Exploring the underlying factors affecting capital structure decision: A quantitative analysis

AuthorMd. Nazmul Hossain,Nikhil Shil,Md. Nayamot Ullah
Date01 October 2019
Published date01 October 2019
Exploring the underlying factors affecting capital structure
decision: A quantitative analysis
Nikhil Shil | Md. Nazmul Hossain | Md. Nayamot Ullah
Department of Business Administration, East West University, Dhaka, Bangladesh
Md. Nazmul Hossain, Department of
Business Administration, East West
University, Dhaka, Bangladesh.
Email: nazmulsajal.2011@gmail.com
Objective: This study deploys an earnest effort to understand the factors that affect
the managers involved in managing the portfolio of funding in companies. Capital
structure decision is one of the crucial decisions that finance managers have to
make. This study tries to identify a host of factors controlling the attitude of finance
managers in choosing different sources of financing, as reflected in financials of
respected companies.
Design/methodology/approach: Based on the data available in different secondary
sources (such as the financial statements published by the sampled companies), an
exploratory form of research is applied here. The samples for the study are selected
from companies which are listed in Dhaka Stock Exchange (DSE) under pharmaceu-
tical, textile, and banking sectors. Different descriptive and inferential statistical tools
are used to present the data and test relevant hypotheses by using statistical package
for the social sciences.
Findings: Based on the literature review, the study has identified a couple of fac-
tors affecting capital structure decision. These factors are replicated in selected
Bangladeshi firms to understand their implications. Although the study fails to
report any determinants having strong relationship which is statistically significant,
the model passes goodness-of-fit test and residual analysis, which shows the pres-
ence of normality.
Research limitations/implications: The findings of the study could not be gener-
alized due to some inherent limitations of the research. The study only covers selec-
tive companies from three sectors, leaving others from the preview of analysis,
which limits the scope of the study. However, the findings of the research could be
helpful for individual firms to find their status in the recent trend of practicing capi-
tal structure decision; thereby they can adopt or revise their policy in this regard.
Another major limitation of the study is that, it applies a quantitative form of analy-
sis based on the data published in general purpose financial statements. It would be
more beneficial if quantitative findings could be validated through qualitative anal-
ysis in order to bring data triangulation which is left for further study. Extending
the analysis to cover all the firms listed in DSE can give a better outlook on capital
structure issues in Bangladesh.
Received: 22 April 2019 Revised: 23 May 2019 Accepted: 8 June 2019
DOI: 10.1002/jcaf.22404
J Corp Acct Fin. 2019;30:6984. wileyonlinelibrary.com/journal/jcaf © 2019 Wiley Periodicals, Inc. 69
Originality/value: This study has been conducted for the first time in Bangladesh,
identifying determinants from different theories which may help the future researchers
to extend the analysis. Thus, the study adds significant value to the current body of
Bangladesh, capital structure, determinants, Dhaka Stock Exchange
For debt-equity choice, there is no universal theory to carry
forward (Myers, 2001). However, there are a number of useful
conditional theories, each of which supports to recognize the
debt-to-equity structure that organizations decide on. These the-
ories can be parted into two sideseither they pretend the
entity of the optimal debt-equity ratio for every firm (so-called
static trade-off models), or they allege that there is no well-
defined practice of capital structure which is known as pecking-
order hypothesis. To avoid the preferences and other conflicting
issues surrounding the capital structure theory, this study
explores a very basic objective in capital structure decision
based on the published data.
Capital structure decision of a firm is affected by a good
number of factors. These factors may be completely external
to the firms or they may be internal as well. External factors
are mostly macroeconomic variables, like inflation, interest
rate, monetary policy, and internal factors, purely specific to a
particular firm, are profitability, size, age, liquidity, tangibil-
ity, and so forth. Corporate finance literature gives a testi-
mony on studying the underlying factors affecting the capital
structure decision of firms. This study is very usual in that
sense, yet it captures different theories on capital structure,
and has identified most internal factors with reference to those
theories, and analyzes the relationship quantitatively.
After two notable stock market debacles (in 1996 and
2010) in Bangladesh, the stock exchanges have undergone
serious reform initiatives. A significant amount of fund has
been spent in improving the efficiency of stock markets in
terms of its breadth and depth. The government is trying to
motivate companies with good financial health to get them
listed in stock market. Still, the trend is not satisfactory. This
study will act as an eye-opener to understand the require-
ments of financing from public and will develop a profile of
companies that require equity from market. The debt-equity
ratio for companies with sound financial health needs to be
studied to give a signal to market. In absence of any prior
study in this area, this study is expected to capture very basic
ideologies in optimal capital structure decisions.
The way Modigliani and Miller (1958) have started capital
structure theory has narrowed down the scope of work,
looking for only an optimum capital structure as a targeted
debt-to-equity ratio that would minimize the overall cost of
financing. However, by 1984, the focus turned into identify-
ing underlying factors influencing the choice of sources of
financing. The primary goal of this study is to determine if
there are any firm-specific factors that systematically influ-
ence the capital structure of the companies based on the quan-
titative data published in general purpose financial statements
by the sampled companies.
The study of capital structure theory begins formally with the
irrelevance proposition of Modigliani and Miller, and they have
hypothesized that, in perfect markets, it does not matter what
capital structure a company uses to finance its operations.
There are a lot of theories addressing the mixture of debt and
equity in forming capital base for companies. Some of the nota-
ble theories are: trade-off theory, pecking order theory, signal-
ing theory, market timing theory, agency cost theory, free cash
flow theory, and contracting cost theory. Every theory has its
own way of bringing optimization in capital structure decision.
The proponents of these theories have also identified different
factors affecting the inclusion of debts in capital structure, along
with the dimensions of relationship, which are presented in
Exhibit 1 below:
Based on the analysis presented in the above table and avail-
able data, this study considers the prevalence of the trade-off
theory in Bangladesh and develops an understanding of capital
structure on the basic premise of trade-off theory. This theory
suggests that optimal point of the debt is where situating at the
edge of benefit-of-debt finance is same as its marginal cost. In
order to calculate financial distress and tax shield with adjusting
debt and equity ratio, firms can acquire an optimal capital struc-
ture. Myers (1984) used the trade-off theory to explain Capital
Structure Puzzle,and suggested that debt should be adjusted to
a certain point to balance interest tax shield and financial dis-
tress. Similarly, Jensen and Meckling (1976) also used trade-off
model to separate bankruptcy cost from agency cost. Agency
cost can be reduced by debt, and higher debt can be paid out
with more cash for large amount of capital (Jensen, 1986).
Harris and Raviv (1991) suggested that debt capital provides

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