Factors Influencing Capital Structure On Firm's Value: A Study On DSE Listed Companies

ISSN 2520-4750 (Online) & ISSN 2521-3040 (Print)
Volume: 3, Issue: 1
Page: 37-51
2019 International Journal of Science and Business
Factors Influencing Capital Structure

on Firm’s Value: A Study on DSE
Listed Companies
Md. Edrich Molla
Abstract:
Using a panel of listed companies on the DSE, researcher investigates the
association of capital structure on firm value and investigates the capital
structure of firms in Bangladesh. This current study focuses that the
results of the analysis on the relevance of capital structure on firm value
indicated, there is no statistically significant relationship between firm
value and the capital structure of firms. This analysis was conducted for
the general sample of firms in the study, within industries and by firm
size; however, the results were consistent throughout all the analysis. The
analysis of the Bangladeshi firms’ capital structure indicated that firms in
Bangladesh tend to use more long-term debt than short-term debt. The IJSB
Accepted 13 January 2019
leverage ratios also differed among industries with the Pharmaceuticals & Published 15 January 2019
Chemicals having the highest levels of leverage and the Textile industry DOI: 10.5281/zenodo.2539383
having the lowest levels of leverage. The results of the capital structure
and its determinants analysis indicated that Bangladeshi firms followed a
pecking order theory. The results also indicated that profitability, size,
asset tangibility and tax shield has a statistically significant relationship to
gearing or the firm’s capital structure.
Keywords: Capital Structure, Leverage, Industry, Profitability, DSE, Bangladesh.
About Author
Md. Edrich Molla, (Corresponding Author), Coordinator & Lecturer of Finance, Department
of Business Administration, Victoria University of Bangladesh, Panthapath, Dhaka
1205, Bangladesh.
37 International Journal of Science and Business Published By

Email: [email protected] Website: ijsab.com
Volume: 3, Issue: 1, Year: 2019 Page: 37-51 IJSB-International
1.0 Introduction
There is a considerable number of theories and research on the effect of capital structure on
firm value, size and profitability. The capital structure of the firm refers to the sources of
funding used to finance a firm’s investments. This refers to the choice between equity
financing and debt financing. According to Modigliani and Miller (1958), the value of the firm,
that is, its stock price, does not depend on the capital structure of the firm. This theory by
Modigliani and Miller is based on a set of simplifying assumptions. These assumptions include
no taxes, no transaction costs and no information asymmetry. The theory says that the total
market value of all financial assets issued by a firm is determined by the risk and return of the
firm’s real assets, not by the mix of issued securities. The main idea behind Modigliani and
Miller’s theory is that a rational investor can create any capital structure on his/her own.
Therefore, the firm should not focus much on its capital structure. “If the investor is highly
indebted, the risk and return of the firm’s stock (to the investor) will simply be the same as if
the firm was highly levered” (Byström, 2007). This substitution called homemade leverage
and the finding that a more leveraged firm doesn’t only yield higher returns to the investor
but also a higher risk, is the root of Modigliani and Miller’s theory. There is a theory that
states the value of the firm, in a world with corporate taxes, is positively related to its debt.
This theory, which is known as the trade-off theory, states that profitable firms will tend to
use more debt in order to capture the tax shield offered by debt financing of investments.
According to this theory, in an all-equity firm, only shareholders and tax authorities have
claims on the firm. The value of the firm is owned by the shareholders and the portion going
to taxes is just a cost. The value of the levered firm has three claimants, explicitly: the
shareholders, debt holders and tax recipients (Government). Consequently, the value of the
levered firm is the sum of the value of the debt and the value of the equity. In these instances,
value is maximized with the structure paying the least in the form of taxes (Hillier, et al.,
2015). Other theories on capital structure include the pecking order theory and the market
timing theory. According to the pecking order theory firms prefer internal finance and if
external finance is required, firms issue the safest security first. Specifically, they start with
debt, then possibly hybrid securities then equity as a last resort (Myers, 1984). This assumes
that a firm’s debt ratio will be reflective of its cumulative requirements for external finance.
In contrast to the trade -off and pecking order theories of capital structure, Baker and
Wurgler (2002) found that firms with low levels of leverage raised capital when their market
valuations were high as measured by the market-to -book ratio whereas firms with high
levels of leverage raised capital when their market valuations were low. This theory is known
as the market timing capital structure theory. According to research by Kurshev and
Strebulaev (2007), it has been recognized that large firms tend to have higher leverage ratios
than smaller firms. International evidence suggests that in most, though not all countries,
leverage is also cross-sectional positively related to size. Intuitively, firm size should be
relevant or related to leverage for a number of reasons. At the outset, in the presence of fixed
costs of raising external funds, large firms have cheaper access to outside financing. Also large
firms are more likely to diversify their sources of financing. Secondly, size may also be a proxy
for the probability of default because it is often assumed that it is more difficult for larger
firms to fail or liquidate. Firm size may also be an alternative for the volatility of firm assets
because small firms are more expected to be growing firms in industries that are rapidly
expanding and inherently volatile. Another reason for the significance of firm size is the
extent of the hold in the degree of information asymmetry between insiders and the capital
markets which have a tendency to prefer larger firms by virtue of a greater scrutiny they face
from the ever suspicious investors (Strebulaev and Kurshev, 2006). One of the most

