Capital Structure and Firm Value: Empirical Evidence from Pakistan

Transcription

1 Capital Structure and Firm Value: Empirical Evidence from Pakistan ABSTRACT Asifa Kausar 1 Mian Sajid Nazir 2 Hashim Awais Butt 3 The purpose of this paper is to empirically examine the impact which capital structure choice has had on firm performance of the Pakistan firms listed in Karachi Stock Exchange (KSE). This study used both multiple regression model symbolized by ordinary least squares (OLS) and panel regression as a techniques and these techniques was applied to 197 companies in Pakistani market listed on Karachi Stock Exchange (KSE)selected to estimates the effect of capital structure on firm performance for the period of 2004 to The result of the study shows that capital structure measured by Long term debt to total assets, short term debt to total assets and total debt to total assets has a significantly negative impact on firms performancemeasured P/E. Capital structure measured by Long term debt to total assets and total debt to total assets has a significant negative impact on firms performancemeasured Tobin s Q while short term debt to total assets has negative but insignificant impact on Tobin s Q. Assets size has also significantly negative impact on firm performance measured by P/E and Tobin s Q. Firm age has also significantly negative impact on firm performance measured by P/E and Tobin s Q. Volume of capital measured by log of equity has a significant positive impact on firm performance measured by P/E and Tobin s Q. Firms listed in KSE of Pakistan are largely dependent on equity and short term debt but debts are attached with strong covenants which affect the performance of the firm. The study more discloses a noticeable fact that Pakistan firms are either mostly financed by equity capital or a mixture of equity capital and short term financing.this is first paper to study multiple sectors in Pakistan on the stated topic. Keywords Capital structure, firm Performance, Debt, Pakistan 1. INTRODUCTION Capital Structure s decision is vital due to the need to maximize revenues to various organizational communities. The capital structure of a firm consists upon a mix of different securities. Combination of equity and debt is called capital structure. Decision about the combination of debt and equity is one of the critical decisions of any firm. A firm can choose amongst many alternatives in capital structures generally. A large proportion of debt can be issue or lesser. Firms try to find the appropriate combination of different fund that maximizes firm s overall value and performance. The association among capital structure and firm performance is one that has received substantial attention in the literature of finance. In increasing the performance and value of the firm the decisions about capital structure play a very essential and central role. Kinsman and Newman (1999) expressed that investigation of the relationship of capital structure choice with performance of firm is very important for several reasons. Between these reasons: First as firm debt level have increased significantly over the last few periods, necessitating an explanation of the impact of level of debt on performance of firm, hence that appropriate level of debt can be made in a specific firm. Second, as managers and investors may perhaps have different emphases so it requires investigating the comparative powers of any precise effects of debt essential be known on firm s performance. Last while have greatest importance for studying level debt and performance of firm in order to investigate the association among debt level and shareholders wealth. As owners wealth maximization is a primary goal of managers of firm. 1 University of the Punjab, Gujranwala Campus, Pakistan, asifa.pugc@hotmail.com 2 COMSATS Institute of Information Technology, Lahore, Pakistan, snazir@ciitlahore.edu.pk 3 University Malaysia Sarawak, Malaysia ~11~

2 Capital structure theories are discussed of how the choice of capital structure impacts and interactions with firm performance. It was emphasized by number of theories the capital structure relationship with the firm performance generally by Trade-off theory, Pecking order theory, Signaling and agency theories ( Khan, 2012). The tradeoff theory in which firms employ the debt up to the debt optimal level and it is arises by the trading-off the benefits and costs of debt. Tradeoff theory expects a positive correlation among debt level and the performance of firm till the optimal combination of capital structure. The optimal combination of capital structure minimizes capital cost, which subsequently maximizes the performance of firm. High leverage firms are expected to increase their performance by simplification the conflicts about free cash flow among shareholders and managers. Hence, firms use high proportion of debt in capital structure and high performance by tax shield benefit. The agency theory avers that high debt ratio is linked to high performance of firm. Agency cost exists between shareholders and management of firms because of the less than hundred percent stake of management. And due to that reason, managers are not interested for the benefit of owners and are more concerned with their own interest and advantages while by this act of management organization and owners suffer loss. Thus, agency cost theory of capital structure states that the optimal capital structure is that point where the cost of agency of all the concerned parties is at the minimum level ( Jensen & Meckling, 1976). Another important theory is asymmetric information theory, states that the insiders of the firm have more information about their firm than to the firm outsiders. By using this advantages management send that information in market which positively