Factors Influence Of Capital Structure On Profitability Of Selected Chemical Industry In India

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1 Factors Influence Of Capital Structure On Profitability Of Selected Chemical Industry In India John Jacob. M PhD. Research Scholar, Dept. of Business Administration, Annamalai University, Chidambaram, Tamilnadu, India & Dr. Jothi Jayakrishnan Associate Professor, Dept. of Business Administration, Annamalai University, Chidambaram, Tamilnadu, India Abstract In this study to investigates the factors prediction of capital structure on profitability. Over fourteen year from 2000 to 2013 periods the research concentrate on that study. Sample criteria for selecting net profit margin based top fifty companies are randomly selected the chemical industry. Random sampling technique was used to decide fifty Indian chemical companies. The result reveals that the total debt ratio is positive significant related with the profitability. Long term ratio and size is negative significant related with the profitability. Key words: profitability, capital structure and chemical industry Introduction Capital structure refers to total liability of the company such as, share capital (preference and equity share), debts, retain earnings and others long term source. The capital structure is major division of debt and equity fund, John Jacob (2014). Firms with moderate level of long term debt, as in the market, will face an increase in sales, but firms with higher levels of debt standard will not have been significant growth in sales or in market, Campello Murillo (2006). Competitive environment and the time-series applications support the notion that the profitability is decreasing with the speed of reversion in profitability. Strebulaev (2003) argued that even though a positive relation between profitability and the optimal leverage ratio can be expected, there is a negative relation between profitability and the actual leverage ratio. Because of transaction costs, firms do not rebalance their leverage ratios constantly; instead, they allow them to move within a range surrounding the optimal leverage ratios. Mesquita and Lara (2003) stated that the choice between the ideal proportion of debt and equity can affect the value of the company, as much as the return rates can. The results indicate that the return rates present a positive correlation with short-term debt and equity, and an inverse correlation with long-term debt. Azhagaiah and Premgeetha (2004) suggested that the rapid ability to acquire and dispose of debt provides the desired financial flexibility of firms with a goal for growth. Harrington (2005) supported the theories of capital structure, which indicates that profitability is an important determinant of leverage. Huang and Song (2006) found that leverage in Chinese firms increases with firm size and fixed assets, and decreases with profitability. Pecking order theory suggests that firms will initially rely on internally generated funds, and then they will turn to debt if additional funds are needed and finally they will issue equity to cover any remaining. Thus, according to the pecking order hypothesis, firms that are profitable and therefore generate high earnings are expected to use less debt capital than those who do not generate high earnings. Hence, internal funds are used first, and when that is depleted, debt is issued, and when it is not sensible to issue any more debt, equity is issued (Myers and Majluf, 1984). Furthermore, Gleason et al. (2000), the utilization of different levels of debt and equity in the firm s capital structure is one such firm-specific strategy used by managers in the search for improved performance. Hence, most firms have strived to achieve an optimal capital structure in order to minimize the cost of capital or to maximize the firm value, thereby improving its competitive > RJEBS: Volume: 05, Number: 01, November-2015 Page 13

2 advantage in the marketplace through a mixture of debt and equity financing. Thus, selecting the right type of debt is an equally important issue as opting for an appropriate debt to equity ratio. The pecking order hypothesis suggests that firms are willing to sell equity when the market overvalues it (Myers, 1984). The relationship between capital structure and profitability cannot be ignored because the improvement in the profitability is necessary for the long-term survivability of the firm. Because interest payment on debt is tax deductible, the addition of debt in the capital structure will improve the profitability of the firm. Therefore, it is important to test the relationship between capital structure and the profitability of the firm to make sound capital structure decisions. Two major sources are available for firms willing to raise funds for their activities. The internal source refers to the funds generated from within an enterprise which is mostly retained earnings. It results from success company earn from their activities. The external funding may be by increasing the number of co-owners of a business or outright borrowing in form of loan. Issuance of equity helps in sourcing for fund through external financing leading to increment in the number of owners where its holders are entitled to dividends when surplus is declared and