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SEMINAR 3 (week 4)

Topic: Capital Structure

Q1: Read the paper Al-Najjar and Hussainey (2011): < Revisiting the
capital-structure puzzle: UK evidence>, The Journal of Risk
Finance.

(1) What are those predictions between firm characteristics

and firm leverage in the UK? (See Section 2. “Theoretical
background and hypotheses”)

Characteristics Relation Reason

to
leverage
+ Or -
Firm size + See trade-off theory in week 3’s lecture slide (p25).

We may expect a positive relation.

Conflicting results in the literature.

Titman and Wessels (1988) found negative relation; while

Rajan and Zingales (1995), Ozkan (2001) found positive
relation.
Tangibility + See trade-off theory in week 3’s lecture slide (p25).

We may expect a positive relation.

Titman and Wessels (1988) , Rajan and Zingales (1995),

Delcoure (2007) all found positive relation.
Profitability - See pecking-order theory in week 3’s lecture slide (p24).

We may expect a negative relation.

Titman and Wessels (1988) , Rajan and Zingales (1995);

Ozkan (2001) ; Delcoure (2007) all found negative
relation.
Market to book - See agency theory in the week 3’s lecture slide (p24).
ratio
We may expect a negative relation.

Rajan and Zingales (1995); Ozkan (2001) both found

negative relation.
Firm Risk ？ Al-Najjar and Hussainey (2009) did not find the exact
(BETA) hypothesised relationship.

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(2) How to measure capital structural in this study

(three approaches)?

long-term debt / Equity

Debt / Capital

Debt/ Equity

Different proxies of capital structure are employed in this study

to check the robustness of result.

(3) Explain the main regression model in section 3.

This regression explains what factors could decide a UK firm’s

capital structure. Those possible factors including ROCE; BETA;
TANG; MB; FIRM SIZE; ASSET UNIQUENESS; CHS;
NEXDR; DRCTR.

The dependent variable is Levi,t, and independent variables are

X (those above mentioned variables). ε is the error. It is
capturing everything that determines Lev after accounting for
X. The expected value of ε is ZERO. ε is independent from X.

See week 3’s lecture slides (P11-20) for the assumptions

for causality inference.

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(4) Explain the relation between long-term debt to equity ratio

and firm characteristics (Table 1).

There are only four variables statistically significant in Table 1.

They are all in italics. They are TANG; MB; SIZE and NEXDR.

For instance, the coefficient of MB in Model (1) is 0.4466117.

It is in italics, indicating the p value is less than 0.05. The
probability of making a mistake to reject the null hypothesis
(the coefficient is ZERO) is less than 5%. So it is safe to reject
the null hypothesis and trust the coefficient (0.4466117). It
means if a company’s market to book ratio increases by 1 unit,
the leverage would increase by 0.4466117 unit. In other words,
a UK firm with a higher market to book ratio (e.g. high
technology firm) would have more debts in its capital.

In summary, the results in Table 1 show that a UK firm’s long-

term debt to equity ratio would be higher if it has less tangible
assets (coefficient of TANG is negative); more growth
opportunity (coefficient of MB is positive); larger size
(coefficient of SIZE is positive); more non-executive directors
(coefficient of NEXDR is positive).

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(5) Are findings in table 1 consistent with financial theory

and prediction (see Q1)?

Comparing Table 1’s findings with prediction in Q1.

For TANG, Table 1 documents a negative relation to capital

structure. It is opposite to the trade-off theory prediction
(positive relation).

For MB, Table 1 documents a positive relation to capital

structure. It is opposite to the agency theory prediction
(negative relation).

For SIZE, Table 1 documents a positive relation to capital

structure. It is consistent with the trade-off theory
prediction (positive relation).

For NEXDR, Table 1 documents a positive relation to capital

structure. It is opposite to Wen et al. (2002)’s findings (negative
relation).

Note: It is very common if the empirical evidence is against the

financial theories predict. The results are sensible to sample
country and time period (you can find many other excuses to
explain the differences). For instance, you may find very
different results if you employ the latest UK data after Covid-19
lockdown.

(6) Both this paper and De Jong, Kabir and Nguyen (2008) cover
UK data. Comparing this paper’s results in question (4) and the
findings of De Jong, Kabir and Nguyen (2008) (See week 3
lecture slides page 35), are those two papers’ results consistent
for firm size, growth opportunity and profitability?

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Comparing Table 1’s findings with De Jong et al. (2008).

For firm size. Table 1 documents a positive relation to capital

structure. De Jong et al. (2008) also document a positive relation.
Its finding is consistent with De Jong et al. (2008).

So both papers support trade-off theory for the UK firms.

Large firms would and could have more debts in their capital.

For growth opportunity, Table 1 (MB) documents a positive

relation to capital structure. De Jong et al. (2008) document a
negative relation. Its finding is opposite to De Jong et al. (2008).

For profitability, Table 1 (ROCE) documents NO relation to

capital structure. De Jong et al. (2008) document a negative
relation. Its finding is not consistent to De Jong et al. (2008).