Anda di halaman 1dari 15

Chaitanya Barhale 1

Components of Capital Structure A detailed analysis

Abstract
According to Rajan and Zingales (1995), the level of leverage is positively correlated to firm-size
and tangibility and negatively correlated to profitability and the level of growth opportunities.
However, as noted by Rajan and Zingales the extent of leverage (gearing) and the most relevant
measure depends on the objective of the analysis (p. 1427). Bevan and Danbolt (2002) in their
analysis of 822 UK companies find results similar to those of Rajan and Zingales (1995). By
constructing more than one measure of leverage, they find that results are highly model-specific.
In a study of 2129 US companies I try to replicate the findings of Rajan and Zingales (1995) and
test if the results are definitional-dependent. Additionally, by analyzing the individual elements of
debt in leverage measure, I test if the determinants of capital structure are sensitive to individual
elements of debt.

I. Introduction
The Modigliani Miller theorem (1958) forms the basis of modern theory on capital structure. According
to their theory, in the absence of taxation, transaction cost, bankruptcy cost (perfect market conditions);
valuation of firms remains unchanged irrespective of the method of financing adopted. In the absence of
these key assumptions in the real world, firms try to reach optimal capital structure by selecting right
levels of debt and equity.
This study attempts to extend knowledge of capital structure and its determinants in listed US companies.
In their study of capital structure in the G-7 countries, Rajan and Zingales (1995) find leverage in US is
positively related to tangibility (the proportion of fixed assets to total assets) and firm size (logsales) and
negatively correlated to growth opportunities (the proportion of market-value of assets to book-value of
assets) and profitability (the proportion of earnings before interest, taxes, and depreciation to total assets).
In this study, the different measures of leverage as defined by Rajan and Zingales (1995) are constructed
and tested against determinants of corporate leverage. The reason to develop more than one measure of
leverage is to test if the relationship between the leverage measure and the determinants vary based on the
definition of the leverage. The results suggest that the relationship between different leverage measures
and the determinants are same; however the absolute values of coefficients are significantly different.
Having established that the results are highly definitional dependent, an attempt is made to understand the
reasons for difference in absolute values. This is done by sub-dividing the elements of leverage into longterm and short-term debt. The results are found to vary significantly depending on which element of debt

Chaitanya Barhale 2
Components of Capital Structure A detailed analysis
is being considered. Short-term debt forms a significant portion of corporate financial structure; hence
analysis based solely on long-term form of debt provides limited insights in capital structure formation.
The most difficult challenge in conducting such analysis is defining the variables (both independent and
dependent), and finding the right proxies for these variables. As noted by Titman and Wessels (1998) the
required explanatory variables may frequently be imperfect proxies for the desired corporate attributes, so
inducing errors-in-variables problems to the regression analysis. This study examines the issue of
corporate financial structure and its determinants from two distinct perspectives; to seek explanation for
the differences in results based on definition of leverage, as suggested by Rajan and Zingales (1995) and
to analyze if the determinants of leverage vary significantly depending on the nature of the debt element.
The remainder of this paper is divided into following five sections; section II presents the theoretical
analysis on capital structure predominantly based on the work of Rajan and Zingales (1995), section III
provides a detailed description of the database and the methodology applied in constructing various
alternative dependent and independent variables; section IV discusses the results of cross-sectional
analysis; section V presents the results on sub-division of elements of debt and their relation with the
determinants of leverage; section VI summarizes and concludes.

II. Capital Structure: Theory and Practice


In their cross-sectional study of the determinants of capital structure, Rajan and Zingales (1995) examine
the extent to which leverage may be explained by following four key factors; market-to-book, size,
profitability, and tangibility. They conduct this analysis at firm-level for each of the G-7 economies. Their
results uncover some fairly strong conclusions, even if they differ slightly across countries.
The first determinant of leverage adopted for the analysis is growth opportunities for a firm. The marketto-book ratio is the proxy for the level of growth opportunities available to the firm. This measure is
commonly preferred as a proxy for firm growth opportunities rather that valuation models (Danbolt et al.,
2000). Theoretical predictions of Jensen and Mekling (1976), based on agency theory, suggests a
negative relationship between growth opportunities and leverage. This is consistent with theory for
information asymmetries by Myers (1977). Companies with high growth options are reluctant to take on
large amount of debt as growth opportunities do not provide current revenues and growth options are
largely intangible providing little collateral value. Thus Myers argues that companies with large amount
of investment option have lower leverage levels.
The second determinant of leverage is firm-size. Natural log of sales is considered as the proxy for size of
the firm. There is no clear theory to provide ex ante expectations as to the effect of size on leverage.
2

