Determinants of Capital Structure: A Study of Indian FMCG Sector

 

Dr. Anil Soni

Associate Professor, DAV Institute of Engineering and Technology, Kabir Nagar, Jalandhar 144008

 

ABSTRACT:

Financing decisions or capital structure decisions are one of the most important decisions which a firm has to take. There have been a lot of studies on this and there is no consensus about the meaning of an optimum capital structure. In this study an attempt has been made to identify the factors affecting the capital structure decisions of the firms in FMCG Sector in India.  The study has been conducted on 15 leading FMCG companies operating in India. All these companies are listed on the Bombay Stock Exchange and are a part of S and P BSE Fast Moving Consumer Goods Index. The study covers a period of 5 years i.e. 2011-12 to 2015-16. For the study, one dependent variable i.e. Debt Equity Ratio and seven independent variables i.e. profitability, tangibility, liquidity, size, business risk, non-debt tax shield and coverage ratio have been used. The correlation and multiple regressions have been used to find out the factors affecting the capital structure of the firms. Out of the seven independent factors, only two factors i.e. liquidity and profitability have been found to be significantly affecting the capital structure.

 

 

 

INTRODUCTION:

It is rightly said that finance is the life blood of any business organization. Finance functions assume a significant role in all types of organizations. The finance functions are broadly classified into three categories namely (a) Investment Decisions (b) Financing Decisions and (c) Dividend Decision.

 

Investment Decisions:

A firm’s investment decisions involve capital expenditures. These decisions are also known as capital budgeting decisions. A capital budgeting decisions involves the decision of allocation of capital or commitment of funds to long-term assets that would yield benefits (cash flows) in the future.

 

Two important aspects of investment decisions are (i) the evaluation of the prospective profitability of new investments, and (ii) the measurement of a cut-off rate against which the prospective returns of new investments could be compared.

 

Financing Decisions:

A financing decision is the second important function to be performed by the financial manager. This decision involves when, where from and how to acquire funds to meet the firm’s investment needs. The central issue before a finance manager is to determine the appropriate proportion of debt and equity. The mix of debt and equity is known as the firm’s Capital Structure. In this paper an attempt has been made to identify the factors affecting the Capital Structure of the firm.

 

Dividend Decisions:

A dividend decision is the third major financial decision. The financial manager must decide whether the firm should distribute all profits, or retain them, or distribute a portion and retain the balance. The proportion of the profits distributed as dividends is called the dividend-payout ratio and the retained portion of the profits is known as the retention ratio. Like the debt policy, the dividend policy should be determined in terms of its impact on the shareholders’ value.

 

Capital Structure:

In order to run its activities, to survive in the complex and ever changing business environment and to expand, the every organization needs funds. The assets of a company can be financed either by increasing the owners’ claims or the creditors’ claims. The owners’ claims increase when the firm raises funds by issuing ordinary shares or by retaining the earnings; the creditors; claims increase by borrowing. The financing decision has direct consequence on the composition of liabilities side of the balance sheet of the firm. The term capital structure is used to represent the proportionate relationship between debt and equity. Equity includes paid-up share capital, share premium and reserves and surplus (retained earnings).

 

The financing or capital structure decision is a significant managerial decision. The capital structure decision influences the shareholders’ return and risk. The capital structure decision of a firm may have its impact on the market value of its shares. A demand for raising funds generates a new capital structure since a decision has to be made at to the quantity and forms of financing. The debt- equity mix has implications for the shareholders’ earning and risk, which in turn will affect the cost of capital and the market value of the firm.

 

Financial Leverage:

A company can finance its investments by debt and equity. The company may also use preference capital. The rate of interest on debt is fixed irrespective of the company’s rate of return on assets. The company has a legal binding to pay interest on the debt. The rate of preference dividend is also fixed; but preference dividends are paid when the company earns profits. The ordinary shareholders are entitled to the residual income i.e. earnings after interest and taxes (less preference dividends belong to them. The rate of equity dividend is not fixed. The use of fixed-charges sources of funds, such as debt and preference capita along with the owners’ equity in the capital structure, is described as financial leverage. The financial leverage employed by a company is intended to earn more returns on the fixed-charge funds than their costs. A firm using a very high amount of debt in its capital structure is said to be highly levered. On the other hand, a firm which uses no debt in its capital structure is said to be unlevered.

