Capital Structure in Developing Countries
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Published: Thu, 15 Mar 2018
Capital structure aims to yield the lowest cost of capital basically it refers debt to equity ratio of the firm. To determine the optimum capital structure the capital amount should be fixed with change in the debt ratio. (Kim, 2006). This research analyses the study of capital structure theory of developing countries with different institutional structures. This study demonstrates the capital structure determinants across the countries and analyses two factors one firm-specific factor and other country specific factors in the context of leverage choice. The investigation includes detection of trade-off theory and pecking order theory which describes the financing choice of the firms. The determinants of the capital structure are information efficiency and liquidity premium, which helps to investigate firm’s capital structure. The stability of capital structure is generated with the majority variation in leverage ratios.
The focus of this research is to analyse how the capital structure choice is different between developed and developing countries. There are number of research based on the study of firm’s capital structure.
Capital structure in developing countries:
AIM: The main aim of this literature is to assess whether capital structure theory is portable across different countries.
Mayer (1990) says that there is difference between the financial decision in developed country and developing country. His data comes from aggregate use of funds which is used to differentiate the financial system based on few models, this approach extracts some problems. This research shows how profit-oriented firms make their financial decision. Mayer’s study determines the stylised facts from study of developed countries whether affects only these markets or they are more in general terms. (Laurence, 2001)
The focus of this study is based on three things which include corporate financial decision, factors affecting cross-sectional variability and the nationality of company between developed and developing countries.
This study uses the data across countries with institutional structures which are very important and helps to identify firm’s data as well as aggregate flow of funds data, factors behind institutional structure are business risk and tax rates. (Laurence, 2001). This literature contains cross section country comparisons with the context of testing the leverage.
“Rajan and Zingales (1995) included four variables to investigate the determinants of the capital structures across G-71 countries.” (Laurence, 2001)
The study is further divided into different sections such as analysing financing pattern, determinants of capital structure, elimination model, comparing country factors and finally gives suggestions. The section 1 includes the data sources and macro financial information. The data of this research is coming from IFC which stands for International Finance Corporation which analyses the financial statements of large companies for 10 year period.
In this model simple null hypothesis is everything should institutional and explains capital structure differences.
Empirically hypothesis has proven difficult in this study. The study lacks with statistical power to differentiate the models. Donaldson (1963) concludes that the capital structure choice depends on the investment and the profitability of the firm, and gives direct explanation that the profitable firms have less demand for external financing. Finally the study states that institutional factor helps to predict financial structure of a firm and also states that it is better than knowing the firms nationality. (Laurence, 2001)
This literature suggests finance theory is portable across countries and there is much to be understood in the impact the institutional features. It can be stated from this study that predictions of the study were in line with the predictions of finance theory.
Capital structure around the world
AIM: This study aims to analyse the importance of firm-specific and country-specific factors in the context of leverage choice of firms.
This study demonstrates that firm’s capital structure is influenced by two factors firm-specific and country-specific which affects the corporate leverage in two ways. These factors influence the firms leverage directly and indirectly. This study has systematically investigated the indirect effects.
Rajan and Zingales (1995) argues that the firm’s specific factors have much impact on the capital structure across countries and the country factors are also important. Demirguc-kunt and Maksimovic (1999) found that institutional differences between developed and developing countries explain large variation in use the long term debt and also observed that these factors influence the leverage.
However, “Sons and Philippatos could not find the evidence to support the importance of cross-country legal institutional differences in affecting the corporate leverage.” (Abe, 2008). This study observed some variations in the determinants of this structure the reason is due to difference in country variables.
This study has used data from large number of countries for the period of four years. They have used the power of leverage of regression in most countries.
“Overall, findings of this study indicate that the conventional theories on capital structure, developed using listed firms in the United States as a role model, work well in similar economies with developed legal environment and high level of economic development.” (Abe, 2008)
This study summarised the hypothesis for the firm and country factors and the hypothesis for equal firm specific coefficient tests. The theoretical framework on capital structure of firms is used as methodology, with running OLS regression technique for all firms in all countries.
The study gives two results one finding firm-specific determinants of leverage is different between the countries but the previous study assume equal impact of these determinants. The second result shows that there is indirect impact due to country-specific factors influencing firm-specific determinants of leverage.
Finally the study concludes that the impact of firm specific factors on cross country capital structure is significant with the prediction in the finance theory. These country factors matter in determining the leverage choice globally and can be useful in corporate capital structure.
Trade off theory or pecking order theory : Behaviour of Indian Firms
Determinants of Capital structure – An empirical study of firms in manufacturing industry of Pakistan
Capital structure and output pricing in a developing country
This is the study which investigates the capital structure by using the industry level data of a developing country. This study has an assumption that firms function in oligopolistic product markets. Their assumption is basically depends on the maturity of debt, competition and uncertainties. They have used example of recession, during downturn how the firms have increased their prices which influences the profit margins and do exactly opposite during normal period. This shows that they changed the structure during recession by reducing debt.
This case study investigates the capital structure of developing country by the affect of debt on output pricing. The study estimates two industries of Turkish economies by taking as benchmark which yields the interaction with the debt.
5.2 Methodology and time period
The study has used the empirical pricing model. The estimation period was restricted to ten years (1989-1999). The panel estimation is 8*11 dimension which helps to analyse and present the data.
“A feasible GLS method, weighted fixed effects regression, is used to allow for cross-section heteroskedasticity. The GLS is performed on the estimated variances from the first-stage pooled OLS regression.” (Erol, 2003)
5.3 Results of the study
The study finds two results, one output prices are increased with the influence of short term debt and long term debt has complete opposite effect and the other short term debt shows that is has cyclical effects on prices.
After analysis of Turkish economy the study shows that corporate debt structure is high dominating the short-term debt. The study is related to the prediction in the finance theory.
In the analysis of the direct impact of country-specific
Factors, we observe that certain factors like GDP growth
Rate, bond market development and creditor right protection
Significantly explain the variation in capital structure
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