affects and enhance the value of firm. Debt is one of the important tools for management to send positive signal in market. To check the impact of decisions of capital structure on firm performance a number of research studies were conducted. Deesomsak (2004) in his work found a negative relation between leverage level and firm performance on the Malaysian firm which measured by the gross profit margin. Findings of Abor (2005) revealed that there was a positive association between capital structure (short term debt) and firm profitability while relationship was negative between LTD and performance. Findings of Zeitun & Tian (2007) revealed that there was a negative association between capital structure and firm performance.two studies done in Pakistan one by Khan, (2012) and his results indicate that financial leverage has negative and a significant relationship with the performance andresults of Umar, et al. (2012) revealed that there was a significant negative association between the variables of capital structure and financial performance of the firm. Pakistan is a developing state and has an underdeveloped and small market of debt therefore; organizations in Pakistan depend on debt of bank in order to finance its investment and operations. In Pakistan banks do not issue debts as their main part of banks are privatized and financing of debt is not issue on attractive terms. It is very difficult for the firm to get debt finance because of uncertain incomes of firms and thus these firms decrease their debt borrowing. Beside that higher cost of borrowing also restrict the firms to borrow and prohibit them to depend largely on international fund sources the reason that the equity markets are limited and are on worse levels of trading. The decision of capital structure is at the center of many other decisionsfor a firm. To maximize the returns on investment and compete in a competitive environment successfully business entities give so much importance to capital structure decision.the main significance of this study is that a very few previous research work has been done in the market of Pakistan on the impact of capital structure on the performance of firms while the aim of this study is to extend the prior literature by empirically examine the impact of capital structure choice and leverage level on the firm performance. Consequently, all these factors more support the requirement for an updated research on to the relationship between capital structure and firm performance. The study investigates the capital structure impact on firm performance by including more control variables. This study has used one hundred and ninety seven companies of fourteen sectors for analyses which were not used by earlier studies. This study has used two techniques pooled OLS regression and GLS random effect and fixed effect in analyses and compares the result of these techniques. 2. LITERATURE REVIEW The capital structure effect on performance of the firm and association between structure of capital and performance of firm has been the issue of great discussion.decisions about capital structure play a very crucial role in enhancing the value and performance of the firm.modigliani-miller had form the basis of modern thinking on the capital structure.. It states that under a certain market price process, in the absence of bankruptcy costs, taxes, agency costs and the asymmetric information and also in an efficient market, the value of a company remains unaffected by how the company is financed. Therefore, market value of a firm is defined by its earning power and the risk of its underlying assets. According to this, it does not matter whether the company s capital is raised by issuing debt or issuing equity and also it does not matter that what is company s ~12~

3 dividend policy. Therefore, the Modigliani Miller Theorem is often also called the Capital Structure Irrelevance Principle. Two dominant theories in general could describe the capital structure and being discussed as follow.myers (1984) concluded the requirement for balancing costs and benefits of debt financing in a widely known theory as Static Trade off Theory. The theory states that capital structure reaches its optimal point when tax shield s marginal present value on additional debt equalize financial distress cost s marginal present value on additional debt. According to the theory of trade-off firms which are more profitable have higher earnings to shield and so that firms could take tax advantages by borrowing more and use higher portion of debt in capital structure. Therefore, according to the theory of trade-off firms which are more profitable have higher earnings to shield and so that firms could take tax advantages by borrowing more and use higher portion of debt in capital structure. Thus, there should be positive association between level of debt and performance of firm (Ebaid, 2009). Myers and Majluf (1984) proposed that firms pursue a hierarchy of financial decisions when establishing its capital structure. At first internal financing is used to finance new project. If in any instance these are not sufficient then firms will look for external financing in that case they will first prefer bank loan and then go for public debt or convertibles. It is suggested by Myers and Majluf (1984) that when firm have to raise external financing then equity is less preferred because of asymmetric information. According to the pecking order theory profitable firms prefer internal financing over external financing in capital structure because they have enough internal funds to finance their investment. Consequently, negative relationship could be expected between debt level and firm s performance (Ebaid, 2009). It is recognized by Jensen and Meckling (1976) that the likely conflicts exist