 

Optimal Capital Structure:

An optimal capital structure is one which maximizes the value of a firm. The leverage has an impact on the shareholders’ earnings and risk. Under favourable economic conditions, the earnings per share increase with the financial leverage. But the leverage also increases the financial risk of the shareholders. As a result, it cannot be said that whether or not the firm’s value will increase with leverage. The objective of a firm should be directed towards the maximization of firm’s value. If capital structure or financial leverage decisions have an effect on the value of the firm, then a Capital Structure which maximizes the value of a firm is said to be the Optimal Capital Structure.

 

Important Theories of Capital Structure:

The capital structure theories can be broadly classified into two schools of thought. One school of thought believes in the existence of optimal capital structure. According to this school of thought, an optimal capital structure it may reduce the overall cost and capital and eventually will maximize the firm’s value. The other school of thought insists that there is no relationship between the capital structure of a firm and its value i.e. the capital structure decisions are irrelevant.

There are four important theories of Capital Structure:

(a)     Irrelevance Theory of Capital Structure of Modigilani and Miller (MM)

(b)     The Trade-Off Theory of Bradley Et Al

(c)     Market Timing Theory by Baker and Wurgler

(d)     Pecking Order Theory by Myers and Mejluf.

 

The Irrelevance Theory (Modigilani and Miller, 1958):

This theory is considered to be the beginning of the modern theory of capital structure. According to MM, in perfect capital markets without taxes and transaction cost, a firm’s market value and the cost of capital remain invariant to the capital structure changes. The value of the firm depends on the earnings and its business risk.

 

The Trade-Off Theory:

According to this theory, a judicious mix of debt and equity capital can increase the value of the firm by reducing the weighted average cost of capital (WACC) upto certain level of debt. As per the prevailing income tax laws the amount paid as interest on the debt is tax deductible whereas the equity income is tax at the prevailing tax rates. This approach clearly implies that WACC decreases only within the reasonable limit of financial leverage and after reaching the minimum level, it starts increasing with the financial leverage. Hence, a firm has an optimal capital structure that occurs when WACC is the minimum, and thereby maximizing the value of the firm.

 

Why does WACC decline under the traditional view? WACC declines with moderate level of leverage since low-cost debt is replaced for expensive equity capital. Financial leverage, resulting in risk to shareholders, will cause the cost of equity to increase. But, this theory assumes that at moderate level of leverage, the increase in the cost of equity is more than offset by the lower cost of debt.

 

Market Timing Theory:

The market theory states that capital structure of a firm largely depends on the time the funds are required. According to this theory, if a firm is to raise the funds, the prevailing market conditions will have an impact on the method of financing. If the rate of interest is low, then the firm will go for debt financing. On the other hand, if conditions in the equity market are quite favorable, it will raise the funds through equity. Baker and Wurgler (2002), claim that market timing is the first order determinant of a corporation's capital structure use of debt and equity. In other words, firms do not generally care whether they finance with debt or equity; they just choose the form of financing which, at that point in time, seems to be more valued by financial markets.

 

The Pecking Order Theory:

The ‘Pecking Order Theory’ is based on the assertion that managers have more information about their firms than investors. This disparity of information is referred to as asymmetric information. Other things being equal, because of asymmetric information, managers will issue debt when they are positive about their firm’s future prospects and will issue equity when they are unsure. According to pecking order theory the managers raise finance in the following order:

1.        Managers always prefer to use internal finance.

2.        When they do not have internal finance, they prefer issuing debt. They first issue secured debt and then unsecured debt followed by hybrid securities such as convertible debentures.

3.        As a last resort, managers issue shares to raise finances.

 

REVIEW OF LITERATURE:

For the first time, Modigliani and Miller (1958) argued that in a tax free world, the capital structure decisions are irrelevant and the value of the firm is independent of its capital structure. In 1963, incorporating corporate tax, they argued that the value of a levered firm i.e. the firm which is using both debt and equity will be greater than the value of an unlevered firm due to the interest tax shield on debt, which makes the capital structure relevant for a firm. According to these theories, there is no optimal capital structure.

 

Titman and Wessel (1988) have examined that various debt ratios are related to a firm’s growth rate, volatility, non-debt tax shields, profitability, the collateral value of assets, industry classification, and size of the firm and uniqueness of the firm. The study covered a period of nine years i.e. 1974-1982 and the sample size was 105 manufacturing firms. The Factor Analysis technique was used in the study. The results indicate that transaction costs may be an important determinant of capital structure choice. Short-term debt ratios were shown to be negatively related to firm size, possibly reflecting the relatively high transaction costs small firms face when issuing long-term financial instruments. In particular, they have found that debt levels are negatively related to the “uniqueness” of a firm's line of business.

