INTRODUCTION:
According to Gerstenberg, “Capital structure of a company refers to the composition or make-up of its capitalization and it includes all long-term capital resources viz loans, reserves, shares and bonds”. Capital structure is a vital decision that has to be taken in a company by the management in the modern era. It is needed to know how the firm requires to raise its capital in order to develop and establish their business activities. In other words, it basically shows the debt and equity in the firm that can be used to finance the business activities.
A false financial decision may lead to financial distress and even bankruptcy. A firm’s basic motive is to increase profitability and shareholder’s wealth. Corporate finance related decisions like capital structure affects the management decisions directly and indirectly and this will further affect the wealth of the shareholders. The main purpose of capital structure is to increase the wealth of the shareholders by ensuring low cost of capital. Therefore, capital structure can be stated as one of the vital tools of management.
The Miller–Modigliani (1958) theorem is base for all capital structure theories. This is known as the static trade-off theory and states that debt financing is comparatively initially cheaper than equity financing and a company can lower its weighted average cost of capital through a capital structure with debt over equity. Hence this theory identifies a mix of debt and equity where a decreasing weighted average cost of capital offsets the increasing risk to the company. The pecking order theory is another theory that helps a firm in choosing its capital structure. This theory has been most used in determining the capital structure a firm wishes to have. The pecking order theory states that a firm should prefer to finance itself internally first through retained earnings. If the internal source of finance is unavailable to the firm, then the firm should finance itself through debt and only as a last resort should the firm move to IPOs. This theory also signals the performance of the company. If the firm is able to finance internally, it shows that the company is showcasing a good performance, if it has borrowed funds it shows that the company is in a state to pay off its obligations and if the company goes for an IPO it normally gives a negative signal and it signals that the company’s shares are overvalued and seeks to make money prior to the fall in its share price. In this paper we compare the similarities between effects of banks and Non-banking Financial Services on D/E ratio of various independent variables and by what percentage.
REVIEW OF LITERATURE:
Harris, Milton. Raviv,Artur (1990) studied the capital structure and informational role of debt and finds that the optimal structure is obtained through a trade-off between liquidation decisions and higher investigation costs. The high leverage can be an outcome with large firm value, lower probability of reorganization following default and higher debt level. Rajan and Zingales (1995) found levels of leverage across the G7 group of countries. This is a surprising result because it has been usually asserted that firms in bank-oriented countries are more levered than in market-oriented countries. They also show that the determinants of the capital structure that have been previously reported for U.S. data are equally important in other G-7 countries.Basudeb Guha-Khasnobis, Saumitra N. Bhaduri (2002) in their study “Determinants of Capital Structure in India (1990-1998): A Dynamic Panel Data Approach” gives an insight into the choice of capital structure of developing countries through a case study of the Indian corporate sector. the results of the study suggest that restructuring cost is important in adjustment towards an optimal capital structure. Mishra, Chandra Sekhar. Gill, Amarjit. Biger, Nahum. Pai2, Chenping. Bhutani, Smita (2009) studiedthe determinants of capital structure in the service industry from United States shows the extension to the findings of Biger, Nguyen, and Hoang’ (2008) and finds that leverage is negatively related to the firm's profitability. Maria Psillaki, Nikolaos Daskalakis (2009) in their study “Are the determinants of capital strcture country or firm specific?” investigates the capital structure of Greek, French, Italian and Portuguese medium sized enterprises (SMEs) and compares the capital structures of companies across various differences to know how these impacts the capital structure choices. The study concludes that firm specific rather than country differences influence the choice of capital structure in SMEs. Gupta, Vinod (2011) in their study determinants of capital structure of manufacturing sector PSUs in India identified the determinants of Indian central PSU's capital structure and suggest that the capital structure (Total Borrowing to Total Assets) of the profit-making PSUs is affected by Asset Structure (Net Fixed Assets to Total Assets, NFATA), Profitability (Return on Assets, ROA) and Tax. Unlike suggestion of pecking order hypothesis, growth (defined as growth in total assets) is positively related to leverage. Kaushik Basu and Meenakshi Rajeev (2013) verifies whether capital market regulations exert any control on the capital structure decisions of Indian corporate firms. The results suggest that capital market regulations have adverse impact on the use of public debt and positive impact on the use of equity capital. The study concludes that the assets are negatively related to the leverage. Banerjee, Arindam. De, Anupam.(2014) in theirstudy investigates the factors (independent variables) on which the dependent variable profitability depends upon for the firms belonging to the Indian Iron and Steel industries and also to examine determinants of financial performance during pre- and post- recession periods. Anshu Handoo and Kapil Sharma (2014) in their study “A study on determinants of capital structure” identifies the most important determinants of capital structure of Indian firms comprising both private and government companies. The study concludes that factors such as profitability, growth, asset tangibility, size, cost of debt, tax rate have significant impact on the leverage of the companies. The study was an empirical study based on well-known capital structure theories. Bhag Singh Bodia (2017) in his study “Determinants of Capital Structure-A Study of Selected Pharma Companies” studies the significant determinants of listed Pharmaceutical companies. Multiple regression study was carried out for selected companies and variables like capital density, debt service capacity, cashflow coverage ratio were found to be the most significant determinants of pharmaceutical companies. Berhe and Kaur (2017) in their study identifies the key factors that affected the profitability of insurance companies in Ethiopia. ROA was the measure of profitability used and the results of the study indicated that the size of insurance, capital adequacy, liquidity ratio and real growth of GDP are the key factors that affect the profitability of insurance companies.