between shareholders and a manager s interests because the manager s share is less than 100% in the firm. Due to that managers do not put maximum of their efforts for the benefit of shareholder and put efforts for their personal gain and due to that Organization suffer loss by this act of managers. So financing of debt is used as a controlling tool by restricting the managers to put their personal gain first than the owners of the firm. Free cash flow available to firm will be reduced by using debt financing and motivating the manager to act in the interest of owners and prohibit them from investing in risky and less profitable project. Corporations are considered better with heavy proportion of leverage because the management do not have ability and control to utilize resources for their own interest ( Muritala, 2012). Rajan and Zingales (1995) examined the choice of capital structure determinant by assessing the public firm s decisions of financing in industrialized countries. They concluded that firm issue equity when their prices perceive to be high in market. Changes in profitability negatively associated with level of leverage in case of fixing the investment and dividend in short run. Abor (2005) focused on the study of the relationship between capital structure and firm profitability. Findings revealed that there was a positive association between capital structure (short term debt) and firm profitability which was measured by ROE. It was suggested that short-term debt had a tendency to be less expensive and therefore with a reasonably low interest rate on short-term debt would lead to an increase in levels of profit. From the results it was also showed that profitability increases with the control variables (growth of sales and size). While findings revealed that there was a negative association between capital structure (long term debt) and firm profitability which was measured by ROE. Result had found a significant positive relationship between the total debt to total assets ratio and performance.further the capital structure and firm performance was investigated by Zeitun & Tian (2007). Their results showed that short term debt to total assets had significant and negative impact on the firm s performance which was measured by return on assets. That negative result conclude that firms that have more short-term debt to total assets those firms also have low performance. Shortterm debt exposed risk of refinance to firm as it shown a negative impact on ROA.Pratheepkanth (2011) found in his study negative and weedy correlation between structure of capital and net profit. There was a negative but weak correlation between variables of capital structure and ROI. There was also negative but a weak correlation between variables of capital structure and ROA. From that result it was concluded that there was negative but weak correlation amongst variables of capital structure and performance of firm. There was also a negative association amongst financial performance and structure of capital. Thomas, et al. (2012) found a negative correlation of short term debt and total debt with the retrn on assets measure of profitability. Whereas long term debt had a significant and positive relationship with profitability. It was also found a positive association of size of rural banks and level of risk with financial performance with deference to the control variables. Using leverage comprising of bigger proportion of short-term debt influenced adversely the rural banks profitability. Moreover the findings of Muritala (2012) revealed negative and significant relationship between debt and performance. Financial performance measure ROE with size and age are moreover considered as major determinants of firm financial performance. Evidence from the result showed a negative and significant relationship between asset tangibility and ROA as a measure of firm financial ~13~

4 performance.ahmad, et al., (2012) concluded that total debt and short term debt had a significant relationship with return on assets. Whereas the relationship between each debt level and return on equity found significant. Though the analysis with lagged values displayed those non- lagged values for STD, TD and LTD had significant relationship with performance of firms. Soumadi and Hayajneh (2012) found financial leverage negatively influence the firm value. This Negative relationship states that desire of firm to finance its activities by increasing borrowing operations and this excess borrowing lead to bankruptcy risks which result into decrease the tax shields and consequently minimize the firm performance. The result found no significant difference between high levered firms and low levered firms to influence of financial leverage on performance of the firm. Finally, there is no difference between the financial leverage of high growth firms and low growth firms on the performance in regard that the effect of financial leverage on the basis of the growth. Further Shubita and alsawalhah (2012) found that there is negative and significant relationship between debt and firm profitability. These findings suggest that an increase in the level of debt is accompanying with a decrease in firm profitability. Consequently the greater the debt, the lower will be the profitability of the firm. Findings also indicated that profitability positively associated with the control variables it mean an increase in control variables there will be increase in profitability of the firm. By means of increases in leverage, not only potential return in Jordan decrease but a firm s ability to pay off its debt usually destroys due to which credit default risk rise. Ferati and Ejupi (2012) indicated that return rates and debt were inversely proportion mean the higher the debt the lesser the profitability. The