 

Das and Roy (1998) in their study analyzed the inter-industry differences in the capital structure of the firms and identified the sources of variation in the capital structure. They tried to find out the differences in financing pattern in the pre and post liberalization era. They used the technique of One Way Analysis of Variance (ANOVA) for this purpose. The size of the firm was found to be a crucial factor in deciding the capital structure across industries. But the important source of variation was nature of the industry itself or more precisely differences in the differences in the fund requirement of the industry group based on the technology used.

 

Anand’s (2002) analysis of capital structure finds that the retained earnings are the most preferred source of finance followed by debt and then equity. The results seem to suggest that firms do not have specific capital structure in mind when deciding as to how best to finance their projects. Low growth firms prefer more use of debt in their capital structure vis-à-vis the high growth firms. The large firms prefer making bonds issue in the primary market. Very few firms use hybrid securities as a source of finance to protect bondholders from the firm/shareholders taking on risky or unfavorable projects.

 

Baral (2004) showed a positive influence of operating leverage, dividend payout ratio, business risk, growth rate and size but negative influence of debt service capacity and profitability on leverage ratio. This study was conducted on the 40 firms listed on the Nepal Stock Exchange and the period of the study was 1996-2001.

 

Madan (2007) examined the role of financing decision in the overall performance of companies. The study concluded that while leverage seems to be working well for few categories of companies, it is affecting some others negatively. Thus, firms that have been moderately geared have been able to generate a good return on equity. Companies that are moderately geared, in the range of gearing ratio of 50 percent until 85 percent, have been able to generate a good ROE. Hence, low-geared companies and very highly geared companies need to work on improving their ROE by either increasing or reducing their debt-equity mix respectively.

 

Pathak (2010) in his work examined the relative importance of six factors affecting the capital structure of the publicly traded firms in India. This study covered 135 firms listed on the Bombay Stock Exchange (BSE) and it covered a period of 1990-2009. The study found that factors such as tangibility of assets, growth, size of the firm, risk associated with the business, liquidity and profitability have a significant impact on the capital structure decided by the firms

 

Mishra (2011), in his study on the capital structure of Indian Manufacturing Companies, concluded that asset tangibility, profitability and tax had a significant effect on the capital structure of the selected companies. The size, volatility and non-debt tax shield were found to be insignificant while deciding the capital structure of the companies.

 

Pahuja and Sahi (2012) conducted a study on Factors Affecting Capital Structure Decisions: Empirical Evidence from Selected Indian Firms. This study was based on agency cost theory and pecking order theory. This study covered a period of three years from 2008-2010 and sample was the 30 companies which were the constituents of BSE Sensex. The results of the study showed that growth and liquidity had a positive relationship with debt-equity ratio.

 

Riyazahmed.K (2012) studied determinants of capital structure considering of Indian Auto Manufacturing Companies which are the constituents of Auto Index of the National Stock Exchange. A sample of 15 firms was considered for the study. The factors considered for the study included size, earning rate, business risk, growth, dividend payout, debt service capacity and degree of operating leverage. The study showed relationship between determinants and financial leverage found that debt service capacity, operating leverage, dividend payout and business showed statically significant and size, earning rate and growth showed statically insignificant.

 

Basu and Rajeev (2013) in their working paper on Determinants of Capital Structure of Indian Corporate Sector: Evidence of Regulatory Impact, have found that impact of capital market regulations on debt is significantly negative. On the other hand, the study has found that capital market regulations have a significant positive impact on the use of equity in the capital structure. This implies that with the increased regulations and transparency the use of equity in the capital structure has increased.

 

Yadav (2014) in his study titled Determinants of the Capital Structure and Financial Leverage: Evidence Of Selected Indian Companies has examined the relationship between financial leverage and determinants of capital structure of 50 companies listed on the national stock exchange, NIFTY Index during the period 2002-2012. In relation to the study determinants considered are profitability, collateral value of assets, growth, size, debt service capacity, tax rate, non debt tax shields, liquidity, uniqueness, and business risk. The study found that the correlation between various independent variables with dependent are: profitability is negatively correlated to debt equity ratio, collateral value of asset is negatively positively to debt equity ratio, size is negatively correlated to debt equity ratio, growth is positively correlated to debt equity ratio, debt service coverage is positively correlated to debt equity ratio, Tax rate is negatively correlated to debt equity ratio, non debt tax is negatively correlated to debt equity ratio, liquidity is positively correlated to debt equity ratio, Uniqueness is negatively correlated to debt equity ratio and Business Risk is negatively correlated to debt equity ratio.