Chaitanya Barhale 3
Components of Capital Structure A detailed analysis
Large firms tend to have better credit rating and lower risk of default and thus have access to credit which
is usually unavailable to smaller firms. Rajan and Zingales (1995) find firm-size to be positively
correlated with leverage.
The third determinant of leverage is profitability. The negative relationship between profitability and
leverage reported by Rajan and Zingales (1995) is consistent with Toy et al. (1974), Kester (1986), and
Titman and Wessels (1988). As argued by Modigliani and Miller (1963), profitable firms would prefer
debt over equity to avail the tax-shield on interest payments. The pecking-order theory by Myers and
Majluf (1984) suggests that firms would prefer internal sources of finance over external sources due to
information asymmetry. Thus profitable firms would prefer financial investment with retained earnings
rather than by raising external debt.
The fourth determinant of leverage is tangibility (ratio of fixed assets to total assets). Rajan and Zingales
(1995) find a positive relationship between tangibility and leverage. These results are consistent with the
findings of Bradley et al. (1984) and Titman and Wessels (1988). Debt may be more readily available to
firms with high amounts of tangible assets which may act as collateral.
The four determinants of leverage are applied in the cross-section analysis of the leverage measure. Each
leverage measure is further sub-divided into individual elements of debt and results are analyzed to
understand the extent on their influence on various leverage measure. Section III provides a detailed
description of the dataset and the rationale behind the methodology adopted for various dependent and
independent variables.

III. Data and Methodology


The data used for the empirical analysis is derived from COMPUSTAT (Standard & Poors). The database
contains annual balance sheets, income statements, and cash flow statements for companies in North
America. I exclude from the dataset information from companies in division H (Group 60 67) of SIC
codes; these included finance, insurance and real estate companies. As per Rajan and Zingales (1995), the
capital structure of banks and insurance companies is influenced by investor insurance schemes and the
debt issued by these financial firms is not directly comparable to debt issued by non-financial companies.
This gives a sample of 2129 companies. Data for the fiscal years from 1995 to 2005 is collected for these
companies. However, for the cross-section regression analysis, data from fiscal year 2001 to 2005 is used.
The variables, both dependent and independent, are constructed to be consistent with those defined by
Rajan and Zingales (1995). I construct three additional measures of leverage as suggested by Rajan and
Zingales (1995), apart from the one used by them in their cross-sectional analysis. The main reason for
3

Chaitanya Barhale 4
Components of Capital Structure A detailed analysis
constructing more than one measure of capital leverage is to compare the sensitivity of the cross-sectional
results based on different definitions of the leverage variable.
Following are the four measures of capital leverage constructed for cross-sectional analysis:
1. Non-equity Liabilities to Total Assets: This leverage measure is defined as the ratio of total debt
excluding shareholders liability to total assets. The book value measure (IB) is the ratio of total debt
plus total current liability to total assets. The market value measure (IM) is calculated by subtracting
the book-value of equity from total assets and adding the market-value of equity.
(TD + TCL) / TA (IB)
(TD + TCL)/ (TA BVE + MVE) (IM)

2. Debt to Total Assets: This leverage measure is defined as the ratio of total debt (long-term and shortterm) to total assets. The book value measure (IIB) is the ratio of book value of long-term plus shortterm debt to total assets. The market value measure (IIM) is calculated by subtracting the book-value
of equity from total assets and adding the market-value of equity.
TD / TA (IIB)
TD / (TA BVE + MVE) (IIM)