after meeting the mandatory. In the same way, the equity holders exercise a greater decision control over the firm because they bear the larger share of risk. On the other hand, outright borrowings by a company make her a creditor to the lenders. This may be through issuance of debentures, bonds or other forms of debt instruments. The holders of this are entitled to a fixed amount of interest to be paid before the equity or shareholders. They have lesser control over decision in the organization. The present study has been designed to address these shortcomings and to find out industryspecific determinants of capital structure by taking the chemical sector as a empirical study. Furthermore, an attempt has also been made to elucidate the finding and implication of the model and to make suggestions for analysts, managers, investors, and researchers. Operational definition Total debt ratio John Jacob (2015-a) mentioned that the total debt refers to both long term and short term debt is called total debt. Source of fund for which the firm has to pay a fixed cost or fixed return may be termed as leverage. They are stated that total debt ratio accepted level ranged between 30 to 40 percent is best mix of debt and equity. Debt/ equity ratio The debt-to-equity ratio is a measure of the relationship between the capital contributed by creditors and contributed by shareholders. A high debt/equity ratio means that a company has been aggressive in financing its growth with debt. Short-term debt: Debt with a short maturity, usually one year or less year liability is called short term debt. The value of this account is very important when determining a company's financial health. The company may be in poor financial health and does not have enough cash to pay off its short-term debts. Long- term debt A company held the loans and financial obligations lasting one or more year. Long-term debt for a company would include any financing or leasing obligations that are to come due in a greater than 12- month period. Capital gearing ratio A company with high gearing is more vulnerable to downturns in the business cycle because, decrease the sale and also affect the capital structure of firm or leveraged firm. A larger proportion of equity provides a cushion and is seen as a measure of financial strength. Size of a firm The firm size has been one of the most common variables used in explaining a company level of debt liability. Pecking order theory implies that size of a firm is positively related with leverage. Statement of Problem The choice of the combination of Debt- equity funding is made by the managers of the business. They decide whether to borrow, plough back the profits the business has made, the owners to raise more > RJEBS: Volume: 05, Number: 01, November-2015 Page 14

3 funds to expand the business, to increase the shareholders payout of returns on their investment, John Jacob (2015-a). Research focus on how the return on borrowed funds compared with the return on assets financed was also carried out to determine, whether the return on assets warranted the borrowing. Debts choice is very critical and unpredictable problem in company financial management, John Jacob (2015-a). In this research which capital structure funds are most influence the profitability of firm because, Chemical industry is importance part of Indian economic so, industry are affect and also affect the shareholders and markets. Hence, companies are use appropriate debt and equity fund and also get more profit and increase their shareholders benefit with getting deduction of tax shield. Objective of study To identify the profitability average of chemical industry in India To evaluate the factors influence the profitability on capital structure chemical industry in India Hypotheses Ho: the positive relationship between short-term debts with profitability Ho: the negative relationship between gearing, total debt, long term debt and size with profitability. Scope and limitation The contribution of this study was to help the manager of the companies to make good decisions on the proportions of their capital structure. If they have taken too much debt in the operations of the company, thus can make the companies go bankrupt. Hence, this will provide and add new knowledge to corporate managers as a benchmark in making their own decision on the company performance. To the author s knowledge there is a lack of similar research done on Indian companies especially on examination of lagged values towards the firm profitability. Hence, this research will explore the extent to which debt influences firm profitability. In addition, it is interesting to differentiate shortterm debt, long- term debt and total debt effects since they have different risk and return profiles. Variable measurement and Authors Variable Measurement Authors Profitability Debt ratio Debt / equity ratio Short term debt ratio Long term debt ratio Gearing ratio Size of a firm PBIT / Total Assets Total Debt / Total Assets Debt / equity Short term debt / Total Assets Long term debt / Total Assets (Preference shares + Total Debt) / (Total capital + short term borrowing) Log of assets Myers and majluf (1984); Aloy Niresh (2012); John Jacob (2015-a) Titman and wessel (1988); SAUMITRA (2002), PATRIK BAUER (2004); Chandrasekara Mishra (2011); Amsavani and Gomathi (2012); John Jacob (2015-a); John Jacob and Jothi Jayakrishnan (2015) Titman and wessel (1988) ); PATRIK BAUER (2004); Wan Mansor and Rozimah Zakaria (2006); Aloy Niresh (2012); Pervaiz et, al., (2012); John Jacob and Jothi Jayakrishnan (2015) Titman and wessel (1988); Titman and Wessel (1998); Patrick Hutchinson (2003); Han-Suck Song (2005); John Jacob and Jothi Jayakrishnan (2015) Titman and wessel (1988); Titman and Wessel (1998); Patrick Hutchinson (2003); Han-Suck Song (2005); John Jacob and Jothi Jayakrishnan (2015) Wan Mansor and Rozimah Zakaria (2006); John Jacob and Jothi Jayakrishnan (2015) Titman and wessel (1988); John Jacob (2015-b); John Jacob and Jothi Jayakrishnan (2015) > RJEBS: Volume: 05, Number: 01, November-2015 Page 15