encompassing studies that have been conducted on Bangladesh found that companies in the
market tend to follow a modified pecking order. This study looked at Bangladeshi market
(DSE). In this study, it is examined for capital structure dependence on variables such as asset
tangibility, corporate tax, profitability, size and firm age. In terms of finding, some questions
to be explained such as; Has Bangladesh sophisticated institutional and physical capital
markets infrastructure? Is the legal environment encompassing clearly stated and enforced
laws? Are the courts effective in forcing borrowers to honor business contracts?
1.1 Statement of the Problem

In Bangladesh all firms are still not fully automated (websites not up-to-date, or linked with
internet) from where secondary data can be retrieved by the researchers. There is limited
opportunity to access directly to collect financial statements or other data from the
companies. Authenticity is another concerning matter for the researcher while conducting
research work. Researcher finds many firms do not want to disclose their financial conditions
like income, equity, financial position and other financial statements or strategies.
1.2 Significance of the Study

In Bangladesh firms are considered the dominant capital structure in their sector and general
economy. The difficulty is that not knowing the average cost of external funds will lead firms
to make inadequately informed capital budgeting decisions. For a firm to grow it has to
embark on value adding projects; hence effective capital budgeting is indispensable. One of
the ways for enhancing the effectiveness of the capital budgeting process is to estimate cash
flows from the projects and the cost of capital. If a company does not have a good sense of
what the dominant capital structure is in the market, it will not have a good sense of what the
appropriate cost of external capital should be, whether debt or equity. This research may
prove useful in filling the research gap that exists in the literature and increase our
understanding of the capital decisions taken by firms in Bangladesh.
1.3 Scope of the Study

Limited research exists on the capital structure of firms in Bangladesh, as a result researcher
knows little about how these firms make capital structure decisions. It is, therefore, necessary
to deliberate on the capital structure of firms in Bangladesh. Firms in Bangladesh operate
within a different environment as compared with firms in developed countries mainly due to
the differences in institutional infrastructure. Capital markets in Bangladesh are
characterized by inefficiency; they are small and thinly traded. On the contrary, capital
markets in developed economies are characterized by well-functioning and efficient stock
markets and well developed credit markets. It is therefore inappropriate to claim that the
findings that come out of studies done on developed economies apply to developing
economies i.e. the Bangladeshi markets precisely in Dhaka Stock Exchange (DSE). Even
though there have been limited studies on capital structure, a few of these studies focused on
developing capital markets. The literature on capital structure and firm value association is
still very slender in the Bangladeshi perspective.
1.4 The Study Objectives

Apart from trying to shed sufficient light on the dominant capital structure in Bangladesh, this
study attempts to answer the question of: what is the role of capital structure in firm
valuation? In addition, the role of other market and economic variables like taxation will be
assessed using a regression model and data drawn from financial markets. This study is

therefore intended to build upon the work that has been conducted so far and to contribute to
the body of literature with the following questions as per guidelines: i) Is capital structure
irrelevant as per MM I? ii) What is the capital structure (debt-to-equity) of firms per industry
in Bangladesh? iii) How persistent is the equity-debt capital structure? iv) What factors
determine the equity-debt structure divide? v) What is the debt structure in terms of funding
between long term and short term debt? vi) How persistent is the long term-short term
structure?
2.0 Data Collection and Methodology

The research analysis will be carried out on the firms listed on the DSE, excluding financial
firms. Financial firms are excluded because their capital structure is different from that of
non-financial firms, as their capital structure, sources and allocation of funds are dictated by
regulations including mainly the capital adequacy ratio and reserve requirement. The
distinction between the deposit type debt and the absolute debt of financial firms is distorted,
which also makes the capital structure of these firms difficult to distinguish. The study will
focus on listed firms because of the availability of data as listed firms have several data
sources above and beyond their financial reports. The data that will be used for the analysis
will be largely financial data, drawn mainly from the DSE database and the Industries own
profiles. DSE is the preferred source of the required financial data relating to the firms
because it is a relatively all-encompassing data base of information, however, McGregor, B. F.
A. (2014) was also used as a source of data. The financial data compiled and used for the
analysis will be in panel data form. Regression analysis will be used in answering the research
questions. According to Dayton, C. M. (1992), Regression analysis is a statistical tool for the
investigation of relationships between variables the investigator assembles data on the
underlying variables of interest and employs regression to estimate the quantitative effects of
the fundamental variables upon the variable that they influence. The data collected on the
DSE listed firms will be analyzed using econometric techniques and a software tool pack
called E-views. Relevant economic theories and empirical studies will be examined in order to
build the most appropriate structure for assessing the hypothesized relationships.
3.0 Review of Literature