3. Debt to Capital: This leverage measure is defined as the ratio of total debt (Long-term and shortterm) to total capital. The book value measure (IIIB) is the ratio of book value of long-term plus
short-term debt to total capital (Total debt plus shareholders equity, including preference capital). The
market value measure (IIIM) is calculated by substituting the book-value of equity with market value
of equity.
TD / (TD + BVE + PS) (IIIB)
TD / (TD + MVE + PS) (IIIM)

4. Adjusted Debt to adjusted Capital: This leverage measure is applied by Rajan and Zingales (1995)
in their cross-sectional analysis. Adjusted debt is defined as the book value of total debt less cash and
marketable securities. According to Rajan and Zingales (1995), cash and marketable securities
provide liquidity and hence reduce the burden of debt. Adjusted book value of capital is computed by
adding total debt, book value of total share capital (both equity and preference), provisions, and
deferred taxes and by subtracting intangibles. Market value of adjusted capital is computed by
adjusting for the market, rather than book-value of equity capital in the denominator.
(TD CHE) / (TD + BVE + PS + PROV + DTAX - INTANG) (IVB)
(TD CHE) / (TD + MVE + PS + PROV + DTAX - INTANG) (IVM)

Previous studies by Bradley, Jarrell, and Kim (1984), Long and Malitz (1985), and Harris and Raviv
(1991), suggests that tangibility of assets, investment opportunity, firm size and profitability are shown to
be consistently correlated with leverage. Rajan and Zingales (1995) adopt proxies of the above mentioned
factors as independent variables in their cross-sectional analysis.
Following are the independent variables constructed for cross-sectional analysis:
4

Chaitanya Barhale 5
Components of Capital Structure A detailed analysis
1. Market-to-book ratio (MTB): This measure is considered as a proxy for investment opportunities. It
is calculated as a ratio of book value of total assets less the book value of equity plus the market value
of equity, to the book value of total assets.
MTB = (TA BVE + MVE) / TA

2. Logsales (LNSALE): This measure is considered as a proxy for size of the company. It is the natural
logarithm of net sales.
LNSALE = ln (SALE)

3. Profitability (PROFIT): This measure as the name suggests is a measure of profitability of the
company. It is calculated as a ratio of cash flows from operations (earnings before interest, taxes,
depreciation and amortization), to the book value of total assets.
PROFIT = EBITDA / TA

4. Tangibility (TANG): This measure provides the proportion of fixed assets held by the company.
Fixed assets are often used as collateral to raise debt. It is calculated as a ratio of book value of
depreciated fixed assets, to the book value of total assets.
TANG = FA / TA

One of the major challenges in conducting such an analysis is the potential of reverse causality that might
exist between the dependent and independent variables. Rajan and Zingales (1995) tackle this problem by
lagging the independent variables. Furthermore, the independent variables are averaged over a period of
four years to remove any noise in the data. So the regression analysis contains the 2005 leverage
measures as the dependent variable, and the average of market-to-book, profitability, log of sales, and
tangibility for the period 2001-2004 as the independent variables.
All necessary measures are taken to ensure that the data is relatively clean. All large outliers existing in
the dataset are eliminated by winsorizing all dependent and independent variables at the 1% level (Tukey
(1962)). The summary statistics and results from the regression analysis are reported in the following
section.

IV. Results and Analysis


Summary statistics for various measures of leverage for 2129 US companies are reported in Table (1)
along with the four independent variables (market-to-book, logsales, profitability, tangibility). As

Chaitanya Barhale 6
Components of Capital Structure A detailed analysis
observed from Table (1), the level of indebtness of US companies varies significantly depending on the
measure of leverage adopted.

Table (1) Summary Statistics (Corporate Leverage)

Variable
Book-Value
Non-Equity Liability to Total
Assets - IB
Debt to Total Assets IIB
Debt to Capital IIIB
Adjusted Debt to Adjusted
Capital - IVB
Market-Value
Non-Equity Liability to Total
Assets - IM
Debt to Total Assets IIM
Debt to Capital IIIM
Adjusted Debt to Adjusted
Capital - IVM
Independent Variables
MTB
LNSALE
PROFIT
TANG