 

Poddar and Mittal (2014) in their study on Capital Structure Determinants of Steel Companies in India have concluded that larger firms will have higher leverage and vice versa as larger firms can borrow funds easily. A profitable firm will have a lower leverage as compared to as compared to a less profitable firm.

 

Hossain and Hossain (2015) in their study on Determinants of Capital Structure and Testing of Theories: A Study on the Listed Manufacturing Companies in Bangladesh found that the results of PCSE regression models that all of the selected variables were the significant determinants of capital structure of the listed manufacturing companies in Bangladesh. Managerial ownership was found to have positive influence on the leverage ratios. On the contrary, Growth rate, Profitability, Debt service coverage ratio, Non-debt tax shield, financial costs, free cash flow to firm, Agency costs and Dividend payment have negative relationship with the leverage ratios. Tangibility and Liquidity ratio have positive relationship with Long term debt only but negative relationship with Short term debt and Total debt. It was also found that the capital structure of various industries of Bangladesh differs significantly from each other. The results also suggest that the Pecking-order theory and the Static Trade-off theory are the most dominant capital structure theories in Bangladesh.

 

 

Sathyanarayana, Harish and Kumar (2017) in their study titled Determinants of Capital Structure: Evidence from Indian Stock Market with Special Reference to Capital Goods, FMCG, Infrastructure and IT Sector have concluded that for capital goods sector Business Risk and NDTS are not statistically significant but Profitability, Growth and Tangibility have been found to be statistically significant. However, in case of FMCG sector, Profitability, Tangibility, Growth, Size and NDTS have been found to be statistically significant. In case of infrastructure sector Business Risk, Size and Growth are found to be statistically significant whereas in case of IT sector Profitability, Business Risk and Size are found to be significant.

 

NEED AND OBJECTIVES OF THE STUDY:

The review of literature revealed that though a good number of studies have been conducted on the topic, but majority of these studies have been conducted in foreign countries. Even in these studies there seems to be no consensus on the determinants of capital structure. In India, a few studies have taken place and a very few studies have been conducted in FMCG sector. Hence a need arises to conduct a fresh research to determine the factors affecting the capital structure of the firms in FMCG sector in India.

 

Major Determinants of Capital Structure:

The term Capital Structure or Financial Leverage, is referred to as use of equity share capital, preference share capital and debt in financing the business of the firm. In this section an attempt has been made to briefly discuss the various determinants of capital structure of the firm.

 

1.       Profitability:

According to Pecking Order Theory there is negative relationship between profitability and debt-equity ratio. The firms with high profits will use less debt in their capital structure and vice versa. Moreover, as per agency theory framework, if the contest for corporate control is in efficient, managers of profitable firms will use the higher level of retained earnings in order to avoid the disciplinary role of external finance. So according to these theory there is negative relationship between financial leverage and profitability. In the present paper the profitability has been measured as:

 

Profitability = EBIDTA/Total Assets.

 

2.       Tangibility:

The ratio of fixed assets to total assets is known as the asset tangibility. According to many theories of capital structure there is a positive relationship between financial leverage and assets tangibility. So, the firms having large amount of fixed assets shall be having higher debt equity ratio as compared to the firms with less amount of fixed assets. Since most of the earlier studies have used ratio of fixed assets to total assets as a measure of tangibility, in this paper the same ratio has been used.

 

Tangibility = Fixed Assets/Total Assets

3.       Size:

The size of the firm is considered as one of the most important determinants of the capital structure of a firm. The Bankruptcy Cost Theory predicts that there exists a positive relation between leverage and size of the firm. Trade-off theory predicts that larger firms tend to be more diversified, and hence less risky and less prone to bankruptcy. Further, if maintaining control is important, then it is likely that firms achieve larger size through debt rather than equity financing. However, it can also be argued that size serves as proxy for availability of information that outsiders have about the firm. From pecking order point of view, less information asymmetry makes equity issuance more appealing to the firm. Thus, a negative link between size and leverage is expected. This study uses natural logarithm total assets as a proxy for size.