The Bangladesh paper attempts to test the influence of debt-equity structure on the value of
shares given different sizes, industries and growth opportunities with the companies
incorporated in Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE) of
Bangladesh. For the strength of the analysis samples were drawn from the six most dominant
sectors of industry from DSE i.e. services & real states, food & allied, engineering,
pharmaceuticals & chemicals, textile and fuel & power to provide a comparative analysis. A
strong positively correlated association is evident from the empirical findings when stratified
by industry claimed by Chowdhury, A. et al. (2010). To see the relationship between capital
structure and firm value in Bangladesh the research paper considered share price as proxy
for value and different ratios for capital structure decision. The interesting finding of this
paper suggests that maximizing the wealth of shareholders requires a perfect combination of
debt and equity, whereas cost of capital has a negative correlation in this decision and it has
to be as minimal as possible. This is also seen that by changing the capital structure
composition a firm can increase its value in the market. Nonetheless, this could be a
significant policy implication for finance managers, because they can utilize debt to form
optimal capital structure to maximize the wealth of shareholders. Capital structure decisions
have important implications for the value of the firm and its cost of capital according to

Hasan, M. B. et al. (2014). Inadequate capital structure decisions can lead to a large cost of
capital thereby lowering the net present value (NPV) of the firm’s investment projects making
the investment projects unacceptable i.e. the underinvestment problem. Efficient capital
structure decisions will lower the firm’s cost of capital and increase the NPV of the firm’s
investment projects leading to more projects being suitable to accept thereby increasing the
value of the firm. Capital structure is a very significant decision for firms to make so that they
can maximize returns to their various stakeholders. Furthermore, the correct capital
structure is important to the firm as it will aid in dealing with the competitive environment
within which the firm operates. As per statement of Modigliani and Miller (1958) an ‘optimal’
capital structure exists when the risks of going bankrupt is offset by the tax savings of debt.
When this optimal capital structure is realized, a firm would be able to maximize returns to
its stakeholders that are higher than returns that would be attained from a firm whose capital
consists of equity only i.e. an all equity firm. Despite the importance that capital structure can
play in adding value to the firm, decade’s worth of theoretical literature and empirical testing
have not been able to give guidance to practitioners with regards to the choice between debt
and equity in their capital structures explained by Frank, M. Z., & Goyal, V. K. (2009). It is
rather baffling to try to logically understand capital structure literature because different
capital structure theories are frequently utterly opposed in their predictions while sometimes
they may be in agreement but have opposing views about why the outcome has been
predicted. It is for this reason that Myers, S. C. (2001) stated that there is no universal theory
of capital structure, only conditional ones. Factors that are of significance in one context may
be of substantial insignificance in another. The notion of financial management can be defined
as a managerial activity, which is highly concerned about controlling and planning of firm’s
financial resources, Pandey, I. M., & Bhat, R. (2007).
Furthermore, the functions of finance encompass a diverse area. These functions comprise
choices on investments, choices on financing, choices on dividends, and choices on liquidity.
This paper encompasses aspects with respects to the financing decision of a company i.e.
deciding on how to obtain funds in order to fulfill the firm’s needs of investments. The study
of capital structure centers around the mix between debt, equity and the range of other
hybrid instruments used to finance the investments of the firm. Capital structure is therefore
concerned with the right hand side of the balance sheet mentioned by Bhaduri, S. N. (2002).
All items on the right hand side of the balance sheet, excluding current liabilities, are sources
of capital employed to finance the real assets required to conduct the business of the firm
observed by Welch, I. (2004). Below is a simplified graphical depiction of the capital
structure. If you want to evaluate the performance of the firm it is important to consider all
interest bearing borrowings as loan capital regardless of whether they are short term or long
term loans claimed by Fama, E., & French, K. (2011). Firms manage their capital structure by
issuing new debt and equity and by settling old debt or repurchasing issued shares. It is
frequently stated that the goal of financial management is to maximize the wealth of the
shareholders or owners of the firm. According to Desai, M. A. et al. (2004) the goal of financial
management is to maximize the current value per share of the existing shares. However, fixed
assets working capital net assets capital equity loans retained profit equity capital overdraft
long-term loans owners only have a residual claim to the assets of the firm and are only paid
once every other stakeholder with a legitimate claim to the firm’s assets has been paid. Since
the lenders, employees and suppliers all have a superior claim on the firm’s assets, it stands
to reason that if the owners’ wealth is maximized then all the other claimants will stand to
gain. The market values of the firm's debt and equity, D and E, add up to total firm value V and

