INTRODUCTION:
The capital structure of a business is the mix of types of debt and equity the company has on its balance sheet. Debt is an essential element of capital structure of any organization. An appropriate capital structure is necessary to maximize the returns for shareholders. Proper capital structure is attained by a proper mix of debt and equity. It takes into consideration of various theories of capital structure developed by professionals. The capital or ownership of business can be evaluated by knowing how much of the ownership is in debt and how much in equity.
The capital structure management is one of the essential areas of concern of every organization. A company succeeds or fails due to its capital structure management. An optimum capital structure is the one which maximizes the value of the firm. The capital structure of a company may consist of:
1. Equity shares only,
2. Equity and preference shares,
3. Equity shares and debentures,
4. Equity share, preference share and debenture
Among these forms any one can be chosen by a company. Capital Structure is a significant concept because it reflects the firm’s strategy, indicates of the risk profile of the firm, acts as a tax management tool, helps to brighten the image of the firm. The factors like risk, profit, nature of the project, control of the firm are the important determining factors of capital structure. Economic Value Added, a measure provided by stern Stewart and Co., is the performance measure directly linked to creation of shareholder’s value. EVA is also considered as economic profit. Operating profits (tax adjusted) of the business are deducted by the weighted average cost of capital to get EVA. It is considered a good measure to check the performance of management of the company and it clearly shows how much profits a company is able to generate overa and above the returns required for the shareholders.
The combination of Debt and equity in the capital structure of the company determines its returns to the shareholders. Present study is aimed at checking if there exists any relationship between capital structure of the organization and Economic Value Added by the organization. It further checks how much is the impact of Debt- equity ratio (measure of capital structure) on EVA
REVIEW OF LITERATURE:
Right decisions on financing can lead to optimum capital structure. Therefore, it is one of the important decisions that a company makes on the financial leverage which can directly affect the shareholders wealth (Bhayani, 2009) Kumar and Subramanyam (2017) says that one of the important roles which has to be performed by the financial manager deals with analysis of the firm’s value to take better decisions. In order to determine the goodwill of the firm and to keep the shareholders happy it is important to conduct a value analysis in various situations to know the negative and positive implications. The researchers have used two modern financial tools known as EVA and MVA.
Decisions on capital structure are essential for a company to be financially strong. Unsuitable decisions on capital structure might take the companies to financial trouble and ultimately to insolvency. All such decisions regarding capital structure are taken by Top Level Executives to attain the main objective shareholders wealth maximization (Baser, Brahmbhatt, and Joshi 2011). Any investor who invests in a company must give importance to information because it helps them to find out the company’s priority on shareholders wealth. This task can be effective only when there is reliable data hence the software companies and stock exchanges which provide information about companies must also calculate value based performance variables which can be used by analysts, investor and researchers in their decision-making process (Shahveisi, Navid, Najafi, and Hosseini 2012). The leverage or mix of debt and equity maintained by the companies can affect risk and returns which directly affects value of the firms. This is a risk that management has to face while making decisions pertaining to debt and equity mix. But this risk is under the control of management, wrong decisions on capital structure can increase the cost of capital, which unavoidably lowers the net present value of the projects. The determining factors of capital structure differs in different industries therefore, it is must for a financial manager to wisely analyse the specific characteristics of that industries before planning for optimum capital structure (Krishnan and Mohandas 2013). Chadha and Sharma (2015) analysed that factors such as size, growth, profitability, business risk, uniqueness, ownership structure etc. influences the capital structure decisions.
The main aim of a company is maximizing the shareholders wealth and attracting more investments from the investors. Therefore, the success of a firm and its management is determined based on the level of value creation to its shareholders. Economic Value Added is an important performance measurement tool which is interrelated to market value of the firm. EVA is an important tool which measures the profit after considering capital and taxes. Better EVA indicates greater value to the shareholders of a company (Vijayalakshmi,2013). To improve the value for its shareholders the companies should maximize their MVA (Market Value Added), it is possible only when company strive towards maximizing EVA, because EVA indicates firm’s capacity to gain returns on capital above its cost (Wet and Hall, 2004)
PURPOSE AND SCOPE OF THE STUDY:
The purpose of the study is to find the relationship between Economic Value Added and Capital Structure in the Pharmaceutical Companies listed in National Stock Exchange. The scope has been restricted to 5 Pharmaceutical Companies selected randomly. One of the selection criteria was that the Companies should be running in profits. Due to stiff competition, Pharmaceutical manufacturers find it difficult to be profitable and successful in the market. This research intends to analyse the scope beyond profitability by concentrating on debt equity mix and analysisng its relationship with Economic Value Added. The period of the study is 2013-2017.
RESEARCH METHODOLOGY:
The research material and methods deal with secondary sources and the data has been collected from Prowess the data base from Centre for Monitoring Indian Economy (CMIE), annual reports and websites like www.moneycontrol.com. Top 5 Pharmaceutical companies are identified and analysis is done from 2013-2017 i.e. for a period of five years. The selected Companies include Lupin Ltd., Dr. Reddy’s Laboratories Ltd, Aurobindo Pharma Ltd, GlaxoSmithKline Pharmaceuticals Ltd and Glenmark Pharmaceuticals Ltd.
