Thisstudy focuses on the relationship of the capital structure with firmperformance and firm value of the listed firms in Pakistan stock exchange (PSX).
The capital structure is one of the most complicated issues in the corporatefinance. This concept is generally explained by the mixture of debt and equitythat make a total capital. The part of debt and equity is up to financemanagers, that’s what percentage they choose of debt and equity. The decisionof making capital structure is an important one as the performance and value ofany organization is based on this decision. So, full attention has to be givenon this while making the capital decision. In any organization, the overallposition, including all types of assets, liabilities are shown. The term”capital structure” is a mixture of equity shares, preferred shares and longterm debts.
A careful attention has to be made when making the capital structure.With unplanned capital structure, companies fail in using funds in the correctmanner. It is important that the company should realize that by making a planof capital structure, it will maximize the use of funds and will be able toadopt the changes easily. Maximizing the firmsperformance and value capital structure play crucial role. Capital structure isone of the major sources to collect the fund which is used by firms in itsoperations and capital investment. The source contains debt financing whichfurther include long-term debt finance and short term debt finance. Equityfinancing include preferred stock and common stock which is sometime called asequity financing.
Many theories like, the agency theory, Information asymmetrytheory, Signaling theory and Trade off theory highlighted the relationshipbetween capital structure decisions with the firm performance. Agency problemis most important of all that happens between shareholder and managers, andthat’s why management does not get motivation for their maximum efforts whichare required for personal gain and that is for their interest and that’s whyfirm values goes down which are ultimately harm shareholder’s interest.Therefore debt financing is used to control or restrict the interest of managersregarding their personal gain. Debt financing reduces the free cash flowregarding the manager’s personal interest and focuses them to work for interestof shareholders. As per the asymmetric information theory manager of the firmshave more information than shareholders.
The managers which do have polishinformation provide positive information to shareholders and potentialshareholders for increase of its firm’s values. Signaling theory states thatmanager use incentive and signals the market that how their companydifferentiates from weaker one. Use of debt is important tool for abovementioned signals. By involving of debt in capital structure indicates thatmanager do have better expectation for future performance.
While equityindicates bad signals for the firms performance. For checking the impact ofcapital structure on firm performance many studies have been conducted tillnow. Debt financing and equity financing are main sources on which capitalstructure bases. The source shows mixed and contrasting results regarding theperformance and value of firm.
In un appreciating there is a positive relationbetween debt financing and firm value. While debt financing which are from bankreduces information irregularly problem and increase the investor interest infirm. Theconnection between profitability and capital structure is the one that acquiresappreciable attention in the finance literature. The study that tells us theeffects of capital structure on profitability will help us to know the complicationsin the performance and in capital structure. The new industrial firms have totake their firm into most complexes and in the most competitive environment.Therefore, these types of research findings will be useful in selecting thecapital structure to achieve its greatest level of firm’s profitability.
Thisstudy shows the statistical analysis to find the connection between the capitalstructure and profitability of the listed banks, finance and insurance sector.Firm’smanager faces financial problem and issue regarding equity and debt decision.Some of debt result has been mixed regarding the study of capital structure that has beencarried by scholars and researchers. According to the kochar(1997)strategic assets can be do valued or strategy which sometimes facts-thereforeorganizations do have ability to maintain and manage their policies regardingtheir work of key understand that what can they get from their resources. Soorganization should have to be more cautions regarding their policies andresources they have. Therefore it is significant for firm in Nigeria to haveknowledge about debt credit mix which with eventually increase the firmsperformance efficiently and effectively because by that they do have knowledgeof business functions and operation which is ultimately important for raisingfund in an organization and its operations research problem is to use theresources and capital structure in optimal level and to get maximum positiveresult that can be obtained of firm performs it’s operation with efficient andin effective manner. Firms are affected by debt financing because there arefixed which is to be rapid by companies agreement in specific period of timethose pay have nothing to do with the firms performance. Firm has to pay whetherthey are getting profit or loss.
