Advertisement

Impact of Firms’ Market Value on Capital Structure Decisions: Panel Data Evidence from Indian Manufacturing Firms

  • Dhananjaya Kadanda
Chapter

Abstract

India witnessed a significant development in stock market in the post-1990s due to series of reform measures. As a result, firms are able to raise market-based capital which helped them to reduce their dependence on institution-based finance. Consequently, market valuation of the firm has become an important variable in corporate finance decisions. However, traditional theories of capital structure fail to offer unambiguous explanation on the impact of market value on capital structure. To bridge this lacuna in capital structure literature, Baker and Wrugler (J Financ 57(1):1–32 2002) propounded market timing theory which argues that firms’ time the market, that is, firms raise equity capital when market valuation is high and buy back when market valuation is lower and hence the current capital structure of the firm is the cumulative result of past attempts to time the equity market. This study attempted to understand the role of market value in influencing the capital structure decisions of the manufacturing firms in India. The study found that market value negatively influences the debt ratio both in short term and in long term, indicating the practice of market timing. Further, the study also shows that the negative impact does indeed come from changes equity issues rather than changes retained earnings or debt retirement.

Keywords

Capital structure Market valuation Market timing 

JEL Classification

G3 

References

  1. Ali Ahmed, H. J., & Hisham, N. (2009). Revisiting capital structure theory: A test of pecking order and static trade-off model from Malaysian capital market. International Research Journal of Finance and Economics, 30, 58–65.Google Scholar
  2. Alti, A. (2006). How persistent is the impact of market timing on capital structure? The Journal of Finance, 51(4), 1681–1710.CrossRefGoogle Scholar
  3. Baker, M., & Wurgler, J. (2002). Market timing and capital structure. The Journal of Finance, 57(1), 1–32.CrossRefGoogle Scholar
  4. Barton Sidney, L., Hill, N. C., & Sundaram, S. (1989). An empirical test of stakeholder theory predictions of capital structure. Financial Management, 18(1), 36–44.CrossRefGoogle Scholar
  5. Baxter, N. D. (1967). Leverage, the risk of ruin and the cost of capital. Journal of Finance, 22(3), 395–403.Google Scholar
  6. Berger, A. N., & Udell, G. F. (2005, December). A more complete conceptual framework for financing of small and medium enterprises. World Bank Policy Research Working Paper 3795.Google Scholar
  7. Bhabra, H. S., Liu, T., & Tirtiroglu, D. (2008). Capital structure choice in a nascent market: Evidence from listed firms in China. Financial Management, 37(2), 341–364.CrossRefGoogle Scholar
  8. Bhaduri, S. N. (2002a). Determinants of corporate borrowing: Some evidence from the Indian corporate sector. Journal of Economics and Finance, 26(2), 200–215.CrossRefGoogle Scholar
  9. Bhaduri, S. N. (2002b). Determinants of capital structure choice: A study of Indian corporate sector. Applied Financial Economics, 12(9), 655–665.CrossRefGoogle Scholar
  10. Bole, L. M., & Mahakud, J. (2004). Trends and determinants of capital structure in India: A panel data analysis. Finance India, 18(1), 37–55.Google Scholar
  11. Booth, L., Aivazian, V., Demirguc-Kunt, A., & Maksimovic, V. (2001). Capital structure in developing countries. Journal of Finance, 56, 87–130.CrossRefGoogle Scholar
  12. Brav, A., Graham, J., Harvey, C., & Michaely, R. (2005). Payout policy in the 21st century. Journal of Financial Economics, 77, 483–527.CrossRefGoogle Scholar
  13. Chauhan, G. S. (2015). Capital structure in India: Implications for the development of bond markets. Indian Journal of Economics & Business, 14(2), 245–267.Google Scholar