Mean

Media
n

Std
Dev

2129
2129
2129

0.4710
0.1885
0.2717

0.4792
0.1703
0.2497

0.2033
0.1641
0.2300

2129

0.2742

0.1168

5.0730

2129
2129
2129

0.3200
0.1345
0.1069

0.2972
0.1000
0.0907

0.2002
0.1354
0.0955

2129

0.0264

0.0348

0.1801

2129
2129
2129
2129

1.7517
6.0163
0.0994
0.2997

1.4289
6.0975
0.1114
0.2319

1.1243
2.2935
0.1154
0.2322

The table displays mean, median, and standard deviation values for measures of leverage as defined in the section III. It also provides
the mean, median, and standard deviation for the four year lagged independent variables. The four measures are leverage variables
are defined from I to IV. The book-value measure of leverage variable is denoted by B whereas the market value measure is denoted
with M. MTB is the proxy for growth opportunities, LNSALE is the proxy for size of the company, PROFIT refers to the profitability
ratio, TANG refers to the tangibility ratio.

The first measure of leverage is the total non-equity liability, which is the total of total debt plus trade
credit, to total assets. At book value, non-equity liabilities account for 47% of total assets for 2005. The
market value of non-equity liabilities accounts for 32% of total assets. The book-value measure of
leverage is computed at depreciated historical costs of assets and hence is highly underestimated when
compared with the market value of assets. This is confirmed by the summary statistic of MTB (Market-tobook) variable. The market value of companies in the sample is 1.75 times the book value of assets.
The second measure of leverage is debt to total assets, which is the total of long-term and short-term debt,
to total assets. The total debt to assets ratio is found to be at 19% at book value and 13% at market value.
The large difference between the two measures of leverage indicated that current liabilities like trade
credit and equivalent account for a significant portion of debt in US companies.
6

Chaitanya Barhale 7
Components of Capital Structure A detailed analysis
The third measure of leverage is debt to total capital, which is the total of long-term and short-term debt,
to total capital. The total debt to capital ratio is 27% at book value and 11% at market value. At bookvalue this reported leverage measure is higher than total debt to total assets (27% as compared to 19%), as
total capital is less than total assets.
The fourth leverage measure is adjusted debt to adjusted capital. This is the measure adopted by Rajan
and Zingales (1995) in their cross-sectional analysis of capital structure. The debt level is adjusted by
deducting cash and other marketable securities. Similar adjustments are made to capital by adding
provisions, and deferred taxes and subtracting intangible assets. Adjusted debt to adjusted capital ratio is
27% at book value and 3% at market value.
Table (1) also provides summary statistics for the independent variables. The average market-to-book
(MTB) ratio is 1.75. This indicates that US companies on average have high growth opportunities.
However, it should be understood that a high MTB ratio doesnt always indicate that a company has
valuable growth opportunities. The natural logarithm of sales is used as a proxy for size.

Cross-sectional analysis
For the cross-sectional analysis, I use OLS (Ordinary Least squares) estimation technique. Rajan and
Zingales (1995) estimated the regression using maximum likelihood and a censored Tobit model.
However, they argue that using OLS regression estimates provides similar results. The results for OLS
estimation technique are found to be extremely robust. I use a total of eight leverage measures (four each
for book-value and market-value). For four of the eight leverage measures (IIB, IIIB, IIM, IIIM), I use
left censored tobit model. However, the results for these estimates are found to be similar to the OLS
regression estimates. Hence I report only the OLS regression results.
Following is the estimation model used for the regression analysis:
Leveragei,t = 1 + 2 * Market-to-Booki,t-4 + 3 * Logsalesi,t-4 + 4 * Profitabilityi,t-4 + 5 * Tangibilityi,t-4 + i,t

In the equation above, i refer to the individual company in the cross-section analysis; t refers to the time
period of the leverage measure (Financial data for fiscal year 2005 in this study); and t-4 refers to average
of past four years for the independent variables (Financial data for fiscal years 2001-2004). Results of the
regression analysis are reported in Table (2). Panel (A) in table (2) reports the estimated coefficients of
the book-value measure of leverage and panel (B) reports the market-value measure.