Modigliani and Miller's (1958) Proposition 1 says that V is a constant, regardless of the
proportions of D and E, provided that the assets and growth opportunities on the left-hand
side of the balance sheet are held constant explained by Myers, S. C. (1984).
4.0 Capital Structure Theories

There are a number of capital structure theories but for the purposes of this study researcher
will review only the three most prevalent theories, the trade-off theory, the pecking order
theory and the market timing theory. To start off the section we will look at the Modigliani
and Miller (1958) theory of capital structure irrelevance.
4.1 Modigliani and Miller’s Capital Structure Irrelevance

The departure point for virtually all discussions on capital structure theory is Modigliani and
Miller’s capital structure irrelevance theory first published in 1958. According to Modigliani,
F., & Miller, M. H. (1958) financing doesn’t matter in perfect capital markets. The value of the
firm is maximized by the quality and productivity of the assets in which the firm has invested.
Consider the market-value balance sheet below:
Assets-in-place Debt (D)

and growth
opportunities Equity (E)
Firm value (V)
Figure 1: Market-Value Balance Sheet, Source: Myers, S. C. (2001) Page- 85
The market values of the firm's debt and equity, D and E, add up to total firm value V and
Modigliani and Miller's (1958) Proposition 1 says that V is a constant, regardless of the
proportions of D and E, provided that the assets and growth opportunities on the left-hand
side of the balance sheet are held constant according to Myers, S. C. (2001). The Modigliani
and Miller’s (1958) Proposition 1 as captured in the equation below also states that:
VL=VU ………………….. (i)
Where: VL= the value of the levered firm, VU= the value of the unlevered firm. The expression
above states that the value of the levered firm (VL) is equal to the value of the unlevered firm
(VU) (Firer et al, 2008).
4.2 The Trade-Off Theory

Modigliani, F., & Miller, M. H. (1963) delivered a correction of their 1958 seminal paper and
stated that the deduction of interest in computing taxable corporate profits will prevent the
arbitrage process from making the value of all firms in a given class proportional to the
expected returns generated by their physical assets. The correction restated the Proposition 1
equation to be expressed as:
VL=VU+TC D ………………….. (ii)
Where: VL= the value of the levered firm, VU= the value of the unlevered firm, TC= the
corporate tax rate, D = the amount of debt. The above expression states that the value of the
levered firm (VL) is equal to the value of the unlevered firm (VU) plus the present value of the

interest tax shield. The principal value of debt is the fact that interest payments earned on the
repayment of debt is deductible from corporate income tax. Debt, however, does have
shortcomings that include an increased probability of bankruptcy if the firm failed to service
its obligations, the agency costs earned by the lender to monitor the activities of the firm and
the fact that managers have better prospects of the firm than the investors do, narrated by
Gitman, L. J. (2003). The trade-off theory rationalizes reasonable debt ratios. It says that the
firm will borrow up to the point where the marginal value of tax shields on additional debt is
just offset by the increase in the present value of possible costs of financial distress according
to Myers, S. C. (2001). Fama, E. F., & French, K. R. (2005) explained this optimal capital
structure is attained when the marginal benefit of an extra unit of debt is offset by the
marginal cost of an extra unit of debt.
4.3 Pecking Order Theory

In the pecking order theory there is no well-defined target of the debt-equity mix, because
there are two kinds of equity, internal and external, one at the top of the pecking order and
one at the bottom for each firm's observed debt ratio reflects its cumulative requirements for
external finance as per the statement made by Myers, S. C. (1984). The pecking order arises if
the costs of issuing risky securities such as transactions costs and the costs created by
management’s superior information about the value of the firm’s risky securities overwhelm
the costs and benefits proposed by the trade-off model by Fama, E. F. et al. (2005). According
to the pecking order theory, firms will first finance new investments with retained earnings,
then with safe debt, then risky debt and finally, but only under duress, with outside equity in
order to lessen adverse selection costs also mentioned by Fama, E. F., & French, K. R. (2005).
Below is a graphical illustration of the pecking order theory.
Equity
Debt
Financing
Internal
Funds
C D
Investment
Figure 2: The Financing Hierarchy of the Pecking Order, Source: Leary, M. T., & Roberts, M. R.
(2004), Page- 49
Although the pecking order theory is based on the adverse selection based on information
asymmetry, it has been proven that information asymmetry does not need to exist for a
financing hierarchy to arise. It has, however, been shown that other factors such as incentive
conflicts could generate a pecking order behaviour mentioned by Leary, M. T. & Roberts, M. R.
(2004). Titman, S. et al. (1988) also found that transaction costs may also be an important
factor in the pecking order behaviour and this is substantiated by the fact that short-term
debt ratios are negatively related to firm size. This variance in financing practice probably

reflects the high transaction costs that small firms face when they issue long-term debt or
equity claimed by Titman, S., & Wessels, R. (1988).
4.4 The Market Timing Theory