 

Size = Natural Logarithm of Total Assets

 

4.       Liquidity:

The term liquidity refers to the ability of the firm to meet its obligations as and when they become due. Liquidity ratios are mostly used to judge a firm’s ability to meet its short-term obligations. They provide information about the ability of the firm to remain solvent in the event of the adversities. The liquidity ratio may have conflicting effects on the capital structure decision of the firm. First, the firms with higher liquidity ratios might have relatively higher debt ratios. This is due to greater ability to meet short-term obligations. From this viewpoint, one should expect a positive relationship between the firm’s liquidity position and its debt ratio.

 

However, the firms with greater liquid assets may use these assets to finance their investments. If this happens there will be a negative relationship between the firm’s liquidity ratio and the debt ratio. Moreover, as Prowse (1990) argues that liquidity of the company assets can be used to show the extent to which these assets can be manipulated by shareholders at the expense of bondholders. Like many previous studies, in the present study the ratio of current assets and current liabilities has been used as a proxy for liquidity.

 

Liquidity = Current Assets/Current Liabilities

 

5.       Non-Debt Tax Shield:

Firms with high leverage component in their Capital Structure gain more benefits in the form of tax shield on interest pay­ment as interest payment is an allowable expenditure according to tax laws. However, Pecking Order Theory (POT) ranks NDTS as second order and ranked retained earnings as a first order of preference to external financ­ing. According to Pecking Order Theory, profitable firms generally have financial surplus. In order to utlise the surplus, the firms supply their financial requirements from internal sources when necessary. However, empirical studies showed contradictory results on this issue. Studies conducted by Bradly, Jarrell and Kim (1984), Titman and Wessel could not lead to any result. The marginal tax rate is described as the present value of current and expected future taxes paid on an additional rupee of income earned today. In the present study the depreciation to total assets ratio has been used as a proxy for Non-Debt Tax Shield (NDTS).

 

NDTS = Depreciation/Total Assets

 

6.       Business Risk:

The earlier research studies on capital Structure have used various models of volatility such as standard deviation of returns on sales, operating cash flow and change in operating income to determine the relationship. The high volatility in earnings and cash flows of firms face a higher degree of risk than when earnings level drops below the debt exposure and default while serv­ing the debt. Therefore, various theories claim that more volatile the earnings of the firm, the greater is the chance of financial failure while serving the debt funds and more will be the bankruptcy costs. As far as capital structure is concerned when debt is introduced in it, the agency problem is extended to the relationship between owners i.e. shareholders, lenders and management. These conflicts positively influence the agency problems. Agency costs have their influence on a firm’s capital structure. The empirical findings show that firms with high earnings volatility will prefer equity financing to debt when fac­ing external financing choices. Thus, business risk is a substitute for the probability of failure and expected to share an inverse relationship with leverage. Empirical studies conducted by (Taggart, 1985), Garg (1988) and Paudel (1994) supported this view which suggests that as business risk (volatility) increases; borrowed funds in the CS of the firm should decrease. However, studies carried out in India and Nepal contradicts the view of agency cost and the bankruptcy theories. In present study the standard deviation of EBITDA has been used as a proxy for business risk.

 

Business Risk = Standard Deviation of EBITDA

 

7.       Coverage Ratio:

According to Harris and Raviv (1990) that coverage ratio has negative correlation with leverage. They conclude that an increase in debt will increase default probability. Therefore, interest coverage ratio will act as a proxy of default probability, which means that a lower interest coverage ratio indicates a higher debt ratio. This study takes EBIDTA to interest payment ratio as a measure of interest cover.

 

Interest Coverage Ratio = Interest Payments/EBIDTA

Objectives:

The following are the specific objectives of the study:

1.        To study the factors affecting the capital structure of the selected companies.

2.        To study the effect of the various variables such as Profitability, Tangibility, Size of the firm, Liquidity, Business Risk, Non-Debt Tax Shield and Coverage Ratio on the Capital Structure.

3.        To Rank the various independent variables in order of their importance in the capital structure.

 

RESEARCH METHODOLOGY:

Data Sources and Sample Size:

For conducting this study the data for 5 years (2012-16) for 15 sample companies have been taken. These companies are leading companies in the FMCG sector and are a part of the S and P BSE Fast Moving Consumer Goods Index. For all variables (dependent and independent), simple arithmetic mean has been calculated to arrive at a single figure representing the value of the variable for the chosen period of 5 years and to absorb structural changes if any. If there are any missing values for a variable for a particular year, average of the values for remaining years is calculated. The list of the companies included in the sample is given below:

 