MOTIVATION FOR THE STUDY:
The optimal capital structure of a firm is reached when the cost of the capital is at the minimum. Many firms face a difficulty in obtaining the optimal capital structure and are perplexed to know what factors influence and determine the capital structure of a company. Through this study, the various factors that influence in determining the capital structure of the BFSI sector is worked out.
Banking, Financial Services and Insurance (BFSI) is an emerging sector in the economy and by assessing the determinants of capital structure it will help the parties involved in this sector to take innovative actions that will help them strengthen their competition in the industry. There have been various studies related to the determinants of capital structure but not related to BFSI specifically and hence this study aims at contributing to the literature by evaluating the capital structure. The study will also provide insights to the external investors and shareholders, policy makers and lenders.
METHODOLOGY:
This study is intended to verify the determinants of capital structure of banking and non-banking financial companies in India. For this purpose,financial data is collected for a period of five years starting from 2013 to 2018 of selected listed 20 companies consisting of 10 banks, 5 financial service and 5 insurance companies of India. The study is limited to only the BFSI sector and it only contains a five-year analysis of select twenty companies. Hence analysis subject to other firms may vary accordingly.
Hypothesis:
Ho: The financial ratios do not influence the debt equity ratio and the capital structure
H1: The financial ratios influence the debt equity ratio and the capital structure
The research approach is a quantitative approach because the study deals with numbers in form of financial ratios. The methodology is based on SPSS regression model with 7 independent variables as following:
|
Variable |
Explanatory Definition |
Variable |
Explanatory Definition |
|
ROA |
Earnings Before Interest and Tax to Total Assets |
DE |
Debt to equity |
|
ROE |
Net Income to Shareholder’s Equity |
DPR |
Total dividends paid out to shareholders to net income |
|
EPS |
Earnings per Share |
PER |
Price to Earnings ratio |
|
TA |
Total Assets |
TR |
Total Revenue |
Empirical results:
Table 02 provides the descriptive statistics of the variables considered in this study. Stepwise regression is performed in order to know what the level of impact is of different variables on the debt ratio.
Table 02 Descriptive Statistics
|
|
N |
Min |
Max |
Mean |
SD |
|
ROA |
100 |
-12.08 |
13.87 |
2.253 |
3.825 |
|
ROE |
100 |
-50.99 |
30.47 |
6.380 |
13.392 |
|
DE |
100 |
.00 |
19.38 |
8.034 |
7.129 |
|
EPS |
100 |
-70.47 |
242.30 |
22.115 |
47.187 |
|
DPR |
100 |
.00 |
509.74 |
30.376 |
55.250 |
|
PER |
100 |
-81.72 |
425.36 |
22.246 |
52.514 |
|
TA |
100 |
745.78 |
3616433.01 |
412111.743 |
677896. 02337 |
|
TR |
100 |
35.09 |
562227.36 |
37139.865 |
69788. 18881 |
|
Valid N (listwise) |
100 |
|
|
|
|
The total observations of the dependent and independent variables are 100. The table shows the minimum, maximum, mean and the standard deviation of the dependent and independent variables. The mean debt to equity is 80% and their standard deviation is 7.1%. This shows that more than 80% of the BFSI firms are financed by debts.
Profitability is measured by the Return on Asset (ROA) and it shows a mean of 2.25 percent, standard deviation of 3.8 percent and varies between -12.08 and 13.87. This shows there is no much variation in the profits of the firms.
The size of the firm is measured by the total assets. It registers a mean of 412111.7 million and ranges between 745.78 and 3616433 which shows that there is great variation in the size of the firms.
The findings derived from the study are that ROA and ROE has negative correlation and has a significant effect on the Debt Equity Ratio. Total Assets, Total Revenue and Price to Earnings Ratio has a significant effect on the Debt Equity Ratio of banking and NBFCs. EPS doesn’t hold any value for banking sector but it is important for NBFCs.