short-term debt (ECP) showed negative sign and significance level of 2%, it showed that short term debt was an important variable. It showed that there was low participation of debt and suggested that ECP was a common practice amongst the most profitable companies. The participation of equity in structure of capital had a positive relationship with profitability and was significant at 2% level. From the result it was indicated that the return rates had a positive association with equity and short-term debt whereas it had an inverse association with long-term debt. In Pakistan Umar, et al. (2012) had studied the capital structure effect on financial performance of the firms in Pakistan. Their result revealed that there was a significant negative association between the variables of capital structure and financial performance of the firm which measured by EBIT. Total liability had an insignificant negative relation with financial performance of the firm. Size of the firm and firm performance had a positive relationship and concluded that performance of the firm increased by increasing assets of the firm. Result also revealed that there was a significant negative association between the variables of capital structure and financial performance of the firm which measured by return on assets of the firm. Result also revealed that there was a significant negative association between the variables of capital structure and financial performance of the firm which measured by EPS of the firm. Capital structures variables also had a negative relationship with net profit margin of the firm. 3. RESEARCH METHODOLGY Pakistan has a thin market of capital as it is a developing country. Total population of the present study is all non-financial firms those are listed at Karachi Stock Exchange. Based on the Non-financial firms nature of business, they are divided into many industrial sectors by Karachi Stock Exchange (KSE). During the period of study all new incumbents are also excluded from population and these firms must have whole and complete data during the period of study? Firms also have been excluded those have negative equity during the period of study from the study population. This study will cover Non-Financial firms which are listed on Karachi Stock Exchange (KSE) covers the period of eight years from 2004 to In the beginning, 250 non-financial firms were selected as these firms had whole and complete data during the period of study Additionally, firms were removed from the sample of the study that had negative profit, negative equity and with absent of data. This screening process leaves us with 197firms. The research data for this study is taken from secondary sources from financial statement of non-financial firms listed on the Karachi Stock Exchange published each year by the State Bank of Pakistan s Statistics Department in order to examine above stated research objective. This study uses performance as dependent variables in order to examine the capital structure impact on firm performance. Here market based measures have been used in this study. Zeitun and Tian, (2007), Abor (2007) and Abu-Rub (2012) had used market based measure to measure the firm performance. In this study two variables have been used to measure the firm performance and to examine the performance of the market based measures P/E and Tobin s Qare used. P/E is measured by price per share / earnings per share while Tobin s Q is measuredby BV of assets - BV of equity + market value of equity / BV of assets. Three most commonly used measures by earlier researchers are short term debt, long term debt and total debt to total assets in order to measure the financial leverage. These three measures were used by Rajan and Zingales (1995), Abor (2005 and 2007), Akhtar (2005), Harris (2005), Ebaid (2009), Saedi (2009), and Abu-Rub (2012) to measure the leverage of firm. Present study also measures the financial leverage by these three important ~14~

5 variables to measure the firm s capital structure. Theses capital structure s measures are as follow: 1) Short Term Debt divided by the Total Assets of the firm (SDTA), 2) Long Term Debt divided by the Total Assets of the firm (LDTA) and 3) Total Debt divided by the Total Assets of the firm (TDTA). If capital structure does impacts the performance of firm and then a robust association among capital structure and firm s performance would be found. Therefore, it has been argued that capital structure of firm impacts negatively the firm performance. Moreover, it has also been argued that short term debt affects negatively a firm s performance as it reveals the risk of refinancing to firm. Thus, the hypotheses are: H0: There is insignificant relationship between short- term debt and performance. H1: There is significant relationship between short- term debt and performance. H0: There is insignificant relationship between long-term debts and performance. H2: There is significant relationship between long-term debts and performance. H0: There is insignificant relationship between total debt and performance. H3: There is significant relationship between total debt and performance. A numbers of control variables are used in present study after forming both dependent and independent variables and these control variables have been used in many previous studies which are: size, age, assets structure, growth turnover, risk, volume of capital, liquidity and effect of borrowing. Firm size is considered as important determinant in determining the profitability of firm. So, size of the firm is used in the present study as a controlled variable. Number of studies that have examined the impact of firm size on firm performance found a positive relation among size of firm and it performance (For example: Gleason et al., 2000 and Zeitun and