S.No.	Security Name	Company Name
1	DABUR	Dabur India Limited
2	HINDUNILVR	Hindustan Unilever Limited
3	ITC	ITC Limited
4	GODREJCP	Godrej Consumer Products Limited
5	BRITANNIA	Britannia Industries Limited
6	COLPAL	Colgate-Palmolive (India) Limited
7	TATAGLOBAL	Tata Global Beverages Limited
8	NESTLEIND	Nestle India Limited
9	EMAMILTD	Emami Limited
10	MARICO	Marico Limited
11	TATACOFFEE	Tata Coffee Limited
12	PGHH	Procter and Gamble Hygiene and Healthcare Limited
13	GILLETTE	Gillette India Limited
14	GSKCONS	Glaxo Smithkline Consumer Healthcare Limited
15	VENKYS	Venky’s India Limited

 

Ordinary Least Squares (OLS) multiple regression analysis has been used to study the impact of each independent variable on capital structure of sample companies and build a consolidated econometric model. All five assumptions of OLS regression i.e. the linear specification, normality of error term, homoscedasticity of error term, no auto-correlation of error terms and no multicollinearity assumption have been verified and corrected for.

On the basis of the review of literature and various studies conducted, in the present study one dependent variable and seven independent variables have been used. The list of the variables along with their definitions and measurement is given in the following table:

 

Dependent Variable:

S. No.	Variable Indicators	Full Name	Measurement
1.	DE	Debt Equity Ratio	Debt/Equity

 

Independent Variables:

S. No.	Variable Indicators	Full Name	Measurement
1.	PR	Profitability	EBITDA/Total Assets
2.	TG	Tangibility	Total Fixed Assets/ Total Assets
3.	SZ	Size of the firm	Natural Logarithm of Total Assets
4.	LQ	Liquidity	Current Assets/ Current Liabilities
5	NDTS	Non-Debt Tax Shield	Annual Depreciation/ Total Assets
6	BR	Business Risk	Standard Deviation of EBITDA
7	CR	Coverage Ratio	Interest Payments/ EBITDA

 

Specification of the Model:

Based on one dependent variable and nine independent variables the following regression model has been designed to estimate the significant determinants of the capital structure.

 

Y (Debt Equity Ratio) =

a + b1 X1 (PR) + b2 X2 (TG) +b3 X3 (SZ) + b4 X4 (LQ) + b5 X5 (NDTS) + b6 X6 (BR) +b7X7(CR) + Є

 

Y = Debt Equity ratios of the firms and the dependent variable in the model

X is the vector of explanatory variables in the estimation model

X1 = Profitability (PR)

X2 = Tangibility (TG)

X3 = Size of the firm (SZ)

X4 = Liquidity (LQ)

X5 =Non-Debt Tax Shield (NDTS)

X6 =Business Risk (BR)

X7=Coverage Ratio

 

a = constant intercept term of the model

bs = coefficients of the estimated model

Є = error component

 

Dependent Variable (Y):

It is known as leverage or Debt Equity Ratio:

 

FL or DE= D/E

Where FL= Financial Leverage DE or Debt Equity Ratio, D = Debt and E = Equity

 

Independent Variables (S) (Xn):

Profitability (X1)

It is given by X1 = EBITDA/Total Assets

Tangibility (X2)

It is given by X2 =TFA/TA

Where, TFA = Total Fixed Assets and TA= Total Assets

 

Size of the Firm (X3)

Size of the firm = Natural Logarithm of Total Assets

 

Liquidity of the Firm = X4

It is given by X4= TCA/TCL

Where, TCA = Total Current Assets and TCL = Total Current Liabilities

 

Non-Debt Tax Shield (X5)

It is given by X6= Annual Depreciation/Total Assets

 

Business Risk (X6)

It is defined as Standard Deviation of EBITDA.

 

Coverage Ratio (X7)

It is given by X7= Interest Payments/EBITDA.

 

Hypothesis:

On the basis of the second objective, the following hypothesis have been formed:

 

Ho1:

Profitability does not affect the capital structure of a firm

 

Ho2:

Tangibility does not affect the capital structure of a firm

 

Ho3:

Size does not affect the capital structure of a firm

 

Ho4:

Liquidity does not affect the capital structure of a firm

 

Ho5:

Non-Debt Tax Shield does not affect the capital structure of a firm

 

Ho6:

Business Risk does not affect the capital structure of a firm

 

H07:

Interest Coverage Ratio does not affect the capital structure of a firm.

 

Data Analysis and Interpretation:

Descriptive Statistics:

The descriptive statistics of all the variables are given in Table 1.