While a firm which has its own funds that willnot have to repay anyone. Through that owner can gamble itself in organizationspecially have venture its investor and through over external financing companywill result by over-leveraging. Which result wide variety of debt in thebusiness which ultimately results in barrier in business operation andfinancial return, The study has been carried on this topic in bulk in differentadvanced countries which do have effectively running stock market some of bestresearcher has best knowledge has conducted regarding this topic in the contextof Pakistani and get help from the studies carried out by Pakistani firms. Itis obvious that there isn’t been any agreement regarding the structure ofcapital on the value of Pakistani firm. Generally,banks involve in financial intervene to ensure effective compilation andexpenditure of funds to the real sector of the economy. Though other financialinstitution continues to involve in the intermediation process banks aretreated the most financial intermediaries. According to Miller and Modigliani,(1958, 1963, and 1977) “The aim of a firm is to maximize the wealth of a firm.The link between capital structure and profitability has been subject ofexceptional breakthrough over the past decades throughout the irrelevancetheory.
In the article of Miller and Modigliani (1958) irrelevance theory, theyquarrel that capital structure not linked to the firm’s value. In the presenceof corporate income tax and cost of capital in MM”so they quarrel that themarket value of the firm is linked to the value of long-term debt used in itscapital structure.Structureof the capital is maximum considerable discipline of company’s procedure. Torecognize in what way businesses, companies and firms finance their operationor processes. It is essential to study determinates of their funding or capitalbuilding choice. Decisions of company related to the financing involve anextensive series of policy matter. For the capital market growth, rate ofinterest, security price determination and guideline they have application atthe private. Such decision has been influence at capital structure, corporategovernance and development of company, (Green, Murinde and Suppakitjarak,2002).
Association between thecapital building or structure and financial performance is that acknowledgedsignificant consideration in the finance literature how essential isconcentration of control for the company performance another words the types ofinvestor using, that control are question that journalists have tried toanswered for an extensive time previous studies show that capital structure hasrelating with corporate governance which is the significant issue of stateowned enterprise. To study the impact of capital structure or financialperformance, will support us to identify the potential problems in performanceand capital structure. Capital structure denotes to a combination of a verityof long period source of funds and equity shares as well as funds and surplusof an enterprise.
Understanding about capital structuretypically has been resulting from established economic that have manyinstitutional correspondences (Booth 2001). Main objective of the firm is to make profit and create a competitiveadvantage when company process the objective that is to maximize the profitsame-time minimize the its cost of goods. Whenever companies search resourcesrelated to the finance the debits investment they should take this objectivethat is minimize the cost increase the profit in consideration.
Capitalstructure as define by the Modigliani and Miller as capital structure is themixture of debt and equity that company uses in its operation.Themain objective of this paper is that effect of the capital structure measure bythe debt ratio on the financial performance measure by the earing per share,return on equity and return on the assets.Generally,banks involve in financial intervene to ensure effective compilation andexpenditure of funds to the real sector of the economy.
Though other financialinstitution continues to involve in the intermediation process banks aretreated the most financial intermediaries. According to Miller and Modigliani,(1958, 1963, and 1977) “The aim of a firm is to maximize the wealth of a firm.The link between capital structure and profitability has been subject ofexceptional breakthrough over the past decades throughout the irrelevancetheory. In the article of Miller and Modigliani (1958) irrelevance theory, theyquarrel that capital structure not linked to the firm’s value. In the presenceof corporate income tax and cost of capital in MM “so they quarrel that themarket value of the firm is linked to the value of long-term debt used in its capitalstructure.Theconnection between profitability and capital structure is the one that acquiresappreciable attention in the finance literature. The study that tells us theeffects of capital structure on profitability will help us to know the complicationsin the performance and in capital structure.
The new industrial firms have totake their firm into most complexes and in the most competitive environment.Therefore, these types of research findings will be useful in selecting thecapital structure to achieve its greatest level of firm’s profitability. Thisstudy shows the statistical analysis to find the connection between the capitalstructure and profitability of the listed banks, finance and insurance sector.Structureof capital is the combination of debt and equity to finance the firm itsassets. The running business go to finance projects for which it needs to raisefunds from different sources and make capital mix. While newly born firmfinance all its assets from those funds. During the succession periods firm maynot distribute all its profit as dividend.