Tian, 2007a). Awan and Gleason found in their studies a positive relation among size and profitability. Therefore, it is expected that a firm s size has a positive impact on a firm s performance. Size is measured by taking the natural log of total assets. This measure is used by Fama & French, (2002), Abor,(2005), Zeitun & Tian, (2007), Rajcaniova and Bielik, (2008) and Ebaid (2009).So, based on the discussion the size is expected to have a positive impact on a firm s performance.firm age: The log of number of years since the company is incorporated to This measure is used by Abu-Tapanjeh and Muritala, (2012). Tangibility of Asset: Here for the measurement of assets tangibility the ratio of fixed assets to total assets is used. It is used by Muritala (2012) and Ahmed, et al. (2011). Hence, Assets tangibility is expected to have a positive impact on a firm s performance. Growth: Here, a growth is measured by percentage increase in sales. This measure is used by prior researchers: Abor, (2005), Zeitun & Tian, (2007). Here, positive impacts of sales growth are expected to have on performance of the firm. Growth opportunities are expected to have a positive impact on a firm s performance. Risk is measured by taking the ratio of financial expenses to earnings before interest and taxes. This measure is used by Ahmed, et al. (2010) and Manawaduge, et al., (2011).Volume of capital is measured by taking the book value of equity. Total equity capital=book value of equity and it will be measured by taking the natural log of book value of equity. It is earlier used by Malik, (2011). Liquidity: It is measured by taking the ratio of current assets to current liabilities. It is used by Akbas & Karaduman (2012), Ahmed, et al. (2010) and Rajcaniova and Bielik,(2008). A positive relation also is expected as high proportion of liquid assets avoid from costly borrowing. To examine the impact of capital structure on the performance of the firm the following regression equations have been run. Performance = α + β 1 LTDTA I,t + β 2 TURN I,t + β 4 SIZE I,t + β 3 AGE I,t + β 4 TANG I,t + β 5 GROW I,t + β 6 RISK I,t + β 8 LIQ I,t + β 9 VOC I,t + ε i,t. 1 Performance =α + β 1 STDTA I,t + β 2 TURN I,t + β 4 SIZE I,t + β 3 AGE I,t + β 4 TANG I,t + β 5 GROW I,t + β 6 RISK I,t + β 8 LIQ I,t + β 9 VOC I,t + ε i,t. 2 Performance = α + β 1 TTDTA I,t + β 2 TURN I,t + β 4 SIZE I,t + β 3 AGE I,t + β 4 TANG I,t + β 5 GROW I,t + β 6 RISK I,t + β 8 LIQ I,t + β 9 VOC I,t + ε i,t. 3 where: P/E: price per share / earnings per share Tobin s Q: BV of assets - BV of equity + market value of equity / BV of assets STD/TA: Short-term debt to total asset LTD/TA: Long-term debt to total asset TD/TA: Total debt to total asset ~15~

6 TURN: Assets Turnover (Sales / total assets) SIZE: Natural logarithm of total assets AGE: Age (log of number of years since the company is incorporated) TANG: Assets Tangibility (Fixed Assets/ Total Assets) GROW: Annual change in sales RISK: Business Risk (Financial Expenses / EBIT) LIQ: Liquidity (Current assets / Current liabilities) VOC: Volume of capital (log of book value of equity) α: Intercept ε: Error term of the Model 4. RESULT AND DISCUSSION Descriptive statistics for all variables used in this study including dependent, independent and control variables are reported in table 1. Descriptive statistics find out here the mean, standard deviation, minimum, median, maximum skewness and kurtosis of the variables in the sample. Dependent variables are P/E and Tobin s Q whereas independent variables are LTD, STD and TD and numbers of control variables are also used to check their effects on performance. The mean of total debt ratio is 32 percent it indicates that most of the Pakistani firms are not highly levered while minimum value is zero and maximum is reflecting that some companies equity proportion have been completely damaged and changed into negative values. This result indicated that there is high variation in using debt. Standard deviation of total debt is 61.9 percent which showed that there is high variation in values of firm. The mean values of long term debt and short term debt are 14.5 percent and 17.3 percent respectively while there is high standard deviation and high dispersion in minimum and maximum values which show Pakistani companies overall finance their assets and projects by equity, this show that they operate in low risk. The mean value of price earning is percent while average mean value of Tobin s Q is percent. This result showed that market performance measures (P/E and Tobin s Q) displayed high percentage of performance as compared to accounting performance measures. Table 4.1: Summary Statistics of all Variables, Variables Mean SD Min. 1 st Median 2 nd Quartile Max. Skew. Kurt. Quartile Dependent Variables P/E Tobin s Q Independent Variables LTD STD TD Control Variables SIZE(Million PKR) GROW TANG AGE RISK LIQ VOC(Million PKR) TURN Beta N valid 1576 Note: P/E= price per share / earnings per share; Tobin s Q= book value of assets - book value of equity + market value of equity / book value of assets; LTD/TA= Long-term debt to total asset; STD/TA= Short-term debt to total asset; TD/TA= Total debt to total asset; SIZE= Natural logarithm of total assets; GROW= Annual change in sales; TANG= Assets Tangibility (Fixed Assets/ Total Assets); AGE= Age (log of number of years since the company is incorporated); RISK= Business Risk (Financial Expenses / EBIT); LIQ= Liquidity (Current assets / Current liabilities); VOC= Volume of capital (log of book value of equity); TURN= Assets Turnover (Sales / total assets); ~16~

