1. Capital Structure Theory
Nia Christina
16598

2. Article from CRP
Title: An Empirical Study on the Determinants of the Capital Structure of Listed Indian Firms.
Theory used by the article / research:
Trade-off theory, a firm’s optimal debt ratio is viewed as determined by a trade-off of the cost and benefit of borrowing, holding the firm’s assets and investment plan constant.
The signaling theory based on asymmetric information problems.
The agency theory, based on asymmetric information problem that is principal-agent conflict.
Pecking order theory, use their retain earning, and then move to debt when their internal fund run out.

3. Variable use in research: Dependent variables:
Hypothesis of research: Traditional factors affect financing decision, namely profitability, tangibility, taxes and growth.
Variable use in research:
Dependent variables:
Book leverage
Market leverage
Explanatory Variable:
Non-debt tax shield (NDTS)
Tangibility
Profitability
Business Risk
Growth opportunities
Growth
Size
Agency variables

4. Method of analysis: Regression model, used to analyze the determinants of Indian firms’ capital structure
Result of analysis :
There has been significant decrease in mean debt-equity ratio in post liberalization period across the group and industries.
Except growth rate and size all other explanatory variables have significant correlation with leverage during pre-liberalization period whereas all the explanatory variables are significantly correlated with leverage during post-liberalization period.
The estimated coefficient of non-debt tax shield, cash operating profit, market-to book value ratio are consistently significant and have predicted sign across the equations.
Foreign investors are not adopting high leverage to discipline management.

5. Conclusion:
Measure of traditional factors that hypothesized to affect financing decision, namely profitability, tangibility, taxes and growth are all significant.

6. Article from students
Title: Testing trade-off and pecking order theories financing SMEs
Topic: Capital Structure Theory
Theory used by the article / research:
Trade-off theory, companies seek to obtain optimum capital structure and weigh up the advantages and disadvantages of an additional monetary unit of debt.
Pecking order theory, use their retain earning, and then move to debt when their internal fund run out.

7. Hypothesis of research: Based on trade-off model
The effective tax rate is expected to be positively related to the debt level.
Non-debt tax shields should be negatively related to firm debt.
Default risk should be negatively related to the firm’s debt ratio.
Companies with greater growth opportunities will have a smaller debt ratio.
There should be a positive relationship between debt ratio and firm profitability.
The size of the company should be positively related to the level of debt.
SMEs face significant transaction cost which keep them far from their target.

8. Based on pecking order
The financing deficit of SMEs should be positively related to the change in the level of debt.
Firm debt should be negatively related to the volume of firm cash flow.
Firm with few investment opportunities and high cash flow should have a low level of debt, while firms with strong growth prospects and reduced cash flow should have high debt ratio.
The age of the company should be negatively related to its level of debt.

9. Variable use in research:
Total debt ratio (D)
Effective tax rate (ETR)
Non-debt tax shield (NDTS)
Default risk (DR)
Growth opportunities (GO)
Profitability (ROA)
Size
Cash flow (CF)
CFGO
AGE

10. Method of analysis: Panel data methodology, by simultaneously combining cross-section and time series data
Result of analysis :
Spanish SMEs seem to find the cost of an unbalanced position less of a burden than the cost of adjusting. Hypothesis 7: accepted.
Current Spanish tax regulation does not provide relevant advantages to SMEs. Hypothesis 2:accepted but Hypothesis 1: is not
SMEs also prone to having large growth prospects and high debt ratios, thus making them very sensitive to Myers’ underinvestment problem. Hypothesis 4: accepted.
Firm size and leverage are found to be positively connected. Hypothesis 6: accepted.
All Hypothesis 9, 10,11 are found to be overwhelmingly confirmed. As expected, cash flow is negatively related to firm leverage; so the SMEs that generate the most internal resources are the least levered. The result consistent with pecking theory prediction.
A positive and significant relationship between the interactive variable CFGO and firm leverage is obtained. Hypothesis 10 is fulfilling.
Older SMEs may have generated sufficient internal resources to not depend as much on debt as younger SMEs, whose dependence on external resources will be greater.

11. Conclusion:
Regarding the trade-off theory, results clearly indicate that SMEs face high transaction costs which are probably derived from typical agency problems and financial restriction in capital markets.
Empirical evidence confirms that internal resources represent the main source of financing for SMEs.
Empirical evidence prove that NDTS, growth opportunities and internal resource play an important role in the decision making process.
SME and large firms display significantly distinct financial behavior, thus confirming the presumable financial restriction of SMEs.

12. Thank You