Table (2) Cross-sectional Analysis of leverage

Chaitanya Barhale 8
Components of Capital Structure A detailed analysis

Depende
nt

Interce
pt

IB
Tstat
IIB
Tstat
IIIB
Tstat
IVB
Tstat

IM
Tstat
IIM
Tstat
IIIM
Tstat
IVM
Tstat

Panel A : Book-Value
LNSAL
MTB
E
PROFIT

TANG

0.2840

-0.0396

0.0403

-0.3635

0.1650

20.17

-9.72

21.90

-8.85

9.65

0.0948

-0.0274

0.0170

-0.1814

0.1882

7.87

-7.85

10.79

-5.16

12.87

0.0978

-0.0410

0.0335

-0.3574

0.2613

5.94
0.1150

-8.59

15.58

-7.43

13.06

-0.1480

0.0592

0.3531

0.2975

-2.63

-11.69
10.37
2.77
Panel B : Market-Value

N
212
9

Adj
R2
0.27
41

F-stat
201.8
4

212
9

0.17
08

110.5
7

212
9

0.22
24

153.1
3

212
9

0.16
28

104.4
3

212
9

0.38
57

335.0
5

212
9

0.22
52

155.5
9

212
9

0.25
15

179.7
7

212
9

0.22
23

153.0
4

5.60

0.3126

-0.0971

0.0287

-0.3362

0.1195

24.60

-26.38

17.29

-9.07

7.74

0.1133

-0.0436

0.0118

-0.1490

0.1328

11.85

-15.76

9.46

-5.34

11.44

0.0859

-0.0322

0.0095

-0.1046

0.0985

12.84
0.0984

-16.63

10.92

-5.36

12.11

-0.0315

0.0191

0.0482

0.2016

-8.01

-8.86

11.95

1.35

13.53

Panel A reports the estimated coefficient of book-value measure of leverage and panel B reports the market-value measure. Model I measures
non-liabilities to total assets, Model II measures total debt to total assets, Model III measures total debt to total capital, Model IV measures
adjusted debt to adjusted capital. N is the sample of firms in the dataset. T-statistics, Adjusted R2 and F-stat from the results are also displayed in
the table.

The independent variables explain roughly 16.28% to 27.41% of variation in the book-value measures of
leverage and 22.23% to 38.57% of variation in the market-value measures of leverage. The results in table
(2) indicate that the results are highly model-specific. The results reported in table (2) provide following
insights regarding the independent variables:
Market-to-book: The results suggest a significantly negative relationship between leverage and market-tobook which is a proxy for growth opportunities. These results have a similar relationship for both the
8

Chaitanya Barhale 9
Components of Capital Structure A detailed analysis
book-value measure as well as the market-value measure of leverage. These results are consistent with the
findings of Barclay et al. (1995) and Rajan and Zingales (1995). Firms that have large growth
opportunities tend to have low leverage levels.
Logsales: The results suggest a significantly positive relationship between leverage and logsales which is
a proxy from firm size. These findings are true for both measures (book-value, market-value) of leverage.
As suggested by Rajan and Zingales (1995), large firms tend to be more diverse. The relatively lower risk
profile of large firms makes it easier for them to raise debt. The results in table (2) are consistent with this
explanation.
Profitability: The coefficients for the effect of profitability on corporate leverage are largely negative and
highly statistically significant. The coefficients for effect of profitability on leverage measures (adjusted
debt to adjusted capital (IVB, IVM)) are positive. The coefficient for market-value measure (IVM) is
statistically insignificant (T-stat 1.35). The results in table (2) are consistent with the pecking order theory,
but contradict the tax shield theory. From above results, it can be said that profitability has the strongest
explanatory power of the cross-sectional variation in US leverage levels, regardless of the measure of
leverage applied.
Tangibility: The results suggest a significantly positive relationship between leverage and tangibility.
These results are true for both the book-value measure as well as the market-value measure of leverage.
Firms with sizeable amount of fixed assets on their books, find it easier to raise debt. Fixed assets can
serve as collateral, diminishing the agency cost risk for the lender. The results in table (2) are consistent
with this explanation.
According to Brealey and Myers (1996), in a well-functioning capital market, firms should aim to match
maturities of assets and liabilities. So ideally, long-term assets (fixed) should finance long-term liabilities
and short-term assets (non-fixed) should finance non-fixed liabilities (current liabilities). Comparing the
tangibility coefficients with regards to various leverage measure can provide an insight into the treatment
of long-term and current liabilities in capital leverage. Model I, which is a measure of non-equity liability
to total assets, has a lower tangibility coefficient in comparison with other models with the exception of
model III, total debt to capital at market-value, at market-value (IIIM). This lower tangibility coefficient
for model I can be related to treatment of current liabilities in capital leverage measure. In model I,
current liabilities are included as part of liabilities in the numerator.
In the next section, I analyze if the lower tangibility coefficient in model I is due to inclusion of current
liabilities in the leverage measure. This is done by further dividing the elements of leverage measure into
9