  14. Chen, L., & Zhao, X. (2006, June). On the relation between the market-to-book ratio, growth, opportunity, and leverage ratio.Google Scholar
  15. Daskalakis, N., & Psillaki, M. (2008). Do country or firm factors explain capital structure? Evidence from SMEs in France and Greece. Applied Financial Economics, 18, 87–97.CrossRefGoogle Scholar
  16. DeAngelo, H., & Masulis, R. (1980). Optimal capital structure under corporate and personal taxation. Journal of Financial Economics, 8, 3–29.CrossRefGoogle Scholar
  17. Demirgüç-Kunt, A., & Maksimovic, V. (1996). Stock market development and financing choices of firms. The World Bank Economic Review, 10(2), 341–369.CrossRefGoogle Scholar
  18. Espinosa Christian, M., Carlos Maquieira, V., Vieito, J. P., & Marcelo Gonzalez, A. (2012). Capital structures in developing countries: The Latin American case. Investigation Economica, 71(282), 35–54.Google Scholar
  19. Fama, E., & French, K. (2000). Testing trade-off and pecking order predictions about dividends and debt. Review of Financial Studies, 15(1), 1–33.CrossRefGoogle Scholar
  20. Frank, M. Z., & Goyal, V. K. (2003). Testing the pecking order theory of capital structure. Journal of Financial Economics, 67, 217–248.CrossRefGoogle Scholar
  21. Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: Which factors are reliably important? Financial Management, 38(1), 1–37.CrossRefGoogle Scholar
  22. Gaud, P., Jani, E., Hoesli, M., & Bender, A. (2005). The capital structure of Swiss companies: An empirical analysis using dynamic panel data. European Financial Management, 77(1), 51–69.CrossRefGoogle Scholar
  23. Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2–3), 187–243.CrossRefGoogle Scholar
  24. Hall, G., Hutchinson, P., & Michaelas, N. (2004). Determinants of the capital structure of European SMEs. Journal of Business Finance and Accounting, 31(5), 711–728.Google Scholar
  25. Harris, M., & Raviv, A. (1990). Capital structure and the informational role of debt. The Journal of Finance, 45(2), 321–349.CrossRefGoogle Scholar
  26. Harris, M., & Raviv, A. (1991). The theory of capital structure. The Journal of Finance, 46, 297–355.CrossRefGoogle Scholar
  27. Hovakimian, A., Opler, T., & Titman, S. (2001). The debt-equity choice. Journal of Financial and Quantitative Analysis, 36(1), 1–24.CrossRefGoogle Scholar
  28. Huang, R., & Ritter, J. R. (2009). Testing theories of capital structure and estimating the speed of adjustment. The Journal of Financial and Quantitative Analysis, 44(2), 237–271.CrossRefGoogle Scholar
  29. Jalal, A. I. M. (2007). The pecking order, information asymmetry, and financial market efficiency, Doctoral Dissertation, The University of Minnesota.Google Scholar
  30. Jensen, M., & Meckling, N. (1976). The theory of the firm: Managerial behavior agency cost and ownership structure. Journal of Financial Economics, 3, 305–360.CrossRefGoogle Scholar
  31. Jung, K., Kim, Y., & Stulz, R. (1996). Timing, investment opportunities, managerial discretion, and the security issue decision. Journal of Financial Economics, 42, 159–185.CrossRefGoogle Scholar
  32. Khasnobis, B. G., & Bhaduri, S. N. (2002). Determinants of capital structure in India (1990–1998): A dynamic panel data approach. Journal of Economic Integration, 17(4), 761–776.CrossRefGoogle Scholar
  33. Korajczyk, R., Lucas, D., & McDonald, R. (1991). The effects of information releases on the pricing and timing of equity issues. Review of Financial Studies, 4, 685–708.CrossRefGoogle Scholar
  34. Mahakud, J. (2006). Testing the pecking order theory of capital structure: Evidence from Indian corporate sector. ICFAI Journal of Applied Finance, 12(11), 16–26.Google Scholar
  35. Miller Merton, H. (1977). Debt and taxes source. The Journal of Finance, 32(2), 261–275.Google Scholar