But some proportion retain forfurther investment in productive assets. In attempt of capital structure choicefirm’s goal is to maximize overall value. However, it is not an easy task to concludeit accurately because irrelevant decision may lead to financially distress andenhance probability of bankruptcy.Modern theories mainly focus on factors of the structureof capital characteristics and its effect on the performance of the business.Aggarwal and Kyaw (2010) reported capitalstructure and dividend policies can be used to control agency cost. Capitalstructure and financing policies are internationally important to maximizefirms’ value (kayo & Kimura, 2010). Pachori and Totala (2012) found thatfinancial leverage strategy is riskier because wrong decision cannot besuccessful in any period in which it is implemented. Rauh and Sufi (2010) isdescribed that determinants of capital structure and various debt types areheterogeneous.
This finding suggests the capital structure choicesnecessarily how and why the firm use different types, sources and prioritiesfor debt. In the promotion stage of the firm need to raise debt finance whilerunning business can internally generated funds provide to finance newinvestment project (Rocca, Rocca & Cariola, 2009). In 2011, Uysal conducteda study which showed that target capital structure useful for managerialdecision to acquire rival in order to dominant in economy. Capital structureacross the countries as the positive and significantly correlated firms value(Psillaki & Daskalakis, 2009). Firm-specific factors on cross-country capital structure choicessignificant and consistent with standard finance theories (Jong, Kabir , 2008). Amidu (2007) also reported that the factors of capital mixsignificantly influence firm’s value.
Capital structure choices heavily rely ondebt (Delcoure, 2007).The purpose of the study is to answer the questionthat what should be the optimal capital structure of manufacturing firms.Sheikh and Wang (2011) have worked on the capital structure of manufacturingfirms of Pakistani listed companies in KSE-100 Index from 2003-2007. But thereis no signal study specifically conducted on determinants of capital structureimpact on leverage of textile industries in Pakistan. In addition, economic andenergy crises several firms have been affected which in results major problemsfaced by industries like corporate marriage or merger and acquisition, probability of default and high rate ofunemployment occurred.It has beenargued the profitable firms were less likely to depend on debt in their capitalstructure then less profitable ones.
It has also been argued that firms with ahigh growth rate have a high debt to equity ratio. Bankruptcy costs were alsofound to be a significant consequence on capital structure Kraus &Litzenberger (1973), Harris & Raviv (1991). Capital structure decisionsaffect a firm in two ways. Firstly, firms of the same risk class could possiblyhave higher cost of capital with higher leverage. Secondly, capital structuremay affect the valuation of the firm, with more leveraged firms, being riskier,being valued lower than less leveraged firms.Animportant question in capital structure theory relates to the size of thefirm’s financing decisions are driven by their own characteristics rather thanbeing the result of the institutional environment in which they operate Rajan& Zingales (1995), Hall et al, (2004). Capital structure and dividendpolicies can be used to control agency cost.
Capital structure and financingpolicies are internationally important to maximize firms’ value (kayo &Kimura, 2010). Rauh and Sufi (2010) is described that determinants of capitalstructure and various debt types are heterogeneous. Thecapability of a firm in managing its financial policies is very important iffirm realize that something should be gained from its specialized resources. The raising of efficient funds in an organization willhelp the corporation in its operations. Capital structure decision isimportant for any business for maximizing profit to the different stock holdersand also to improve firm’s power to work in competitive atmosphere.
Modigliani& Miller (1958), Damodaran (2001), Chou (2007), Dare and Sola (2010), Saad(2010), Pandey (2010)Theobjective of any corporation is to maximize the capital of the shareholder ofthe firm. The term structure of capital represents the relationship betweendebt and equity. This study focuses on the impact of capital structure onfinancial performance. Capital structures play an important role determiningthe risk level of the company and financial decision making process along withother resources.
