PES Business Review

N. R. Parasuraman ¹

Affiliations
1 SDM Institute for Management, Mysore, IN

Abstract

It is widely recognized that working capital constitutes an important aspect of corporate financial management with considerable bearing on shareholder value creation. However, the practices of leading companies do not always suggest that they concentrate on optimizing the key parameters of working capital as against looking at growth parameters. On the contrary, strategically, a number of companies have allowed their working capital positions to suffer in compensation for growth. The study looks at the broad general parameters of Indian companies as regards their working capital and seeks to establish relationship, if any, with these companies' profitability. Predictably, such an overall relationship does not seem to exist.

Keywords

Working Capital, Profitability. Nifty, Market Capitalization.

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N. R. Parasuraman ¹

Affiliations
1 SDM Institute for Management, Mysore, IN

Abstract

The determination of the ideal capital structure for a company involves a number of theoretical and practical considerations. The theoretical literature on the subject is widely divided as to the influencing factors that lead to a corporate decision on the matter. A number of empirical studies have been conducted the world over to test the applicability of various postulates and the conclusions on these have thrown light on many aspects of the leverage decision. In India there have been few studies which have highlighted the specific factors governing the decision. Also, most of these Indian studies have been highly theoretical in nature. This paper seeks to do an empirical analysis of leading Indian Companies and to test broad hypotheses on leverage. The Study finds that a combination of factors influences the leverage decision of companies. The relative importance of these factors varies from Company to Company. Also, the separate contribution of each of these factors to the leverage decision could also change from year to year. It would thus not be possible to draw a trend line of the contributions of these factors. However, the regression as a whole is significant in all the years and has high predictive power. The mean B coefficients of these factors when applied to the values of 2003 show a high level of accuracy in predicting the debt-equity ratio.

Companies have tended to move towards a target capital structure over a 3-year period. However, growth companies and highly profitable companies have moved away from high leverage to moderate and low leverage levels. The pecking order theory may be in vogue in the short run but this cannot be tested. The fact that debt-equity ratios move towards an average debt-equity ratio shows the prevalence of the target capital structure theory over the pecking order theory in the case of leading Indian companies.

Keywords

Leverage, Capital Structure, Debt-Equity Ratio, NIFTY.

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