Informatics Publishing Limited

Sulagna Mukherjee ¹, Jitendra Mahakud ²

Affiliations
1 T.A. Pai Management Institute Manipal-576104 (Karnataka)
2 Department of Humanities and Social Sciences Indian Institute of Technology Kharagpur-721302

Abstract

The objective of the paper is to find out whether the trade-off and pecking order theories are mutually exclusive or complimentary to each other in determining the optimal capital structure of the Indian manufacturing companies during the period 1993-94 to 2007-08. We find that the trade-off and pecking order theories are complimentary to each other to determine the capital structure and therefore, companies' financing behavior is best explained by the modified pecking order theory. We also find that Indian manufacturing companies do have target leverage ratios and the adjustment speed towards the target has been around 40 percent.

Keywords

Trade-off Theory, Modified Pecking Order Theory, Target Leverage Ratio, Adjustment Speed

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Sulagna Mukherjee ¹, Jitendra Mahakud ²

Affiliations
1 TA Pai Management Institute, Manipal-576104 (Karnataka)
2 Department of Humanities and Social Sciences Vinod Gupta School of Management, IIT, Kharagpur-721 302

Abstract

The objective of this paper is to investigate the role of economic condition on determination of financial leverage and the adjustment speed to target leverage for the Indian manufacturing companies. Using the pooled data and the generalized method of moments estimation techniques, we find the evidence that for the Indian firms, macroeconomic condition plays an important role for determination of financial leverage, all the firms do have the target leverage ratio across macroeconomic conditions and the adjustment speed to target leverage has been pro-cyclical. We also find that financing behavior of the companies is different in good and bad economic conditions for both book and market leverage ratios.

Keywords

Financial Leverage, Macroeconomic Condition, Adjustment Speed, Pooled Data, Generalized Method of Moments, Target Leverage Ratio

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Sulagna Mukherjee ¹, Jitendra Mahakud ¹

Affiliations
1 Department of Humanities and Social Sciences Indian Institute of Technology Kharagpur- 721 302

Abstract

The objective of the paper is to investigate the role of historical 'market to book ratio' as a proxy for growth opportunity in determining the optimal capital structure of the Indian manufacturing companies during the period 1993-94 to 2007-08. This study specifies a partial adjustment model and uses the Generalized Method of Moments (GMM) technique to examine the role of historical market to book ratio, adjustment costs and other firm specific variable like size of the firm, profitability, non debt tax shield and tangibility for the determination of target capital structure. We find a robust relationship between the growth opportunity of the company and the capital structure dynamics. The adjustment speed towards the target has been varied between 12 to 39 percent across the various definitions of leverage. This study has the implications for the corporate managers in India to analyze the growth opportunity of the company and other firm specific variables like market to book ratio, size of the firm, profitability and tangibility while taking the appropriate financing decisions of the company.

Keywords

Leverage, Partial Adjustment Model, Generalized Method of Moments, External Financing Weighted Average of Market to Book Ratio, Equity Issue Weighted Average Market-to-book Ratio

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