Capital Structure and Firms Financial Performance; A Study of Selected Companies Listed on The Bombay Stock Exchange

Transcription

1 Capital Structure and Firms Financial Performance; A Study of Selected Companies Listed on The Bombay Stock Exchange Borala Rajeswer Rao 1 Register number PP.MAN.17 Research Scholar Department of business administration Rayalaseema university, Kurnool-184, Andhra Pradesh Dr. A Suryanarayana 2 Retired Professor Department of Business Management Osmania University, Hyderabad Telangana State ABSTRACT In this paper an attempt is made to study the relationship and impact of capital structure on firms financial performance. To achieve the object of the study financial data is collected from the companies listed and represent in SENSEX index of BSE. The sample Companies are selected base on judgmental sampling. The collected data is processed and analysis with the help of SPSS using descriptive and inferential statistics.the results show that there is a significant relationship and impact of debt equity ratio, short-term debt to total assets, and total assets and total debt on return on equity. KEYWORDS Debt equity Ratio,Financial Performance, Long term debt (LTD) to total assets Ratio, Short term debt (STD) to total assets Ratio and Total debt (TD) to total assets Ratio. INTRODUCTION The theory of capital structure and its relationship to the value and performance of a company has been a disconcerting topic in corporate finance and accounting literature, as the theory of Modigliani and Miller theory (198) argues that under capital market conditions perfect that it assumes that, without bankruptcy costs and capital markets have no friction, if there are no taxes and no asymmetric information, the value of the company is independent of the capital structure. According to MM's theory, the only variables that determined the value of the company were its power of future gains (expected cash flow) and, therefore, the decision of the capital structure is irrelevant. Since then, several theories have been developed to explain the structure of the capital of a firm, including the theory of the Pecking Order Theory, Trade off theory, and the Agency Cost theory. id- jamrpublication@gmail.com Page 21

2 While the actual levels of debt and capital may vary slightly over time, most companies try to keep their financial mix close to an objective capital structure. The decision of a company's capital structure includes the choice of a target capital structure, the average maturity of its debt, and the specific types of funding that it decides to use at a given time. With operational decisions, such as (Brigham & Ehrhardt, 211), managers must make decisions about capital structure to maximize the intrinsic value of the company. REVIEW OF LITERATURE The term capital structure refers to the relationship between the various sources of long-term financing, such as equity capital, preferred share capital and debt capital. Deciding on the appropriate capital structure is the important decision of financial management because it is closely related to the company's value (Paramasivan & Subramanian, 29). According to Tudose(212), performance can be explored from two points of view: financial and organizational (both are interconnected); The performance of a company can be measured based on variables that imply productivity, performance, growth or even customer satisfaction. Financial performance (reflected in maximizing profits, maximizing ROA, maximizing ROE and maximizing ROI is based on company efficiency). Abor (2) conducted a study on the influence of the capital structure on the profitability of companies listed on the Ghana stock exchange for a period of five years. He found that there is significant positive interrelationship between SDA and ROE and shows that companies that earn a lot use short-term debt to finance their businesses. In other words, short-term debt is an essential source of financing for Ghanaian companies, as it represents 8% of total debt financing. However, the results showed the unfavorable relationship between LDA and ROE. The result of the regression showed that there is a positive relationship between DA and ROE that measures the relationship between total debt and profitability. This indicates that companies that earn a lot depend on debt as a key funding option. There are many variables in choosing the capital structure and the debt maturity structure that will affect a company's performance. The maturity of the debt will affect the investment option of a company. In addition, the tax rate will also affect the company's performance. In this case, examining the impact of the capital structure variables on the basis of the company's performance will be a performance test of a company due to the effect of the capital structure (Tian & Zeitun, 27). A study by Akintoye(28) was conducted on the sensitivity of performance to the capital structure of a selected food and beverage company in Nigeria. The result shows that performance indicators at turnover (earnings before interest and taxes, earnings per share and dividend per share) and leverage measures (degree of operating leverage, degree of leverage and dividend per share) are significantly sensitive. There are many approaches to examining the company's performance. El-Sayed Ebaid(29) investigates the impact of choosing the capital structure on the company's performance in Egypt as one of the emerging or transition economies. Multiple regression analysis is used in the study to estimate the relationship between the level of leverage and the performance of the company. Using three measures of financial performance based on accounting (ROE, ROA and gross profit id- jamrpublication@gmail.com Page 216