7 The Growth has a mean value of 374 percent; it means companies have more opportunities of growth and are efficiently utilizing the loans from outsiders and the banking sector. High growth firms deliver positive indications about future performance to the market about their. The high sales growth and low long-term debt proportion explain that use of short-term debt in capital structure is high in Pakistani companies. The tangibility has a mean value of 54 percent; it means companies have more collateral assets to take loans from outsiders and the banking sector. The high tangibility and low long-term debt proportion explain that use of short-term debt in capital structure is high in Pakistani companies. Turnover has a mean value of Management efficiency is checked through the turnover of firm s assets and in way they use and exploit the assets of the firm in order to produce and yield a positive return to firms. To find the impact of capital structure on firm performance both pooled ordinary least square and fixed effect model and random effect model for panel data regression were used for the period 2004 to 2011 in this study. In panel regression Hausman test was run to check fixed-effect model and random-effect model Table 4.3: Estimation Results for Pooled Data PE Model Using LTD, STD & TD Variables P/E (LTD) P/E (STD) P/E (TD) Model 1 Model 2 Model (Constant) (59.92) *** (5.42) *** (50.59) *** (5.41) *** (56.28) *** (6.03) *** Debt (-1.30) (-5.18) *** (-6.58) *** (-4.95) *** (-3.23) *** (-6.62) *** SIZE (-2.64) *** (-4.08) *** (-2.73) *** TANG (-2.08) ** (-2.43) ** (-2.08) *** AGE (-2.20) ** (-1.03) (-1.92) * GROW.150 (2.11) ** (1.99) * (2.12) ** LIQ (-.27) (-.58) (-.88) TURN (-3.41) *** (-2.20) ** (-3.18) ** RISK (-.53) (-.49) (-.44) VOC.213 (3.83) ***.266 (5.01) ***.197 (3.60) *** Adjusted R F-Statistics *** *** 8.62 *** *** Durbin- Waston Root MSE Note: Numbers in parentheses are asymptotic t-values. P/E= price per share / earnings per share; LTD/TA= Long-term debt to total asset; STD/TA= Short-term debt to total asset; TD/TA= Total debt to total asset; SIZE= Natural logarithm of total assets; TANG= Assets Tangibility (Fixed Assets/ Total Assets); AGE= Age (log of number of years since the company is incorporated); GROW= Annual change in sales; LIQ= Liquidity (Current assets / Current liabilities); TURN= Assets Turnover (Sales / total assets); RISK= Business Risk (Financial Expenses / EBIT); LIQ= Liquidity (Current assets / Current liabilities); VOC= Volume of capital (log of book value of equity);t values are reported in parenthesis. ***Significant at 1% level, ** Significant at 5% level, and *Significant at 10% level Table 4.3 represents the result the impact of independent variables Long term debt, Short term debt and Total debt on market performance PE ratio. The result indicates a highly significant negative impact of capital structure measures (LTD, STD and TD) on market performance measure PE. This result supports the findings by Zeitun and Tian (2007) and Umar (2012).Model 1, 2 and 3 are run without control variables also indicating a negative and significant coefficient of capital structure measures (LTD, STD and TD). Debt again showing a significant negative impact on market performance PEin the absent of control variables. Fixed effects model and ~17~

8 random effect model produces consistent. Hausman Specification test show a fixed effect for the impact of capital structure on performance which is measured by PE. The negative impact of debt on performance indicates that by increasing one unit of debt, PE decreases by.260, 1.89 and 1.86 respectively. This result supports the findings by Zeitun and Tian (2007) and Umar (2012). Size is used as a control variable to surge the impact of independent variable on dependent variable and significant negative effect are detected, this is significant at 1 percent level. The three different estimators (i.e. pooled OLS, fixed effects model and random effect model) produces consistent results that firm size negatively impact the performance of the firm. Differing to our expectation tangibility and size are found to be negatively associated with firm performance. These finding indicates underutilization of current and non-current assets by Pakistani firms. Result indicates that sales growth has significant positive effect on the market performance PE. Result also indicates that Volume of capital has significant positive effect on the market performance PE. Adjusted R 2 values are satisfactory as capital structure measures (LTD, STD and TD) showing 59%, 65% and 69% variation in performance. Significance of regression equations are also indicated by Durbin-Watson (DW) and F-statistics. F-statistics in long term debt, short term and total debt are 8.80, 8.62 and percent respectively and all are significant at 1 percent level. The statistics of Durbin-Watson of 1.70 more shows that the regression equations are free from autocorrelation problem Table 4.4: Estimation Results for Pooled Tobin s Q Model Using LTD, STD and TD Variables Tobin s Q (LTD) Tobin s Q (STD) Tobin s Q (TD) Model 1 Model 2 Model (Constant) (28.93) *** (5.24) *** (23.95) *** (5.57) *** (27.07) *** (5.30) *** Debt (-.64) (-.19) (-2.82) *** (-2.24) ** (-1.47) (-.86) SIZE (-4.68) *** (-4.46) *** (-4.60) *** TANG.053 (.73).058 (.79).056 (.77) AGE (-2.82) *** (-2.82) *** (-2.88) *** GROW (-.52) (-.62) (-.61) LIQ (-1.48) (-1.81) * (-1.54) TURN.215 (4.09) ***.213 (4.08) ***.211 (4.03) *** BETA.051 (2.10) **.047 (1.96) *.050 (2.09) ** VOC.150 (4.47) ***.137 (4.06) ***.159 (4.80) *** Adjusted R F-Statistics *** 7.97 *** 6.55 *** *** Durbin Waston Root MSE Note: Numbers in parentheses are asymptotic t-values. Tobin s Q= book value of assets - book value of equity + market value of equity / book value of assets; LTD/TA= Long-term debt to total asset; STD/TA= Short-term debt to total asset; TD/TA= Total debt to total asset; SIZE= Natural logarithm of total assets; TANG= Assets Tangibility (Fixed Assets/ Total Assets); AGE= Age (log of number of years since the company is incorporated); GROW= Annual change in sales; LIQ= Liquidity (Current assets / Current liabilities); TURN= Assets Turnover (Sales / total assets); RISK= Business Risk (Financial Expenses / EBIT); LIQ= Liquidity (Current assets / Current liabilities); VOC= Volume of capital (log of book value of equity);t values are reported in parenthesis. ***Significant at 1% level, ** Significant at 5% level, and *Significant at 10% level. From the Pooled (OLS) results in Table 4.4, the leverage measures LTD, STD and TD has a negative and significant effect on Tobin s Q the market performance measure. It is consistent with the argument of Zeitunand ~18~

