all
update information & strategy.

With all these limitations I tried my best to make this report authentic and worth reading.

2.1 Literature Review

Financing decisions are often appeared as complex decisions for management because high
amount of debt can cause an increase in interest expense or low amount of debt can raise in
corporate tax payment. So, the optimal level of debt and equity must be managed with
efficacy in an organization. This optimum amount of debt and equity in capital structures
mainly depends on different factors or determinants.

Ahmed et al. (2010) found that profitability, size, age, risk and liquidity are important
determinants of capital structure. Omet et al. (2015) found that size, growth, profitability and
tangibility are significant determinants of capital structure when working with Saudi 100 and
Palestinian 24 firms from 2006 to 2012. They found positive relationships of capital structure
with growth and size, and negative relations with profitability and tangibility of the firm.

Qaisi & Shubita (2013) found capital structure of business has positive relation with firm size
but negative relation with profitability. In addition to this, Alzomaia (2014) also stated that
size, growth, leverage, tangibility and profitability are prominent determinants of capital
structure, finding positive relationships of capital structure with size and growth and negative
relationships with tangibility and profitability.
Mishra (2011) worked on 48 profit making manufacturing companies during 2011 and found
negative association of capital structure with profitability, tax, and firm size but a positive
association with growth. These results are identical with the studies of Gupta & Gupta (2014)
who worked 25 Indian construction companies from 2008 and 2013. Besides, Fziau et al.
(2013) studied on 79 listed firms of New Zealand during 2013 and found mostly negative
relationships of capital structure with tangibility, profitability, ownerships, firm size, but a
positive relation with growth of the firms. These results are almost similar to the result of
Alipour et al. (2015) who studied the capital structure determinants on total 1,562 firm-year
observations from 2003 to 2007 in Iran. Kariuki & Kamau (2014) found positive association
with growth but negative association with firm size and no relation with tangibility and
profitability.

Sayılgan et al. (2006) identified that growth, firm size profitability, tangibility and non-
deducted tax are prominent determinants of capital structure, while Pratheepan & Banda
(2016) found approximately same result while studying with 55 listed companies of Colombo
Stock Exchange and the obtained results are identical mostly with the study of Sheikh &
Wang (2011).

(Pathak, 2005) studied the leverage decisions of Indian firms. His study explains the observed
variation in capital structure using a regression model. He identified six major factors
(tangibility, firm size, growth, profitability, liquidity) and one second tier factor (R&D) that
are related to leverage decisions. He found that leverage increases with increase in Firm Size,
Tangibility and Growth. In contrast, he found that leverage increases with the decrease in
Business Risk, Profitability, and Liquidity (Pathak, 2005).

Hossin(2020), analyzed the relationship among interest rate reforms, financial development
and economic growth of Bangladesh by using a financial deepening model and a simple
trivariate causality model. The inference of International Journal of Economics and Financial
Research 113 this study was that a deregulated deposit rate of interest will raise financial
depth and eventually enhance the economic growth of Bangladesh.

Lima (2009) conducted research in Bangladesh on pharmaceutical companies and the

findings of the research are almost same and are aligned with research results in rest of the
developed countries of the world. The size, value of assets, and financial cost do effect the
financial decision of the companies in this sector (Lima, 2009). The larger companies have
more access to funds and less chances of default that’s why they enjoy more borrowings as
compared to smaller firms.

Pandey (2001) examined the determinants of capital structure of Malaysian companies

utilizing data from 1984 to 1999. He classified all the data into four sub- periods that
correspond to different stages of Malaysian capital market. The results of his study found that
profitability, size, growth, risk and tangibility variables have significant influence on all types
of debt (Pandey, 2001).

Table-1: Summary of Literate Review

Author (Year) Country Methodology Overall Findings

Omet et al. Saudi and Panel data, OLS Capital structure is positively
(2015) Palestinian regression related with size, growth, but
negatively related with profitability
and tangibility.
Alzomaia (2014) SAUDI Panel data, OLS Capital Structure is positively
ARABIA regression associated with firm size, Growth,
Leverage, but it is negatively
related with Tangibility and
Profitability.
Gupta & Gupta India Panel data, OLS Capital Structure is negatively
(2014) regression related with Growth, Firm Size,
Profitability, Tangibility, but
positively related with NDTS.
Kariuki & Kenya Multiple Capital Structure is negatively
Kamau (2014) Regression related to firm size, but negatively
 Analysis related with growth.
Fauzi (2013) New Panel data, OLS Capital Structure is negatively
Zealand regression related to Tangibility, NDTS,
ROA, ownership structure, firm
size but negatively related with
growth.
Mishra (2011) India Panel data, OLS Capital Structure is negatively
regression related to ROA, Tax, Firm Size,
but positively related to Growth
rate.
Ahmed et al. Pakistan Panel data, OLS Capital Structure is negatively
(2010) regression related to ROA, Liquidity, Firm
age, but positively related to firm
size.