Equity market timing refers to the practice of issuing shares at a high price (when their
valuations are higher relative to book value and past market valuations) and repurchasing
them at low prices (when their market valuations are lower). As a result observed capital
structures are a function of the past market valuations of securities instead of a desire to
attain an optimum capital structure or as a consequence of following a pecking order
mentioned by Baker, M., & Wurgler, J. (2002). According to DeAngelo, H. et al. (2010), most
firms with attractive market timing opportunities tend to fail to issue stock. One probable
reason for this failure to issue stock is the investor rationality that would influence the
managers to disguise their attempts to sell overvalued stocks. Rational investors would
almost instantly recognize any attempts to sell off overvalued stocks and as a result would
reduce the price they are willing to pay for the stock. As indicated by Baker, M. e al. (2002)
one other explanation could be that managers are simply unable to time the market. This
seems to resonate with the recent events where prominent financial institutions repurchased
their shares at higher prices after the 2008 financial meltdown stated by DeAngelo, H. et al.
(2010).
5.0 Hypotheses Development

i) Capital structure is irrelevant as per MM1: According to Ross, S. A. et al. (2008) capital
structure decisions can have important implications for the value of the firm and its cost of
capital. Inadequate capital structure decisions can lead to a large cost of capital thereby
lowering the net present value (NPV) of the firm’s investment projects, making the
investment projects unacceptable, i.e. the underinvestment problem. To determine whether
capital structure is irrelevant in the Bangladeshi context, the hypothesis will be stated as
follows:
H0: μ ˃ 0.05 (debt-to-equity ratio is not correlated to EPS)

H1: μ ≤ 0.05 (debt-to-equity ratio is correlated to EPS)
ii) Does the debt-to-equity ratio differ among industries listed on the DSE? : According to the
capital structure theory the industry within which a firm belongs is likely to have a
substantial effect on the observed leverage levels of the individual firms and also that with
time the firms will tend to converge towards the median industry debt levels. The said
convergence towards the industry median debt level is considered as proof that an optimal
capital structure does exist stated by Bowen, R. M. et al. (1982). To determine the difference
between industry debt-to-equity ratio levels descriptive statistics will be employed, the
hypothesis will be stated as follows:
H0: μ1 ≠ μ2 ≠ μ3… μn (industry median debt-to-equity ratios are heterogeneous)

H1: μ1 = μ2 = μ3…μn (industry median debt-to-equity ratios are homogeneous)
iii) There is a relationship between debt-to-equity ratio and profitability, size of firm, tax
shield and asset tangibility: The findings of the above study showed that firm size, liquidity,
profitability and sales growth affect the leverage ratios of industrials firms significantly.
Among these factors, firm size and profitability are the most significantly influential factors

on capital structures of industrial firms, and these two factors are negatively correlated with
leverage ratios. Growth factor was found to be statistically significant and positively
correlated with leverage ratios. Liquidity factor is also statically significant but negatively
correlated with leverage ratios. These findings are consistent with most of the capital
structure literature and especially support Pecking Order Theory mentioned by Icke, B. T., &
Ivgen, H. (2011). To determine factors affecting the debt-to-equity ratio levels, the hypothesis
will be stated as follows:
H0: P (ROA, tax shield, market capitalization, asset tangibility) > 0.05
H1: P (ROA, tax shield, market capitalization, asset tangibility) ≤ 0.05
6.0 Data Analysis and Discussion

The results and findings are outlined in this section with inferences drawn from the
hypotheses in the previous section of this paper as follows:
6.1 Descriptive statistics