3 margin), and based on a sample of non-financial Egyptian companies listed between 1997 and 2. The results reveal that the decision to choose the structure of the capital, in general terms, has little or no impact on the company's performance. A study conducted by B.Nimalathasan&ValeriuBrabete(21)) on capital structure and its impact on the profitability of manufacturing companies listed in Sri Lanka. The result shows that the debt capital index is positively and strongly associated with all the profitability ratios (gross profit, operating margin and net profit). San and Heng(211) study the relationship between the capital structure and the company's corporate performance before and during the crisis (27). This study focuses on the construction companies listed in the Bursa Malaysia Central Council from 2 to 28. All 49 construction companies are divided into large, medium and small, depending on the paid-up capital. For large companies, the return on equity with the debt at the market value of equity and EPS and long-term debt with Capital have a positive ratio, while EPS with debt on capital is negatively correlated. Meanwhile, only the operating margin with longterm debt of common capital has a positive ratio in medium-sized companies and EPS with debt in capital has a negative relationship in small businesses. In summary, the result reveals that there is a relationship between the capital structure and the company performance in the selected powers. Muzir(211) examines and verifies the relationship between the size of the company, the capital structure and the financial performance provided by the evidence provided by Turkey. It also aims to support the validity of three main theories of capital structure: Irrelevance Theorem, Trade-Off Theory, and Pecking Order Theory, on a comparative basis. A series of balance sheet data for at least years between 1994 and 23 of 114 companies listed on the Istanbul Stock Exchange is used to model insolvency risk on the basis of specific financial ratios through a binary logistic regression analysis. The results present robust evidence to suggest that the effect of company size on financial performance and sustainability may differ depending on how the size expansion is financed. Any expansion of debt-financed activities has been shown to increase risk exposure, especially during economic recessions, which favors computational theory over the others. Abu Mouamer(211) examines the relationship between the capital structure and the life time of the debt between the companies listed on PEX. This study investigates 1 companies over a period of years (2-24). The study the variables used for the analysis include profitability, leverage ratios (TD, STD and LTD), liquidity, age, business structure and size of the company and sales growth are also included as control variables. The data character of the panel allows the use of the panel data methodology. The study showed that service companies have the highest TD ratio (3.69%), followed by industrial companies (.86%), commercial companies (34.11%) and farms (24.2%). The analysis of one-way variance (ANOVA) does not show significant differences in the use of debt, neither total, LTD or STD among the companies of the 4 sectors. Furthermore, ANOVA indicates insignificant differences between the companies of the sample in relation to growth opportunities, size, age, tangibility and liquidity. The correlation analysis showed that TD is positively and significantly related to tangibility, in the country there is no significant relationship between long-term debt and ETS, on the one hand, and age, growth, liquidity, tangibility and size, from other. id- jamrpublication@gmail.com Page 217

4 A study (Pratheepkanth, 211) was conducted on the capital structure and financial performance of selected commercial companies on the Colombo stock exchange in Sri Lanka. The result shows that the debt capital ratio is negatively associated with financial performance. Umar et al. (212) examines the impact of the capital structure on the financial performance of the companies in Pakistan of the top 1 consecutive companies on the Karachi Stock Exchange for a period of 4 years from 26 to 29. The exponential least squares regression is exponentially used to demonstrate the relationship. The results show that the three variables of the capital structure, STDTA, LTDTA and TDTA, have a negative impact on earnings before interest and taxes (EBIT), ROA, EPS and net profit margin, while the earnings index of price shows a negative relationship with STDTA and the positive relationship is with LTDTA where the relationship is negligible with TDTA. The results also indicate that ROE has a negligible impact on STDTA and TDTA, but there is a positive relationship with LTDTA. Skopljak and Luo (212) investigate the relationship between the capital structure and the performance of the company of licensed Australian deposit institutions. The results show a significant relationship between the capital structure and the performance of the company of authorized Australian deposit institutions. At relatively low levels of leverage an increase in debt leads to increased profit efficiency hence superior bank performance, at relatively high levels of leverage increased debt leads to decreased profit efficiency as well as bank performance. Pouraghajan&Malekian(212) investigate the impact of the capital structure on the financial performance of companies listed on the Tehran Stock Exchange. To this end, they studied a sample of 4 companies in the form of 12 industrial groups over the years from 26 to 21. In this study, the ROA and ROE variables used to measure the financial performance of companies. The results suggest that there is a significant negative relationship between the debt ratio and the financial performance of the companies, and a significant positive relationship between the asset turnover, the size of the company, the asset tangibility ratio and growth opportunities with financial performance. In addition, research results show that reducing the debt management rate can increase the company's profitability and, consequently, the amount of the company's financial performance measures and can also increase shareholders' wealth. Abbadi and Abu-Rub (212) established a model for measuring the effect of capital structure on bank efficiency in Palestinian financial institutions measured by ROE, ROA, Total deposit to assets, total loans to total assets and loans to deposits used to measure the structure of capital. The document found that leverage has a negative effect on bank profits, an increase in each ROA and total deposit in assets increases the efficiency of the bank. The document also tested the effect of the aforementioned variables on the value of the banking market as measured by the Tobin Q. The document found that leverage has a negative effect on the market value of the bank, a positive and strong relationship between market value and ROA and bank deposits in total deposits. Taani(213) examines the impact of the capital structure on the performance of Jordanian banks. For this study, the annual financial statements of 12 commercial banks listed on the Amman Stock Exchange have been used, covering a period of years from multiple regressions on performance indicators, id- jamrpublication@gmail.com Page 218