4 Methodology This study uses the descriptive research methods and empirical nature to identify capital structure and profitability of the selected chemical industry in India. The random sampling technique is used to decide the selection of the chemical companies. Top fifty companies were chosen for net profit criteria based. The present study used secondary data for the analysis for a period of fourteen years from will be studied. Further analysis are used SPSS. In this study, the researcher used the purpose of tools such as; descriptive statistic is used to identify the average level of profitability and those determinants. Correlation analysis is used to identify the relationship between capital structure and profitability. Finally, regression analysis is used to identify the prediction between capital structure and profitability Analysis and discussion Table 1 Average level of capital structure and profitability Factors Mean Std. Deviation profitability Total debt ratio debt to equity ratio Short term ratio Long term ratio Gearing ratio size Source: secondary data computed Explain the table indicates the profitability is measures by EBIT to Total assets. Profitability value is 0.21, it is found to be 21 percent. Debt ratio is measure by total debt to total assets. Debt ratio value is 0.42, it is found to be 42 percent consist with total assets. Debt / equity ratio value is Short term debt ratio defined as the ratio of Short term debt ratio to total assets. Short term debt ratio is found to be 0.13, it is noted that the 13 percent consist with total assets. Long term debt is defined as long term debt to total assets. It found to be 0. 39, it is indicate that 39 percent of consist in total assets. Gearing ratio is found to be Size of a firm is defined as log of assets. Size value is These results imply that large firm are increasing their business activities and also diversify their firm. It is found that the chemical companies 21 percent of earning average years Table 2 Relationship between capital structure and profitability Capital structure r-value profitability p-value Total debt ratio (NS) debt to equity ratio ** Short term ratio (NS) Long term ratio * Gearing ratio * size * Source: secondary data computed; * one percent significant level; ** five percent significant level; (NS) non-significant Ho: There is no relationship between capital structure and profitability In order to examine the above stated hypothesis, Pearson correlation is executed. From the above table noted that debt to equity ratio is having positively correlated with profitability. Follow by Long term debt ratio is having positively correlated with profitability. Gearing ratio is having > RJEBS: Volume: 05, Number: 01, November-2015 Page 16

5 positively correlated with profitability Therefore, the hypothesis is rejected. Size is having negative correlated with profitability. Hence, the results are supportive from pecking order theory, this theory suggested that the profitable company may prefer internal financing. John Jacob (2015) it is found that the size, long term debts and liquidity are having positively influenced the profitability. Chisti, et. al., (2013) Debt to Equity ratio is negatively correlated to profitability, which imply that if the debt content is increased aggressively it will adversely impact the profitability. Moreover the companies are exposing themselves to more risk and they can lose control if they do it. Mehdi, et. al., (2013) results shows that there was significant negative relationship between the profitability and the capital structure which means that the pharmaceutical companies have established a Pecking Order Theory and the internal financing has led to more profitability Table 3 Effect of capital structure on profitability R R Square Adjusted R Square F-value p-value * Predictors B Std. Error Beta t-value p-value (Constant) * Total debt ratio * debt to equity ratio (NS) Short term ratio (NS) Long term ratio * Gearing ratio (NS) size * Source: secondary data computed; * one percent significant level; ** five percent significant level; (NS) non-significant Table 3 explains the capital structure on profitability of a firm data from Regression analysis is applied to know the effect of capital structure on the profitability. It is inferred that the independent variable are influenced at levels. It found to be 44.2 percent influence the independent variable such as debt ratio, debt to equity ratio, short term debt ratio and long term debt ratio gearing ratio are