Telecommunications and Jute industries were excluded when running the regression because
they only had two and three firms listed in DSE, respectively, that did not meet the sample
selection specifications. From Table 1 below, several measures of central tendency and
dispersion were computed to show the underlying distribution of each variable. The key
highlights of the table are as follows: i) EPS had an overall average of about 3.84% for all 82
companies and a median of 1.96%, ii) The debt-to-equity ratio had a mean of 50.17%, a
median of 28.98% and a relatively high standard deviation of 71.03%. As can be seen the two
variables, which forms the two main dependent variables adopted for this study, exhibit a
distribution close to normality although they are extremely dispersed. The other variables
whose descriptive statistics were computed are shown in table 1 below.
Table 1: All Industries Pooled - Descriptive Statistics
AT D2E EPS MCap PE ROA TS
Mean 48.84 50.17 3.84 9.23 14.29 11.46 36.21
Median 39.55 28.98 1.96 3.25 11.51 9.40 45.08
Maximum 632.40 582.71 54.52 75.90 265.94 512.28 274.14
Minimum 0.00 0.00 -8.22 0.00 0.02 -45.60 -3,257.14
Std. Dev. 38.72 71.03 5.46 15.01 17.45 21.52 137.83
Note: AT stands for Asset Tangibility ratio, D2E stands for debt-to-equity ratio, EPS stands for
Earning-Per-Share, MCap stands for Market Capitalization, PE stands for Price-Earnings ratio,
ROA stands for Return-On-Asset, TS stands for Tax Shield ratio. Source of Output: E-views 10,
Software Tool Pack.
Source of Output: E-views 10, Software Tool Pack.
6.2 Unit Root Test

A variable is said to have unit root when it is explosive. According to existing literature on
unit root tests, a variable can only be included in a model when it does not have unit root or is
stationary. Since most financial series have an underlying growth rate, their mean and/or
variance are continually increasing which will lead to spurious regression results if they are
included in regression models without eliminating such non-stationarity. Several methods of
testing panel data unit root exist, but the Levin, A., et al. (2002) test was adopted for this
study. The results of this test are given below. According to the results in Table 2 below, all
variables exhibited stationarity and unit root was non-existent and were all suitable to
include in the regression analysis.
Summary Sample: 2009-2018
Exogenous variables: Individual effects
User-specified lags: 1
Newey-West automatic bandwidth selection and Bartlett kernel Balanced observations for
each test
Table 2: Unit Root Test Panel Unit Root Test
Cross-
Method Statistic Prob.** sections
Null: Unit root (assumes common unit root process)
AT -325.366 0.0000 82 576
Debt-to-Equity Ratio -5.66143 0.0000 82 576
EPS -4.34689 0.0000 82 576
PE -12.4399 0.0000 82 576
TS -215.158 0.0000 82 576
ROA -17.2426 0.0000 82 576
Market Capitalization -12.6915 0.0000 82 576
Ratio
** Probabilities for Fisher tests are computed using an asymptotic Chi-square
distribution. All other tests assume asymptotic normality.
Note: EPS stands for Earnings-Per-Share, PE stands for Price-Earnings ratio, TS stands for
Tax Shield ratio, AT stands for Asset Tangibility ratio, ROA stands for Return-On-Assets.
6.3 Research hypothesis one: capital structure is irrelevant as per MM1

The results for the pooled companies across industries show that none of the explanatory
variables were significant at the 5% level of significance. However, asset tangibility showed
significance at the 10% level. The debt-to-equity ratios of Bangladeshi firms sampled in this
study were insignificant in this model, which means that they had no explanatory power on
EPS (firm value). The overall fit of the model shown by the R squared stood at 0.6 or 60%
which indicates that the model can explain 60% of the variance in the EPS (firm value). This is
supported by a significant F-statistic at 5% level.
Dependent Variable: EPS

Method: Panel Least Squares Sample: 2009-2018
Periods included: 10
Cross-sections included: 82
Total panel (balanced) observations: 576
Table 3: Fem Regression of All Companies - Firm Value as Dependent Variable
Variable Coefficient Std. Error t-
Statistic
C 4.451460 0.387097 11.49959 0.0000
D2E -0.002138 0.002996 - 0.4758
0.713499
TS 0.001515 0.001110 1.365001 0.1728
AT -0.011029 0.006351 - 0.0830
1.736578
Effects Specification
Cross-section fixed (dummy variables)
R-squared 0.595398 Mean dependent var 3.86071
2
Adjusted R- 0.548820 S.D. dependent var 5.47505
squared 9
S.E. of regression 3.677593 Akaike info criterion 5.54112
3
Sum squared resid 7871.369 Schwarz criterion 6.00948
3
Log likelihood -1732.865 Hannan-Quinn criter. 5.72278
8
F-statistic 12.78285 Durbin-Watson stat 1.07860
9
Prob(F-statistic) 0.000000
Note: C stands for the Common Intercept, D2E stands for Debt-To-Equity ratio, TS stands for
Tax Shield ratio, AT stands for Asset Tangibility ratio, S.E stands for Standard Error, S.D is the
Standard Deviation and F-statistic stands for Fischer Statistic.
6.4 Research Hypothesis Two: Does the Debt-To-Equity Ratio Differ Among Industries
Listed on the DSE
Table 4: Debt-To-Equity Ratios by Industry
Ratio Services Food & Engineerin Pharmaceutica Textil Fuel &
(%) & Real Allied g ls & Chemicals e Power
states
2009/12 31 44 49 30 15 42
/31
2010/12 29 34 38 32 15 26
/31
2011/12 36 33 26 43 13 29
/31
2012/12 30 41 29 53 32 34
/30
2013/12 29 38 37 194 14 31
/29
2014/12 53 48 41 210 19 25
/31
2015/12 40 61 42 278 18 21
/31
2016/12 35 43 34 238 10 15
/31
2017/12 32 54 31 228 17 13
/31
2018/12 32 44 38 214 38 10
/30
Average 34.7 44 36.5 152 19 24.6
ratio
The table above presents the different debt-to-equity structures per industry. According to
the table above, the Pharmaceuticals & Chemicals industry had the highest levels of debt-to-
equity followed by the Food & Allied sector. The Textile industry had the lowest levels of the
debt-to-equity ratio over the observed period. According to the results presented in the table
above, it can be concluded that the debt-to-equity ratios of the different industries sampled
for this study are heterogeneous; therefore, it is accepted the null hypothesis.
6.5 Research hypothesis three: there is a relationship between debt-to-equity ratio and
profitability, size, asset tangibility and tax shield
According to the regression results presented below, return on assets and asset tangibility
were the only two variables in the model that were significant, meaning that they have
explanatory power over the dependent variable debt-to-equity ratio (proxy for capital
structure). The R squared was significant at the 5% significance level, with the model
explaining 54% of the variation in the capital structure of firms sampled in this study.
Dependent Variable: D2E