 

Correlation Results:

In order to check the relationship between the variables the correlation among the variables has been computed. The results of the correlation analysis are given in Table 2 below

Table 1. Descriptive Statistics

 

Table 2. Correlation Matrix

^** Correlation is significant at the 0.01 level (2-tailed)

 

The Table 2 above shows that there is a significant negative correlation between Financial Leverage i.e. Debt Equity Ratio and Profitability which means that firms with higher profits use less debt in their capital structure whereas the firms with less profits use more debt. The Table also shows that there is a positive correlation between size of the firm and the business risk i.e. as the size of the firm increases the risk also increases.

 

Regression Analysis:

In order to test the various hypotheses, the regression analysis was used and the results of the same are given in the following paragraphs.

 

Multicollinearity Test:

One of the major hindrances in using Regression Analysis is the problem of multicollinearity in the independent variables. Before applying the regression analysis, the multicollinearity of the independent variables was checked and the results of the same are given in the Table 3 below.

 

Table 3 Multicollinearity Statistics

 

It is clear from the Table 3 that none of the tolerance value is less than 0.1, so there seems to be no problem of multicollinearity. To further check the same VIF value was also calculated and none of the value of more than 4. So these two statistics show that multicollinearity is not an issue in this data and Regression Analysis can be used.

 

Model Fit/Robustness of the Model

In order to check the robustness of the model, the ANOVA table was used and the results of the same are given in Table 4.

 

Table 4 ANOVA^a

	Sum of Squares	DF	Mean Square	F Value	Sig.
Regression	2.231	7	0.319	5.25	0.002b
Residual	0.425	7	0.061
Total	2.656	14

a.        Dependent Variable: DE

b.        Predictors: (Constant), CR, PR, NDTS, BR, TG, LQ,SZ

 

The F Value of 5.25 and Sig. value of 0.002 in Table 4 above clearly indicates that model is a good fit/robust.

 

Regression Results:

After checking multicollinearity and robustness of the model, the regression was on the variables using SPSS and the results of the same are given below:

 

Table 5. Variables Entered/Removed^a

Model	Variables Entered	Variables Removed	Method
1	CR, PR, NDTS, BR, TG, LQ, SZb	NIL	Enter

a.        Dependent Variable : DE

b.        All requested variables entered.

 

The Table 5 above shows that enter method has been used and Debt Equity Ratio or Financial Leverage has been used as a dependent variable and the independent variables are Coverage Ratio (CR), Profitability (PR), Non-Debt Tax Shield (NDTS), Business Risk (BR), Tangibility, Liquidity (LQ) and Size (SZ).

 

Table 6. Model Summary

It is clear from the Table 6 that value of R Square is 0.84 which means that model total of seven independent variables are able to explain about 84 per cent of the variations in the capital structure.

 

Table 7 Coefficients^a

Variable	Unstandardized Coefficients	Std. Error	Standardized Coefficients (Beta)	t-statistic	p-value
Intercept	3.701	1.088		3.401	0.011**
Liquidity (LQ)	-0.499	0.192	-0.479	-2.592	0.036**
Profitability (PR)	-0.04	0.009	-0.819	-4.626	0.002**
Size (SZ)	-0.254	0.121	-0.603	-2.093	0.075
Tangibility (TG)	0.463	0.634	0.131	0.73	0.489
NDTS	-1.553	1.004	-0.265	-1.547	0.166
Business Risk (BR)	0.001	0.000	0.38	1.35	0.219
Coverage Ratio (CR)	-5.077E.005	0.000	-0.264	-1.322	0.228

a.        Dependent Variable : DE

** Significant at 0.05 Level

 

The intercept value 3.701 given in Table 7 is the value of total debt to total assets. Further the p-value of 0.011 indicates that it is statistically significant.

 

The liquidity coefficient of -0.499 indicates that if the liquidity is increased by unit it will to 0.499 units reduction in the debt-equity ratio. The p-value of .036 indicates that liquidity has a significant impact on the capital structure of the firm.

 

The profitability coefficient of -0.04 indicates that profitability is negative related to debt-equity ratio. This means that with the increase in the profitability the debt equity ratio decreases and vice versa. Further p-value of .002 indicates that profitability significantly affects the capital structure of the firm.

 

It is clear from the Table 7 that size is negatively related to the debt-equity ratio which implies that with the increase in the size of the firm the debt-equity ratio decreases and vice versa. The p-value of .075 shows that size is not statistically significant as far as capital structure of the firm is concerned.