9 Tian, (2007); Khan, (2012); and Salim, (2012). Both fixed effect model and random effect model shows that capital structure has direct impact on market performance measure Tobin s Q. Firm size displays a significantly negative impact on the market performance measured by Tobin s Q, it means of large size firms shows inefficiency and negatively affects the firm performance. This result supports the argument of Khan, (2012) and Salim, (2012). Assets turnover indicates a direct link with the performance Tobin s Q, it means that with the increase in assets turnover the firms market performance Tobin s Q (with LTD, STD and TD) increase by 0.215, and respectively. Assets turnover shows the management efficiency, more they turn assets into sale, more the market performance Tobin s Q increase. Beta the measure of market risk shows a significant positive impact on the market performance Tobin s Q. It means firm market performance enhance by taking more risk, as they are positively correlated. Hausman specification test select the fixed effect model, result of this model is consistent with the result of pooled regression.result also indicates that Volume of capital has significant positive effect on the market performance Tobin s Q; this suggest that Tobin s Q increase by.150,.137 and.159 respectively with capital structure measures (LTD, STD and TD) with the one unit increase in firm s Volume of capital. Assets tangibility also shows a positive relationship with the performance measure Tobin s Q. Growth has negative but not statistically significant impact on firm performance and this result is consistent with the previous finding of Soumadi, (2012). This result means that the firm takes more debt to achieve its desire to enhance the firm growth, which eventually leads to bankruptcy cost and management fails to utilize the debt by gaining tax shield which at the end negatively reflected the firm performance. F-statistics of long term debt, short term and total debt are 5.98, 6.55 and 6.06 percent respectively and all are significant at 1 percent level. The statistics of Durbin-Watson of 1.50 average more shows that the regression equations are free from autocorrelation problem. 5. CONCLUSION This study examines the impact of capital structure on firm s performance of Pakistan. The study employed analytical tools of descriptive econometric in studying 197 Pakistani quoted companies with 1576 observations for the period 2004 to The analyses were performed using both pooled OLS regression and panel data. Descriptive statistics showed that the performance of the firms in Pakistan was satisfactory during the study period of 2004 to Firms in Pakistan are financed 14% by Long term debt and 17% of the firm assets are financed by short term debt and 32 percent by total debt. It may be because of the undeveloped small debt market and the equity markets are combined with trading of lower levels. Findings from the present study shown that there is a significant negative impact of capital structure on firm s performance as illustrated in Table 4.3 and 4.4. The negative impact of capital structure inferred that a change in the capital structure would result in a decrease in firm s performance. These findings are in accordance with the findings of Rajan & Zingales (1995), Gleason et al., (2000), Zeitun and Tian (2007), Abor (2005) and Ebaid (2009). This study finds that the firms have adopted capital structure on the base of pecking order theory in the Pakistan. Firms in Pakistan are being forced to borrow less. In Pakistan the major source of financing are banks and due to the problems of information asymmetry, volatility in earnings and weak regulatory structure external financing are protected with strict covenants. These findings lead this study to conclude that in general term capital structure choice has weak-to-no influence on performance of listed firms in Pakistan. Size also has shown a negative impact on performance measured by P/E and Tobin s Q; it shows that large companies in size are inefficient in using and exploiting its assets to enhancement in performance. Further research could examine the relationship between structure of maturity of debt of firm and its assessments and performance. Finally, further research could examine the combined impact of both ownership structure and capital structure on firm s performance. REFERENCES Abiodun, B. Y. (2012). The Effects of Optimal Capital Structure on Firms Performances in Nigeria. 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10 Akhtar, S. (2005). The determinants of capital structure for Australian multinational and domestic corporations. The Australian Graduate School of Management, Awan, T. N., Rashid, M., & Zia-ur-Rehman, M. (2011). Analysis of the determinants of Capital Structure in sugar and allied industry. International Journal of Business and Social Science, Badar, R., & Saeed, A. (2013). Impact Of Capital Structure On Performance Empirical Evidence From Sugar Sector Of Pakistan. European Journal of Business and Management, Booth, L., Aivazian, V., Kunt, A. D., & Maksimovic, V. (2001). Capital Structures in Developing Countries. The Journal of Finance is currently published by American Finance Association, Deesomsak, R., Paudyal, K., & Pescetto, G. (2004). The determinants of capital structure : evidence from the Asia Pacific region. Journal of multinational financial management, Ebaid, I. E.