Chaitanya Barhale 10
Components of Capital Structure A detailed analysis
long-term and short-term liabilities and estimating their relationship with the four independent variables.
A negative relationship between short-term liabilities and tangibility will validate the maturity matching
principle.

V. Sub-division of Corporate Debt Structure Composition Analysis


The analysis in previous section suggests that there is no singular capital structure policy adopted by
firms. The results illustrate that alternative definition of leverage result in substantially different absolute
value for the determinants of capital structure. However, it is observed that the correlation between the
leverage measures and the determinants remains the same. These results suggest that these differences
result from the fact that each measure of leverage reflects differing aspect of capital structure. Therefore,
it is important to understand the underlying factors that drive these results. In this section, each element of
leverage measure is extracted and analyzed by performing regression analysis on each element with the
same determinants adopted in the previous section. Total liabilities are divided into loan capital (Longterm liabilities (TLTD)) and short-term borrowings (Total Current Liabilities (TCL)). Loan capital is
further classifieds into long-term securitized debt (LTSD). Short-term borrowing (TCL) is further
classifieds into Trade credit and equivalent (TTC) and short-term borrowing (Borrowings payable in less
than 1 year (BRLT1). Short-term borrowing is further classifieds into Short-term Securitized Debt
(STSD) and bank borrowings (BBLT1). Table (3) reports the summary statistics of each element,
normalized by total assets.

Table (3) Summary Statistics (Elements of debt)


Variab
le
TLIAB
S

2129

TLTD

2129

LTSD

2129

TCL

2129

TTC

2129

BRLT1

2129

STSD

2129

Mean
0.47102
55
0.15244
08
0.04648
66

Median
0.47915
83
0.12517
59
0.00015
30

Std Dev
0.20331
12
0.15081
03
0.09703
53

0.23511
13
0.19036
70
0.03610
25
0.01786
02

0.20955
42
0.16975
95
0.01087
77
0.00308
00

0.13171
76
0.11283
97
0.06279
91
0.03553
30

10

Chaitanya Barhale 11
Components of Capital Structure A detailed analysis
BBLT1

2129

0.01801
05

0.00000
00

0.04878
92

Table (3) reports the summary statistics of elements of corporate debt. TLIABS refers to Total Liabilities; TLTD refers to Total LongTerm Debt; LTSD refers to Long-Term Securitized Debt; TCL refers to Total Current Liabilities; TTC refers to Trade Credit and
Equivalents; BRLT1 refers to Borrowings repayable in less than 1 year; STSD refers to Short-Term Securitized Debt; BBLT1 refers to
Bank-Borrowings repayable in Less than 1 year. All values are normalized at Total Assets.

According to table (3), total liabilities on average account for 47.1% of total book-value of assets. Total
liabilities are further sub-divided into total long-term debt and total current liabilities. Total long-term
debt (loan repayable in more than 1 year) account for around 15.2% and total current liabilities account
for 23.5% of book-value of total assets. From above figures it is quite clear that short-term liabilities
(current liabilities) account for nearly 50% of total debt financing.
The elements of long-term debt are further sub-divided into long-term securitized debt. It accounts for
4.6% of total book-value of assets. It constitutes about 30.5% of total long-term debt. The short-term
liabilities are divided into trade credit and equivalent (TTC) and Borrowings repayable in less than one
year (BRLT1). Trade credit accounts for large portion of current liabilities (80.9%), while bank
borrowings account for only 15.3%. The reliance on trade credit as preferred form of short-term liabilities
is due to the fact that other forms of borrowings involve significant costs (asymmetric information cost).
The preceding analysis suggests that firms in the sample derive on an average 50% of their finances from
short-term debt and trade credit constitutes nearly 80% of the short-term debt.