 

The Tangibility Coefficient of .463 indicates that there is a positive correlation between the tangibility and capital structure. However, p-value of 0.489 indicates that it is not statistically significant.

 

The Business Risk is positively related to the capital structure but this is also not statically significant.

 

The NDTS is negatively related to the capital structure and p-value of 0.166 shows that it is not statically significant.

 

The Coverage Ratio is negatively related to the capital structure and it is also not statistically significant.

 

Hypothesis Testing

H01:

Profitability does not affect the capital structure. The various studies have found divergent results as far as profitability and capital structure is concerned. However in the present study the correlation and regression coefficients (r=-.653 and beta = -0.819) and p value of 0.002 show that there is a significant negative relationship between capital structure and profitability of the firm. Hence null hypothesis is rejected and it is concluded that profitability affects the capital structure of a firm.

 

H02:

Tangibility does not affect the capital structure. In many studies it has been found that tangibility plays an important role in deciding the capital structure of a firm and there is a positive relationship between the tangibility and financial leverage or debt equity ratio. But the present study does not find any significant relationship between the financial leverage and tangibility (r= 0.062 and beta= .131). So, the null hypothesis is not rejected and it is concluded that tangibility does not affect the capital structure of a firm.

 

H03:

Size does not affect the capital structure. Majority of the studies have shown diverse results. The value -.269 of correlation coefficient (r) and regression coefficient (beta) of -2.093 leads to the acceptance of the null hypothesis and it can be said that size does not affect the capital structure of a firm.

 

H04:

Liquidity does not affect the capital structure. As far as liquidity is concerned, it is said that more liquid firms will have a less cost of equity and there should be negative relationship between financial leverage and liquidity and the present study shows the similar results with (r = -0.297) and beta (-2.592). However, p value of .036 indicates that there is a significant relationship between capital structure and liquidity. So, null hypothesis is not accepted and it is concluded that liquidity affects the capital structure of a firm.

 

H05:

Non-Debt Tax Shield does not affect the capital structure. The r value of -0.227 and beta value of -.265 finds no significant relationship between NDTS and financial leverage. The null hypothesis is not rejected and non-debt tax shield does not affect the capital structure of a firm.

 

H06:

Business Risk does not affect the capital structure. The correlation coefficient (r) -.301 and regression coefficient (beta) of 1.350 and p value of .219 show that there is no relationship between the capital structure and business risk. So, the null hypothesis is not rejected.

 

H07:

Interest coverage ratio does not affect the capital structure. The results of the study show no relationship between the interest coverage ratio and capital structure as the p value of .228 is not significant. The null hypothesis is not rejected.

 

The hypothesis testing can be summarised in the following table

Table 8. Summary of Hypothesis

 

It can be seen from the Table 8 above that out of 7 independent variables, only two variables i.e. Tangibility and Liquidity have statistically significant impact on the capital structure i.e. Debt-equity ratio of the sample companies.

 

Ranking of the Independent Variables in order of their importance

In order to determine the relative importance of the various variables, the values of the Standardized Coefficients (Beta) has been used. The variables are arranged in the descending order of their (Beta) value.

 

Table 9 Ranking of the Independent Variables

 

It can be seen from the Table 9 that most important variable is Business Risk followed by Tangibility and Coverage Ratio. The least important variable is Profitability.

 

FINDINGS AND CONCLUSION OF THE STUDY:

In the present study a sample of 15 companies in the FMCG was used. One dependent variable used was Debt-Equity Ratio and seven independent variables such as profitability, tangibility, liquidity, size, business risk, non-debt tax shield and interest coverage ratio have been used. On the basis of the study only two independent variables profitability and liquidity have been found to be significantly affecting the capital structure of the selected companies. As per the standardized beta value the variable business risk has been found to be most important and whereas profitability is found to be least important. The independent variables such as size, tangibility, business risk, NDTS and interest coverage ratios are insignificant.

 

LIMITATIONS OF THE STUDY:

The present study has certain limitations. The sample size 15 is very small and on the basis of such a small sample size, the generalized conclusions cannot be drawn. Further, the data has been taken for a period of five years only. There are many factors affecting the capital structure of the firms. However, only seven factors have been considered in this study.

 

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Books:

19.     Pandey I M, Essentials of Financial Management (4th Edition), Vikas Publishing House Pvt. Ltd.

 

Websites:

20.     www.moneycontrol.com

21.     www.bseindia.com

22.     www.nse-india.com

 

 

 

 

Accepted on 19.08.2017          © A&V Publications all right reserved