  36. Modigliani, F., & Miller, M. (1958). The cost of capital, corporate finance and the theory of investment. American Economic Review, 48, 261–297.Google Scholar
  37. Modigliani, F., & Miller, M. (1963). Corporate income taxes and the cost of capital. American Economic Review, 53, 433–443.Google Scholar
  38. Mohamad, M. H. (1995). Capital structure in large Malaysian companies. MIR: Management International Review, 35, 119–130.Google Scholar
  39. Mujumdar, R. (2014). Indebtedness in the small and midcap segments: New evidences from Indian manufacturing sector. Management Research Review, 37(9), 833–854.CrossRefGoogle Scholar
  40. Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 9, 147–176.CrossRefGoogle Scholar
  41. Myers, S. C. (1984). The capital structure puzzle. The Journal of Finance, 39(3), 575–592.CrossRefGoogle Scholar
  42. Myers, S. C., & Majluf, N. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221.CrossRefGoogle Scholar
  43. Ozkan, A. (2001). Determinants of capital structure and adjustment to long run target: Evidence from UK company panel data. Journal of Business Finance and Accounting, 28(1 & 2), 175–199.CrossRefGoogle Scholar
  44. Patnaik, I., Shaha, A., & Singh, N. (2016). Foreign currency borrowing by Indian firms: Towards a new policy framework. Working Paper No. 167, National Institute of Public Finance and Policy, New Delhi.Google Scholar
  45. Psillaki, M., & Daskalakis, N. (2009). Are the determinants of capital structure country or firm specific? Small Business Economics, 33, 319–333.CrossRefGoogle Scholar
  46. Rajan, R. G., & Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. Journal of Finance, 50(5), 1421–1459.CrossRefGoogle Scholar
  47. RBI. (2015, June). Financial Stability Report, Reserve Bank of India.Google Scholar
  48. RBI. (2017, June). Financial Stability Report, No. 15. Reserve Bank of India, Mumbai.Google Scholar
  49. Reddy, Y. V. (2004, March). Credit policy, systems, and culture. Reserve Bank of India Bulletin.Google Scholar
  50. Scott, J. (1977). Bankruptcy, secured debt, and optimal capital structure. Journal of Finance, 32(1), 1–19.CrossRefGoogle Scholar
  51. Sogorb-Mira, F. (2005). How SME uniqueness affects capital structure: Evidence from a 1994–1998 Spanish data panel. Small Business Economics, 25(5), 447–457.CrossRefGoogle Scholar
  52. Strebulaev, I. A. (2007). Do tests of capital structure theory mean what they say? The Journal of Finance, 62(4), 1747–1787.CrossRefGoogle Scholar
  53. The Hindu. (2016, December). Details of NPA figures of public, private sector banks, December 02, 2016.Google Scholar
  54. Titman, S., & Wessels, R. (1988). The determinants of capital structure choice. Journal of Finance, 43(1), 1–20.CrossRefGoogle Scholar
  55. Tong, G., & Green, C. J. (2005). Pecking order or trade-off hypothesis? Evidence on the capital structure of Chinese companies. Journal of Applied Economics, 37(19), 2179–2189.CrossRefGoogle Scholar
  56. Um, T. (2001, January). Determination of capital structure and prediction of bankruptcy in Korea Doctoral Dissertation, Faculty of the Graduate School, Cornell University.Google Scholar
  57. Van der Wijst, D., & Thurik, R. (1993). Determinants of small firm debt ratios: An analysis of retail panel data. Small Business Economics, 5, 55–65.CrossRefGoogle Scholar
  58. Warner, J. (1977). Bankruptcy, absolute priority, and the prices of risky debt claims. Journal of Financial Economics, 239–76.CrossRefGoogle Scholar
  59. Welch, I. (2004). Capital structure and stock returns. Journal of Political Economy, 112, 106–131.CrossRefGoogle Scholar

Copyright information

© Springer Nature Singapore Pte Ltd. 2018

Authors and Affiliations

  1. 1.St. Aloysius Institute of Management and Information Technology, St. Aloysius College (Autonomous)MangaloreIndia

Personalised recommendations