Cross-sectional analysis (Debt Structure)


The result of cross-sectional analysis conducted on each element reported in Table (3) is reported in Table
(4). The same four lagged determinants of capital structure (MTB, logsales, profitability, and tangibility)
are used in the cross-sectional analysis against each of the debt element. The determinants are lagged one
period and are averaged over a period of four years to reduce any noise in data. All dependent variables
are measure at book-value.

Table (4) Cross-sectional analysis (Elements of debt)


Depende
nt

Interce
pt

MTB

LNSA
LE

TLIABS

0.2840

0.0396

0.040
3

20.17

-9.72

21.90

0.0554

0.0240

0.015
4

Tstat
TLTD

11

PROFI
T
0.363
5
-8.85
0.119
1

TANG

Adj R2

F-stat

0.165
0

212
9

0.2741

201.8
4

212
9

0.1877

123.9
4

9.65
0.191
3

Chaitanya Barhale 12
Components of Capital Structure A detailed analysis
Tstat
LTSD
Tstat
TCL
Tstat
TTC
Tstat
BRLT1
Tstat
STSD
Tstat
BBLT1
Tstat

5.06

-7.57

0.1049

0.0157

10.76
0.009
1

14.31

-7.38

-9.50

0.2460

0.0102

0.010
9

23.71

-3.58

8.45

0.2054

0.0080

0.008
3

24.64

-3.32

7.60

0.0387

0.0042

0.001
7

8.48

-3.14

2.83

0.0110

0.0012

0.001
5

4.46

-1.73

4.67

0.0273

0.0018

6.87

-1.54

-3.73

14.39

0.029
1

0.066
4

1.36
0.140
6

7.46
0.152
1
12.68
0.142
1
14.04
0.004
4

-4.88
0.094
0
-3.86
0.052
4

212
9

0.0880

52.35

212
9

0.1078

65.26

212
9

0.1137

69.22

212
9

0.0143

8.74

-3.94
0.021
0

-0.79
0.004
3

212
9

0.0132

8.10

0.000
0

-2.92
0.034
6

1.42
0.009
4

212
9

0.0086

5.63

0.03

-2.98

-1.96

Table (4) reports the cross-section analysis of determinants of capital structure on elements of debt. All dependent and independent variables
except logsales are scaled to Total Assets. N is the sample of firms in the dataset. T-statistics, Adjusted R2 and F-stat from the results are also
displayed in the table.

The first row of table (4) illustrates that each of the four independent variables, market-to-book, logsales,
profitability, tangibility, are significantly correlated with total liabilities. However, the estimated
coefficients for Tangibility do not concur with the results from cross-sectional analysis in the previous
section.
Market-to-book: The coefficients for market-to-book ratio show a positive correlation and are statistically
significant for all elements of debt, except Short-term securitized debt (STSD) and Bank borrowings
repayable within 1 year (BBLT1). These results still suggest a negative relationship between leverage and
market-to-book ratio indicating that firms with growth opportunities tend to hold less debt.