5 such as net profit, return on investment, ROE and net interest margin and total debt to total funds and total debt to total capital that have been applied to the capital structure variables applied multiple regression models to estimate the relationship between capital structure and bank performance. The results show that the bank's performance must be associated significantly and positively with TD; while TD is insignificant to determine the ROE in Jordan's banking sector. Çekrezi(213) examines several determinants of the capital structure in the company's choice of leverage. The document used three measures of the capital structure; STDTA, LTDTA and TDTA as dependent variables and four dependent variables: tangibility, profitability (measured ROA), size and liquidity. The research uses the panel data procedure for a sample of 6 unlisted companies, operating in Albania, in the period The results revealed a significant negative ROA ratio and a significant positive size relationship for all leverage measures. Goyal (213) tries to study the impact of the capital structure on the profitability of public sector banks in India listed on the National Stock Exchange between 28 and 212. Regression analysis was used to establish relationships between ROE, ROA and EPS with capital structure. The results reveal a positive relationship of STDTA with the profitability measured by ROE, ROA and EPS. Abiodun (214) uses a triangulation approach to investigate the relationship between capital structure and business performance in Nigeria. The document considers 31 manufacturing companies with certified balance sheets for the periods 1999 and 212. The document fined a strong curvilinear relationship between the ROA and the debt-equity ratio, also known as leverage. The document has been denied that large companies are more inclined to maintain a higher return than that of intermediate companies under the same level of debt ratio. STATEMENT OF THE PROBLEM Nowadays, more and more companies tend to use different sources of capital or debts to finance their operations when they need to expand the size of the company or reinvest to get more profits. However, situations are more complicated in the real world of competition than in theory. The structure of capital and the impact on value and financial performance have been studied for many years after MM theories have existed, researchers around the world still disagree about the magnitude of the impact. Indeed, a good allocation of the capital structure will lead to the success of companies. From the above, the problem can be formulated as follows: what is the impact of the capital structure on the financial performance of the company? Research Objectives To know the various components of capital structure of the selected firms To examine the nature of relationship between capital structure and financial performance of the firms. To identify the impact of capital structure on financial performance of the firms. Hypothesis of the study The following hypotheses are formulated for the study; id- jamrpublication@gmail.com Page 219

6 H 1: There is no significance relationship between capital structure and financial performance. H 2: There is no significance impact of capital structure on financial performance. Scope/Area of The Study. The study is limited to know the various components of capital structure and it s influence on firm performance of selected companies listed in Bombay Stock exchange. Research Method and Design Research design The present study is empirical-cum-analytical in nature Population All the companies listed on Bombay Stock Exchange or all indices of Bombay Stock Exchange is the population/universe for the present study. The sampling method the sampling method which is suitable for the present study is judgment sampling, i.e. sample selection based on certain criteria. Sample Selection Criteria: The study covers 1 companies classified under ten groups of industries which are listed in Bombay Stock Exchange index SENSEX. 1. Track record: company should have good track record. 2. Market capitalization: Company should be one among 1 market capitalizations of BSE, 3. Industrial representation; company should be a leader in the industry it represents 4. The necessary financial data required for calculating the measures of dependent and independent variables pertaining to all the years is available. Table 1 the sample companies for the study SNO SCRIP CODE COMPANY NAME SENSEX/Sectors Axis Bank Ltd Finance Bharti Airtel Ltd Telecommunication Coal India Ltd Mining and minerals Dr Reddy's Laboratories Ltd Healthcare 182 Hero MotoCorp Ltd Transport Equipments Hindustan Unilever Ltd FMCG 7 29 Infosys Ltd IT 8 1 Larsen & Toubro Ltd Capital Goods & Construction 9 32 NTPC Ltd Power Oil & Natural Gas Corp Ltd Oil & Gas Sources of Data Collection Main source of data for the present study is secondary sources only. the appropriate information is collected from of BSE, Journals, Company reports, databases such as Cline, Prowess and company websites id- jamrpublication@gmail.com Page 22