Method: Panel Least Squares
Sample: 2009-2018
Periods included: 10
Cross-sections included: 82
Total panel (balanced) observations: 576
Table 4: Fem Regression of All Companies and Industries - Capital Structure as
Dependent Variable
Variable Coefficient Std. Error t- Prob.
Statistic
C 68.56153 6.892333 9.947508 0.0000
MCAP -0.574213 0.492695 - 0.2443
1.165453
ROA -0.226823 0.101865 - 0.0264
2.226697
TS 0.001885 0.015285 0.123351 0.9019
Effects Specification
Cross-section fixed (dummy variables)
R-squared 0.544307 Mean dependent var 50.1892
2
Adjusted R- 0.490972 S.D. dependent var 70.9795
squared 7
S.E. of regression 50.64120 Akaike info criterion 10.7874
9
Sum squared resid 1489993. Schwarz criterion 11.2627
4
Log likelihood -3436.936 Hannan-Quinn criter. 10.9718
3
F-statistic 10.20559 Durbin-Watson stat 0.91002
6
Prob(F-statistic) 0.000000
Note: C stands for the Common-intercept, D2E stands for Debt-To-Equity ratio, MCap stands
for Market Capitalization, ROA stands for Return-On-Asset, TS stands for Tax Shield ratio, AT
stands for Asset Tangibility ratio, S.E stands for Standard Error, S.D is the Standard Deviation
and F-statistic stands for Fischer Statistic.
7.0 Conclusion and Recommendation

As clearly stated above, the study sought to cover the questions, is capital structure irrelevant
as per MM I, what is the capital structure (debt-to-equity) of firms per industry in Bangladesh,
how persistent is the debt-to-equity capital structure, what factors determine the debt-to-
equity structure divide, what is the debt structure in terms of funding between long term and
short term debt and how persistent is the long term-short term structure. Several techniques
were utilized to fulfill this end and each addressed a particular question. To establish
whether capital structure is irrelevant, a panel data regression was done on all firms pooled
across industries and an industry specific analysis was also done to establish the behaviors
and relationships within the industries. To establish the robustness of our model and expand
the analysis of MM I, we also conducted an analysis by firm size. The general pooled analysis
found the model to be significant with the adjusted R squared of 55%. Although none of the
variables were significant at the 5% level of significance, asset tangibility was significant at
the 10% level of significance. The industry specific analysis found all models to be significant
with adjusted R squared figures of 58% for Services & Real states, 48% for Food & Allied,
60% for Engineering, 81% for Pharmaceuticals & Chemicals, 46% for Textile and Fuel &
Power 37%. The re-specified model on all firms was significant at the 5% level of significance
with an R squared of 73%, however, debt-to-equity was still insignificant. The analysis by
firm size also found all models to be significant at the 5% level of significance with R squared
of 83%, 71% and 76% for large, medium and small firms respectively, however, the debt-to-
equity ratio was insignificant in all models. This means that there is no statistically significant
relationship between the firm value and capital structure of firms in Bangladesh. These
findings are highly inconsistent with prominent literature such as Shivdasani, A., & Zenner, M.
(2005), Fama, E. F., & French, K. R. (2005) all of whom concluded that there is a direct
relationship between leverage and firm value. Ward, M., & Price, A. (2006) also indicated that
an increased debt-to-equity ratio increases returns for the shareholders for profitable firms.
Researcher inconsistent findings could be as a result of misspecification or other unfavorable
effects inherent in the data used for the analysis or it could be that the MM I proposition holds
in the Bangladeshi context. To establish the capital structure of firms within the different
industries listed on the DSE descriptive statistics analysis were carried out were the mean of
debt-to-equity ratios for all firms in each industry were computed. According to the
computed means, the Health care industry had the highest debt-to-equity ratio meaning that
firms in this industry used more debt than equity as their source of capital. The industry with
the lowest debt-to-equity ratios was the Technology industry. The Pharmaceuticals &
Chemicals industry had a larger market capitalization ratio of 33.3% as compared to the
Textile industry ratio of 25%. These findings imply that larger firms tend to use more debt
than smaller ones. Large firms are more visible and diversified than small ones and have
access to easy and cheaper debt. This is inconsistent, however, with the findings of the
regression analysis which indicated pecking order behavior of Bangladeshi firms. There may
be other factors not included in this study that are driving the high debt-to-equity ratios of
firms in the Health care industry. To determine the persistence of the capital structure within
the different firms, the results above were plotted on a graph to visually illustrate the
patterns of persistence. The patterns of the capitals structure within the different industries