Capital structure decision is important for any firm for maximizing return tothe different stock holders and also to improve firm’s ability to work incompetitive atmosphere. Therefore the very important issue confronting managerstoday is how to choose the mix of debt and equity to achieve best possiblecapital structure that would minimize the firms cost of capital and improvereturn to owners investment in the business. Does Capital structurematter?? Some people say it does not matter but it does matter in developingcountries like Pakistan. The main problem is deciding the proportion of debtand equity in capital structure. And this decision is depend on the owner’snature the owner is risk adverse, risk mediocre or risk taker. And owners chooseany strategy according to his/her nature. If the owner or shareholder is riskaverse so they choose first strategy that called un-geared/No debt strategy inthis strategy company don’t take it debt and they depend on totally equity inthis strategy the owner of the firm is risk adverse and in this strategy riskis almost zero.
In this strategy cost of debt is Zero percent. And secondstrategy is Low Debt/ Geared If a firm’s owner choose this strategy so thatfirm’s capital structure is probably like 20% debt and 80% equity. In thisstrategy owner is risk mediocre and they take some risk for some high returnand in this strategy Weighted average cost of capital (WACC) is lower thanun-geared. Third strategy is High Debt/geared in this strategy the owner isrisk taker for the more profit in this strategy the capital structure is like80% debt and 20% equity and weighted average cost of capital (WACC) in this strategy is higher than both previouscases. Different industries have different capital structure and nature ofbusiness and culture and social norms are also impact on capital structure. Modigliani and miller(1958) rejected the traditional view and came up with the new propositions toexplain the capital structure theory and here starts the birth of moderncapital structure theory. MM introduce the capital structure irrelevancypropositions in their famous work on the cost of capital corporation financeand the theory of investment. Schlosser (1989) defined as the capital structureproportion of debt to the total capital of the firms.
Bos and Fetherston (1993)pointed out that capital structure, being total debt to total asset at bookvalue, influences both probability and riskiness of the firm. Capitalstructure is most significant discipline of company’s procedure. To recognize in what waybusinesses, companies and firms finance their operation or processes. It is essential to studydeterminates of their funding or capital building choice. Decisions of companyrelated to the financing involve an extensive series of policy matter. For thecapital market growth, rate of interest, security price determination andguideline they have application at the private.
According to the Green, Murindeand Suppakitjarak (2002) such decision has been influence at capital structure,corporate governance and development of company. Thisstudy focuses on the relationship between structure of the capital, value andprofitability of registered corporations in Pakistan stock exchange (PSX). Thestructure of capital is one of the most complicated issues in the corporatefinance. This theory is usually explained by the mixture of equity and debtthat make a whole capital. The part of debt and equity is up to financemanagers, that’s what percentage they choose of debt and equity”. “The decision of makingcapital structure is an important one as the profitability of any organizationis based on this decision.
So, full attention has to be given on this thoughmaking the capital choice. In any organization, the overall position, includingall types of liabilities and assets has displayed. The term “capital structure”is a mixture of equity share long term debt and preferred shares”. “A careful attention hasto be made when making the capital structure. With unplanned capital structure,companies fail in using funds in the correct manner.
It is important that thecompany should realize that by making a plan of capital structure, it willcapitalize on the use of capitals and will be capable to adopt the changessimply”. Accordingto Miller and Modigliani, (1958, 1963, and 1977) “The purpose of a corporationis to increase the capital of shareholders””. Thelink between structure of the capital and firm’s performance and firm’s hasbeen issue of exceptional breakthrough over the previous years through theirrelevance theory. Structure of the capital is not related to firm’s value thestudy of (Miller and Modigliani 1958).Thisstudy is planned as follow. In chapter II, theoretical base has been describedalong with the empirical findings. Chapter III covers the data description andmethodological issues and explains in details the methodology adopted. ChapterIV is data analysis and discussion about empirical results.
Finally, Chapter Vreport conclusion recommendations and future research directions.Aswe know that capital structure effect on the profitability of any firm.Therefore, this research receives highly significant because it focuses thathow a firm can choose their capital structure and how their capital structurewill affect it.
Either it can affect positively or negatively. Thereis a clear and a very big scope for more research to understand how capitalstructure is made, how it mix with profitability, and what things of capitalstructure make a big difference