5 years Debt-Equity Ratio has been taken from www.moneycontrol.com and average of the values have been calculated. The website uses the formula Total Debt / Equity to calculate the ratio. Moreover, Long-term sources of finences are used to calculate the ratio.
The EVA is computed using following equation:
EVA=NOPAT-
(WACC 
CE)
Where,
EVA = Economic Value Added
NOPAT=Net Operating Profit After Tax
WACC= Weighted Average Cost of Capital
CE= Capital Employed
An average of all the values are taken for five years to calculate average EVA.
Correlation is calculated using Microsoft Excel to find out the relationship between EVA and capital structure.Regression analysis is also done to find out the impact of Capital structure on Economic Value Added using Microsoft Excel.
LIMITATIONS OF THE STUDY
The study is limited for a period of five years and only five companies have been selected for the purpose of the study. So, the findings canno be generalised.Also, only Pharmaceutical Companies have been taken into account. This study is based on the information presented in the annual reports, which is secondary data. Limitations applicable in the financial statements would apply to this study also. More companies can be analysed in the future studies and sector wise analysis can also be conducted.
DATA ANALYSIS AND INTERPRETATION:
Table 1: Average values of EVA of select pharmaceutical companies
|
Name of the company |
EVA (in millions) |
|
Lupin Ltd |
-234450.8 |
|
Dr Reddy's Laboratories Ltd |
-401189.97 |
|
Aurobindo Pharma Ltd |
-610053.37 |
|
Cadila Healthcare |
-226065.628 |
|
Glenmark Pharmaceuticals Ltd |
-2,17,937.96 |
Source: Author
Table 1 shows the average Economic Value Added of all the companies. Although the companies which were making profits have been selected, the EVA is negative for all.
Table 2: Average of Debt Equity Ratio
|
Companies |
Debt equity Ratio |
|
Lupin Ltd |
0.04 |
|
Dr Reddy's Laboratories Ltd |
0.25 |
|
Aurobindo Pharma Ltd |
0.59 |
|
Cadila Healthcare |
0.366 |
|
Glenmark Pharmaceuticals Ltd |
0.142 |
Source: Money control
Table 2 shows the avrage Debt-Equity ratio average of five years for all the companies. Lupin ltd has the lowest Debt-equity ratio of 0.04 showing least reliance on Debt by the management. Highest Debt-equity ratio of 0.59 belongs to Aurobindo Pharma Ltd.
Table 3: Correlations
|
|
Debt equity Ratio |
EVA (In millions) |
|
Debt equity Ratio |
1 |
|
|
EVA (In millions) |
-0.789455901 |
1 |
Source: Author
Table 3 shows correlation between Debt-equity ratio and Economic Value Added. The results of the study show that Debt-equity ratio and Economic Value Added have strongly negative correlation.Thus,increase in one variable leads to decrease in another variable.
REGRESSION ANALYSIS
For the purpose of this analysis, Debt-equity is taken as independent variable and EVA is taken as dependent variable.
Table 4: Regression Analysis
|
Multiple R |
0.789455901 |
|
R Square |
0.62324062 |
|
Adjusted R Square |
0.49765416 |
|
Standard Error |
120527.6539 |
|
Observations |
5 |
|
|
Coefficient |
Standard Error |
t-Stat |
P-Value |
|
Intercept |
-162749.306 |
95341.04918 |
-1.7072 |
0.186357 |
|
Debt Equity Ratio |
-631088.76 |
283291.784 |
-2.26277 |
0.112236 |
Source: Author
Table 4 shows regression analysis between the average Debt-equity ratio and average EVA of the 5 Pharmaceutical companies for a period of five years. Adjusted R sqaure of 0.49 shows that 49% of variation in EVA is predicted by Debt-equity ratio of the organization. Thus, it shows not a very strong prediction. So, it can be said that variables not included in the study are impacting EVA more than Debt-equity ratio. P-value of 0.11 shows that influence of Debt-equity ratio on EVA is not significant.
Thus, the study shows that companies with debt composition in their capital structure have negative EVA i.e. the more increase in debt leads to more reduction in EVA of these pharmaceutical companies in India. As per the analysis done using excel, the value of P (significance level) =0.49 indicates that debt has not very significant impact on value of a firm’s EVA.The results of the present study are similar to the results of a study conducted by Jose and Ashok, (2015) and Asif and Aziz, (2016).
CONCLUSION:
This paper attempts to find out impact of capital structure decisions on the value of EVA which reflects the value that companies can create for their shareholders.
The correlation between Capital Structure and Economic Value Added have strongly negative correlation and the Regression analysis reveals that Capital structure does not impact significantly on value of EVA. Hence the value of EVA of these organizations is not only affected by the debt-equity composition in their capital structure but by many other factors.
REFERENCE:
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WEB SOURCE:
1. www.moneycontrol.com
2. www.Equitymaster.com
3. www.lupin.com
4. www.drreddys.com
5. www.aurobindo.com
6. https://annualreports.gsk.com
7. www.glenmarkpharma.com
Received on 03.01.2018 Modified on 31.01.2018
Accepted on 20.02.2018 ©A&V Publications All right reserved
Asian Journal of Management. 2018; 9(1):347-350.
DOI: 10.5958/2321-5763.2018.00054.9