significantly influence the profitability. The unstandarized co-efficient beta value indicates the strongest relationship between the dependent and independent variables. Profitability = (Total debt ratio) (Long term ratio) (size) The equation values displayed that effect of capital structure on the profitability. Total debt ratio is the influence level. On other hand Long term ratio is the influence level and size is the influence It is inferred that the total debt ratio is positive significant related the profitability. Therefore debt ratio is decreasing their profitability. Hence, hypothesis is accepted. Pecking order theory pleads for negative relationship with debt ratio. But, trade off theory stated that positive related with debt ratio. In this theory suggest that positive relationship firm may use equity and other external source. Long term ratio is negative related the profitability. Hence, hypothesis is accepted. Therefore debt ratio is increasing their profitability. Hence, hypothesis is accepted. Size is negative related the profitability. Hence, hypothesis is accepted. It is found that the total debt ratio is positive related the profitability. Long term ratio is negative related the profitability. Size is negative related the profitability. Conclusion To investigates that the factors influence prediction of capital structure on profitability. Over fourteen year from 2000 to 2013 periods the research concentrate on that study. Sample criteria for selecting net profit margin based top fifty companies are randomly selected the chemical industry. Random sampling technique was used to decide fifty Indian chemical companies. The result reveals that the > RJEBS: Volume: 05, Number: 01, November-2015 Page 17

6 total debt ratio is positive related the profitability. Long term ratio and size is negative related the profitability. Suggest that firms in concentrated industries have a slower rate of mean reversion in profitability when compared to firms operating in a more competitive environment. Bibliography Aloy Niresh (2012) Capital Structure and Profitability in Srilankan Banks. Global Journal of Management and Business Research 12 (13) Amsaveni and Gomathi (2012) the affirm that determinants of capital structure: a study of the Pharmaceutical industries in India, Indian journal of finance Chandra Sekhar Mishra, (2011) Determinants of Capital Structure A Study of Manufacturing Sector PSUs in India International Conference on Financial Management and Economics, (11), CHISTI Khalid Ashraf, Khursheed ALI and Mouhi Din SANGMI (2013), Impact Of Capital Structure on Profitability of Listed Companies (Evidence from India). The USV Annals of Economics and Public Administration 13, 1(17), Han-Suck Song (2005) Capital Structure Determinants An Empirical Study of Swedish Companies CESIS Electronic. Innovation, Entrepreneurship and Growth Working Paper Series Paper No. 25, at the Royal Institute of Technology (KTH) Stockholm, November Jamal Zubairi and Shazia Farooq (2014), Factors Influencing The Capital Structure In Pakistan. Pakistan Business Review, John Jacob (2014) Determinants of capital structure theory- Review. Archers & elevators publishing house, Bangalore, ISBN: John Jacob. M (2015-b), Relationship between Leverage and Size, Profitability, Tangibility, Non- Debt Tax Shield, Liquidity and Uniqueness: Evidence from India Select Cement Companies, M-Infiniti-National journal of management, April (2015), John Jacob. M (2015-c), Capital Structure and Profitability of Select Cement Companies in India, Sankhya- International journal of management and technology, April (2015), John Jacob. M and Dr. Jothi Jayakrishnan (2015) IMPACT OF NON-DEBT TAX SHIELDS ON CAPITAL STRUCTURE. Golden research thought. Vol. 00 issue Mehdi Mohammadzadeha, Farimah Rahimia, Forough Rahimib, Seyed Mohammad Aarabic and Jamshid Salamzadeha (2013), The Effect of Capital Structure on the Profitability of Pharmaceutical Companies The Case of Iran, Services Iranian. Journal of Pharmaceutical Research 12 (3): Patrick Hutchinson (2003) growth determines the capital structure of small and medium-sized enterprises (SMEs) in UK. 16th Annual Conference of Small Enterprise Association of Australia and New Zealand, 28 September 1 October 2003 PATRIK BAUER (2004) Capital Structure Empirical Evidence from the Czech Republic Finance Czech Journal of Economics and Finance, 54, 2004, pp Pervaiz Akhtar,Muhammad Husnain and Muhammad Ahsan Mukhtar (2012), The Determinants of Capital Structure: A Case from Pakistan Textile Sector (Spinning Units) Proceedings of 2 nd International Conference on Business Management SAUMITRA (2002), Determinants of capital structure choice: a study of the Indian corporate sector Applied Financial Economics, 12, Titman and Roberto Wessels march (1988) the determinants of capital structure choice: the journal of finance. Xliii, (1) Wan Mansor Wan Mahmood and Rozimah Zakaria (2006), profitability and capital structure of the Property and construction sectors in Malaysia. Pacific Rim Property Research Journal, 13, (1), Myers and Majluf, N.S., (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13, Campello, Murillo, Debt financing: does it boost or hurt firm performance in product markets? J. Financ. Econ. 82, > RJEBS: Volume: 05, Number: 01, November-2015 Page 18