-S. (2009). The impact of capital-structure choice on firm performance: empirical evidence from Egypt. The Journal of Risk Finance, Fama, E. F., & French, K. R. (2002). Testing Trade-Off and Pecking Order Predictions about Dividends and Debt. The Review of Financial Studies, Ferati, R., & Ejupi, E. (2012). CAPITAL STRUCTURE AND PROFITABILITY: THE MACEDONIAN CASE. European Scientific Journal, Harris, M., & Raviv, A. (2008). A Theory of Board Control and Size. Review of Financial Studies, Jensen, M. C., & Meckling, W. H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, Khan, A. G. (2012). The relationship of capital structure decisions with firm performance: A study of the engineering sector of Pakistan. International Journal of Accounting and Financial Reporting, Malik, H. (2011). DETERMINANTS OF INSURANCE COMPANIES PROFITABILITY: AN ANALYSIS OF INSURANCE SECTOR OF PAKISTAN. Academic Research International, Manawaduge, A., Zoysa, A. D., Chowdhury, K., & Chandarakumara, A. (2011). CAPITAL STRUCTURE AND FIRM PERFORMANCE IN EMERGING ECONOMIES: AN EMPIRICAL ANALYSIS OF SRI LANKAN FIRMS. Corporate Ownership & Control, MODIGLIAN1, F., & MILLER, M. H. (1958). THE COST OF CAPITAL, CORPORATION FINANCE AND THE THEORY OF INVESTMIENT. American Economic Association, Muritala, T. A. (2012). An Empirical Analysis of Capital Structure on Firms Performance in Nigeria. International Journal of Advances in Management and Economics, MYERS, S. C., & MAJLUF, N. S. (1984). CORPORATE FINANCING AND INVESTMENT DECISIONS WHEN FIRMS HAVE INFORMATION THAT INVESTORS DO NOT HAVE. Journal of Financial Economics, Modigliani, F., & Miller, M. H. (1963). Corporate Income Taxes and the Cost of Capital: A Correction. American Economic Association, Pratheepkanth, P. (2011). CAPITAL STRUCTURE AND FINANCIAL PERFORMANCE: EVIDENCE FROM SELECTED BUSINESS COMPANIES IN COLOMBO STOCK EXCHANGE SRI LANKA. Journal of Arts, Science & Commerce, Rajan, R. G., & Zingales, L. (1995). What Do We Know about Capital Structure? Some Evidence from International Data. The Journal of finance, Salim, M., & Yadav, D. R. (2012). Capital Structure and Firm Performance: Evidence from Malaysian Listed Companies. Social and Behavioral Sciences, Skopljak, V. (2012). Capital Structure and Firm Performance in the Financial Sector: Evidence from Australia. Asian Journal of Finance & Accounting, Soumadi, M. M., & Hayajneh, O. S. (2012). CAPITAL STRUCTURE AND CORPORATE PERFORMANCE EMPIRICAL STUDY ON THE PUBLIC JORDANIAN SHAREHOLDINGS FIRMS LISTED IN THE AMMAN STOCK MARKET. European Scientific Journal, Thomas, K., Ababio, K. A., & Zakari, A. (2012). Empirical Analysis of the Association between Capital Structure and Performance of Rural Banks in Ghana. Journal of Money, Investment and Banking, UREMADU, S. O., & EFOBi, R. U. (2012). The Impact of Capital Structure and Liquidity on Corporate Returns in Nigeria: Evidence from Manufacturing Firms. International Journal of Academic Research in Accounting, Finance and Management Sciences, Yermack, D. (1996). Higher Market Valuation of Companies with a Small Board of Directors. Journal of Financial Economics, Zeitun, R., & Tian, G. G. (2007). Capital structure and corporate performance: evidence from Jordan. The Australasian Accounting Business & Finance Journal, ~20~

11 Table 3: Estimation Results for Panel Data Regression of P/E Model Using LTD, STD and TD Variables P/E(LTD) P/E (STD) P/E (TD) Fixed Effect Random Effect Fixed Effect Random Effect Fixed Effect Random Effect Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 (Constant) (71.76) *** (7.45) *** (34.04) *** (5.31) *** (41.33) *** (7.51) *** (31.75) *** (5.30) *** (63.76) ** (7.38) *** (34.18) ** (5.44) *** Debt (.60) (.43) (.10) (-1.48) (1.00) (1.10) (-1.89) ** (-1.47) (.81) (1.21) (-.38) (-2.16) ** SIZE (-.76) (-2.77) *** (-.72) (-3.12) *** (-.86) (-2.73) *** TANG (-1.53) (-2.07) ** (-1.50) (-2.18) ** (-1.55) (-2.07) ** AGE (-5.91) *** GROW LIQ TURN (-3.51) *** RISK VOC (3.87) *** (3.56) (-.39) (-.42) (-.36).173 (2.49) *** (-2.51) ** (-6.15) *** (-3.80) *** (-.57).202 (3.27) *** (-2.25) ** (- 5.97) *** (-2.44) ** (3.85) *** (3.53) *** (3.84) *** (3.54) *** (-.32) (-.50) (-.32) (-.58) (-3.54) *** (-.38).176 (2.56) *** (-3.50) *** (-.61).214 (-.54) (- 3.43) *** (-3.81) *** (-.38) (-.53) (2.66) *** (3.12) *** Adjusted R F-Statistics *** *** *** Wald χ 2 - Statistics *** 3.58 * *** *** Hausman test 6.23 ** *** *** *** *** *** ~21~

12 Table 4: Estimation Results for Panel Data Regression of Tobin s Q Model Using LTD, STD and TD Variables Tobin s Q (LTD) Tobin s Q (STD) Tobin s Q (TD) Fixed Effect Random Effect Fixed Effect Random Effect Fixed Effect Random Effect Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 Model 1 Model 2 (Constant) (43.96) *** (4.28) *** (13.11) *** (4.14) *** (25.00) *** (4.52) *** (12.19) *** (4.29) *** (39.02) *** (4.29) *** (12.98) *** (4.11) *** Debt (.36) (2.28) ** (.24) (1.54) (1.00) (1.16) (.31) (.56) (.57) (2.42) ** (.30) (1.41) SIZE (-4.64) *** TANG AGE GROW LIQ TURN RISK VOC (-.10) (3.24) *** (-.47) (-.68).065 (.87).0313 (1.41).002 (.06) (.-2.38) ** (-.13) (-.64) (-.98) (-.65).158 (2.35) **.032 (1.47).031 (.78) (-4.29) ***.006 (.06) (2.80) *** (-.46) (-.61).049 (.65).025 (1.15) (-.33) (-2.11) ** (-.02) (-.95) (-.94) (-.64).141 (2.14) **.028 (1.31).019 (.48) (- 4.59) *** (-2.32) ** (-.04) (-.09) (3.07) *** (-.79) (-.51) (-.98) (-.55) (-.57) (.87) (2.29) ** (1.37) (1.42) (.13) (.76) Adjusted R / F-Statistics *** *** *** Wald χ 2 - Statistics ** *** ** Hausman test *** *** *** ~22~