7 Research Variables The variables used in the present study is divided into two groups, which are dependent, independent variable. Depended Return on Equity (ROE) Independent Short term debt (STD) to total assets Ratio Long term debt (LTD) to total assets Ratio Total debt (TD) to total assets Ratio Debt Equity Ratio Tools of Analysis The collected information is processed by using SPSS (24 version). The study utilizes both descriptive and inferential statistics. Mean Standard deviation Correlation ANOVA Ordinary least squares (OLS) regression analysis Model Specification The static linear models are presented in the following equations: Return on Equity (ROE) = β + β1 Short-term debt/ Total assets + β2 Long-term debt/ Total assets + β3 Total liabilities/ Total assets + ε Where: ε = Error terms. β = constant term Β1 to β3 = regression coefficient for respective variables id- jamrpublication@gmail.com Page 221

8 RESULTS AND DISCUSSIONS Table 2Descriptive statistics Minimum Maximum Mean Std. Deviation Return on Equity (ROE) Debt Equity Ratio Short term debt (STD) to total assets Ratio Long term debt (LTD) to total assets Ratio Total debt (TD) to total assets Ratio The results of table 2 show that the mean of the performance measures Return on Equity (ROE) Debt Equity Ratio, Short term debt (STD) to total assets Ratio, Long term debt (LTD) to total assets Ratio and Total debt (TD) to total assets Ratio are 1.14 (1.9),11.7 (.72),.79 (.14),.3 (.18),.89 (.64), respectively. This suggests that an average firm listed in Bombay Stock Exchange SENSEX have recorded a better performance. The mean for short-term and long-term debt to total assets are.7967 (.14) and.38 (.184), respectively, suggesting that on average the firms listed on the SENSEX use relatively more short-term than long-term debt. The mean for the total debt to total assets is.89 (.64), indicating thatmore than 89% of the total assets are financed with debt. As already mentioned, themean total debt ratio is 89 percent, which indicates that most of the SENSEX representative companies arehighly levered. Table 3Correlation matrix between ROE and Capital structure components Correlations ROE Pearson Correlation 1 Sig. (2-tailed) DER Pearson Correlation.72 ** 1 Sig. (2-tailed).8 SDTA Pearson Correlation ** 1 Sig. (2-tailed).2. ROE DER SDTA LDTA TATD LDTA Pearson Correlation Sig. (2-tailed) TATD Pearson Correlation.62 *.889 **.761 ** Sig. (2-tailed) **. Correlation is significant at the.1 level (2-tailed). *. Correlation is significant at the. level (2-tailed). id- jamrpublication@gmail.com Page 222

9 Table 3 indicates that there is a significant correlation between several independent variables, such as debit equity ratio (r=.72), short-term debt and total asset (r=.72), total assets to total debt (r=.62) which is significant at the.1 and. level. From the results it also found that there is negative correlation between Return on Equity (ROE) and long-term debt to total assets (r=-.37). Multiple regression analysis Multiple Regression analysis is used to test the impact of capital structure on financial performance of the listed trading companies in Bombay Stock Exchange. As we mentioned in mode of analysis, four models were formulated and the results are summarized in Table-4. Table 4 Predictor of Financial performance Dependent Return on equity (ROE) Independ ent Consta nt Bet a t Sig R R 2 Adj. R 2 Standa rd Error Durbi n- Wats on F Valu e Toleran ce VIF DER SDTA LDTA TATD The specification of the three variables such as the ratio of debt capital, the short-term debt for total assets, the total debt to total assets in the previous model revealed the ability to predict financial performance (R2 =.2,.327 and.38 respectively). In this model, the R2 value of over three financial performance ratios shows that 47.8%; 26% and 32.3% of the variability observed in financial performance may be due to differences in three independent variables, namely, the ratio of debt, short-term debt and total assets, total debt to total assets. The remaining 2.2%; 74% and 67.7% are not explained that the remaining part of the change in financial performance is linked to the other variables that are not represented in the model. A summary examination of the model with ANOVA (F value) indicates that the model explains the possible predictors that could contribute to the relationship with the combination of dependent variables. For model 1, 2 and 4, the F values are 11.61, 4868 and 62 and the respective P value is lower than the probability criterion (p <.), which is statistically significant at levels of percent. From the regression coefficient is the ratio of capital debt (β =.72), the short-term debt for total assets (β =.72) and total assets with respect to total debt (β =.62) are a stronger preacher of financial performance of id- jamrpublication@gmail.com Page 223