varied over the observed period. For some industries the patterns had sharp increases and
sharp declines while for some it showed a range bound pattern.
To establish factors that have an effect on the debt-to-equity divide, or simply capital
structure of firms’ researcher employed a panel data regression as in the previous case. All
the models were significant at the 5% level of significance. The findings from the regression
models indicated a negative significant relationship between profitability and the capital
structure of a firm. This is supported by previous research by Gwatidzo, T., & Ojah, K. (2009)
who found a negative significant relationship between profitability and capital structure.
Umar, M. et al. (2012) also found that there was a negative and significant correlation
between gearing and profitability for Manufacturing Small, Medium and Micro Enterprises
(SMMEs) and large sized enterprises (LSEs). The results of the panel regressions indicated a
pecking order behaviour which was also the findings of Gwatidzo, T., & Ojah, K. (2009) as well
as Umar, M. et al. (2012). It could be argued that the results on MM I summarized above are
mostly inconsistent with recent literature and economic theory from across the world. There
is substantial literature that has shown that there is a relationship between firm value and the
capital structure of a firm. This outcome, perhaps, concur with Myers, S. C. (2001) who stated
that there is no universal theory of capital structure, only conditional ones. Factors that are of
significance in one context may be insignificant in another. An interesting future research
agenda would be to find possible explanations for these contrasting results, starting with
verifying differences in test variables alternative and testing techniques deployed in these
studies.
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Cite this article:

Molla, M. E. (2019) Factors Influencing Capital Structure on Firm’s Value: A Study on DSE
Listed Companies. International Journal of Science and Business,3(1), 37-52. doi:
https://doi.org/10.5281/zenodo.2539383
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ISSN 2520-4750 (Online) & ISSN 2521-3040 (Print)

Factors Influencing Capital Structure

Keywords: Capital Structure, Leverage, Industry, Profitability, DSE, Bangladesh.

37 International Journal of Science and Business Published By

38 International Journal of Science and Business Published By

1.1 Statement of the Problem

1.2 Significance of the Study

1.3 Scope of the Study

1.4 The Study Objectives

39 International Journal of Science and Business Published By

2.0 Data Collection and Methodology

3.0 Review of Literature

40 International Journal of Science and Business Published By

41 International Journal of Science and Business Published By

4.0 Capital Structure Theories

4.1 Modigliani and Miller’s Capital Structure Irrelevance

Assets-in-place Debt (D)

Firm value (V)

Figure 1: Market-Value Balance Sheet, Source: Myers, S. C. (2001) Page- 85

4.2 The Trade-Off Theory

42 International Journal of Science and Business Published By

4.3 Pecking Order Theory

43 International Journal of Science and Business Published By

4.4 The Market Timing Theory

5.0 Hypotheses Development

H0: μ ˃ 0.05 (debt-to-equity ratio is not correlated to EPS)

H0: μ1 ≠ μ2 ≠ μ3… μn (industry median debt-to-equity ratios are heterogeneous)

44 International Journal of Science and Business Published By

6.0 Data Analysis and Discussion

6.1 Descriptive statistics

Source of Output: E-views 10, Software Tool Pack.

6.2 Unit Root Test

6.3 Research hypothesis one: capital structure is irrelevant as per MM1

Dependent Variable: EPS

Dependent Variable: D2E

Source of Output: E-views 10, Software Tool Pack.

7.0 Conclusion and Recommendation

49 International Journal of Science and Business Published By

50 International Journal of Science and Business Published By

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