10 companies listed and traded on Sensex Bombay Stock Exchange. Rest of the model 3 Demonstrate that the long-term debt ratio with the total assets does not significantly predict the performance of companies. All the corresponding F value (1.636) is negligible compared to the relative P values (.23). However, it should be noted here that there may be some other variables that may have an impact on financial results, to be studied. CONCLUSION The main financial decisions of an organization include the determination of the best alternative investment, the selection of an adequate financing scheme and the definition of an appropriate dividend policy. The The ultimate goal is to maximize the value of the company's shares among all investment alternatives. This includes the installation of a new business, the expansion of the existing plant capacity and the modernization of production facilities. The theme that will be developed in this document is how to determine the profitability and risk of this alternative, so you need to project a cash flow based on certain assumptions and define the cost of money. In addition, financial resources are required to make investments, which is why it is necessary to determine financing options and measure their impact on profitability and investment risk. These sources of financing have a cost but must be compensated by the investment fund. The financing will be convenient when the percentage cost is equal to or lower than the return or return on the investment. REFERENCES 1. Abbadi, S., & Abu-Rub, N. (212). The Effect of Capital Structure on the Performance of Palestinian Financial Institutions. British Journal of Economics Finance and Management Sciences, 3(2), Abiodun, B. (214). Triangulation Analysis of Capital Structure and Firms Performance in Nigeria. International Proceedings of Economics Development and Research Journal, 69(12), Abor, J. (2). The effect of capital structure on profitability. Journal of Risk Finance, 6(), Abu Mouamer, F. (211). The Determinants of Capital Structure of Palestine-Listed Companies. The Journal of Risk Finance, 12(3), Akintoye, L. (28). Sensitivity of Performance to Capital Structure. European Journal of Social Science, 7(1). 6. Brigham, E., & Ehrhardt, M. (211). Financial Management: Theory and Practice (13 ed.). Mason: South-Western Cengage Learning. 7. Çekrezi, A. (213). The determinants of capital structure: A case of small non-traded firms in Albania. Global Virtual Conference. 8. Ebaid, L. (29). The impact of capital-structure choice on firm performance:empirical evidence from Egypt. The Journal of Risk Finance, 1(), id- jamrpublication@gmail.com Page 224

11 9. Goyal, A. (213). Impact of Capital Structure on Performance of Listed Public Sector Banks in India. International Journal of Business and Management Invention, 2(1), Modiglian, F., & Miller, M. (198). The Cost of Capital, Corporation Finance and the Theory of Investment. The American Economic Review, 48(3), Muzir, E. (211). Triangle Relationship among Firm Size, Capital Structure Choice and Financial Performance: Some Evidence from Turkey. Journal of Management Research, 11(2), Nimalathasan, B., & Valeriu, B. (21). 21 Capital Structure and Its Impact on Profitability: A Study of Listed Manufacturing Companies in Sri Lanka (21), 13,-61. Revista Tinerilor Economisti/The Young Economists Journal, Paramasivan, C., & Subramanian, T. (29). Financial Management. New Delhi: New Age International. 14. Pouraghajan, A., & Malekian, E. (212). The Relationship between Capital Structure and Firm Performance Evaluation Measures: Evidence from the Tehran Stock Exchange. International Journal of Business and Commerce, 1(9), Pratheepkanth, P. (211). capital structure and financial performance: Evidence from selected business companies In Colombo stock exchange Sri Lanka., Journal of Arts, Science & Commerce, San, O., & Heng, T. (211). Capital Structure and Corporate Performance of Malaysian Construction Sector. International Journal of Humanities and Social Science, 1(2), Skopljak, V., & Luo, R. (212). Capital Structure and Firm Performance in the Financial Sector: Evidence from Australia. Asian Journal of Finance & Accounting, 4(1), Taani, K. (213). Capital structure effects on banking performance: a case study of Jordan. International Journal of Economics, Finance and Management Sciences, 1(), Tian, G., & Zeitun, R. (27). Capital structure and corporate performance: evidence from Jordan. Australian Accounting Business and Finance Journal, 1(4). 2. Tudose, M. (212). Capital Structure and Firm Performance. Economy Transdisciplinarity Cognition Journal, 1(2), Umar, et al. (212). Impact of Capital Structure on Firms Financial Performance: Evidence from Pakistan. Research Journal of Finance and Accounting, 3(9), id- jamrpublication@gmail.com Page 22