12

Chaitanya Barhale 13
Components of Capital Structure A detailed analysis
Logsales: The coefficients for logsales show a positive correlation, except for Long-term Securitized Debt
(LTSD), and are statistically significant, except for Bank borrowings repayable within 1 year (BBLT1).
These results imply that large firms tend to hold more debt, as they are perceived to be safe and thus have
easier access to debt. This is true in case of long-term as well as short-term form of debt.
Profitability: The coefficients for profitability show a negative and statistically significant correlation,
except for Long-term Securitized Debt (LTSD). These results are consistent with the results in the crosssectional analysis of the leverage measure. The relative costs of borrowing, encourages profitable firms to
utilize retained earnings.
Tangibility: The coefficients for tangibility are somewhat contradictory to the results from the crosssectional analysis of different leverage measures in table (2). All the coefficients of tangibility are
statistically significant, except Borrowings repayable in less than 1 year (BRLT1) and its components
(STSD, BBLT1). The coefficient of tangibility in table (4) are positively correlated with elements of longterm debt and negatively correlated with elements of short-term debt.
As argued by Van der Wijst and Thurik (1993), Chittenden et al (1996), Barclay and Smith (1999) and
Hutchinson et al (1999), analysis of the determinants of leverage based on total liabilities may mask the
significant differences between long-term and short-term debt. The results in table (4) are consistent with
the maturity matching principle: long-term debt forms are used to finance fixed assets, while the current
assets (reciprocal for tangibility) are financed by short-term debt forms.
The difference in the absolute values of tangibility coefficients in table (2) between model I and model IV
can thus be explained by the results in table (4). The measure of leverage adopted by Rajan and Zingales
(1995), adjusted debt to adjusted capital, is predominantly based on long-term debt elements. The
measure of leverage in model I, total non-equity liability to total assets, is adjusted with short-term debt
elements. Thus the difference in the absolute values of tangibility coefficients in table (2) is explained due
to the treatment of short-term debt elements, especially trade credit which accounts for 80% of short-term
debt for US companies.
The regression analysis of total liabilities has a relatively high explanatory power and produces highly
significant coefficients. However, the results in table (4) illustrate the importance of considering longterm and short-term liabilities separately.

VI. Summary and Conclusion

13

Chaitanya Barhale 14
Components of Capital Structure A detailed analysis

According to Modigliani and Miller (1958), capital structure may be irrelevant under
assumptions of perfect market conditions. However, given the prevailing market imperfections,
such as taxation, bankruptcy costs, transaction costs, information asymmetry, firms tend to prefer
certain types of financing over others. In this paper the determinants of capital structure for a
sample of 2129 US companies have been analyzed, using a variety of leverage measures.
Four different measures of leverage were constructed ranging from ratio of total non-equity
liability to total assets to ratio of total debt adjusted for cash and market securities to total capital
adjusted for provisions, deferred taxes, and intangible assets. As expected, the capital leverage in
US companies varied based on the definition of leverage applied. Following four measures of
determinants of capital structure, as adopted by Rajan and Zingales (1995), were selected:
Market-to-book ratio a proxy for growth opportunity, log of sales a proxy for firm size,
profitability (measured as EBITDA/ Total assets), and tangibility (measured as Fixed assets/
Total assets).
The results of cross-sectional analysis of leverage measure for 2129 US companies were similar
to the results of Rajan and Zingales (1995). Leverage was found to be positively correlated with
size of the company, and tangibility and negatively correlated with growth opportunities and
profitability. However, these results were found to be highly definitional dependent. The
elements of debt were identified and further sub-divided into long-term debt and short-term debt.
Significant differences in the determinants of long-term and short-term debt were observed.
Tangibility was negatively correlated to short-term debt and positively correlated to long-term
debt; thus providing evidence of maturity matching. Thus the results suggest that analysis of
leverage on basis of long-term debt provides only part of the story. Much analysis is needed to be
done on short-term debt, especially trade credit which constitutes 80% of short-term financing.

References
Barclay, M. J. and Smith, C. W. (1999) The capital structure puzzle: another look at the evidence,
Journal of Applied Corporate Finance, 12(1), 8 - 20.
Barclay, M. J., Smith C. W., and Watts, R. L. (1995) The determinants of corporate leverage and
dividend policies, Journal of Applied Corporate Finance, 7(4), 4 - 19.
14

Chaitanya Barhale 15
Components of Capital Structure A detailed analysis
Bevan, A. A. and Danbolt, J. (2002) Capital structure and its determinants in the UK a decompositional
analysis, Applied Financial Economics, 12(3), 159 - 170.
Bradley, M., Jarrell, G. and Kim, E. H. (1984) On the existence of and optimal capital structure: theory
and evidence, Journal of Finance, 39, 857-78.
Brealey, R. A. and Myers, S. C. (1996) Principles of Corporate Finance, 5th international edition,
McGraw-Hill.
Chittenden, F., Hall, G. and Hutchinson, P. (1996) Small firm growth, access to capital markets and
financial structure: review of issues and an empirical investigation, Small Business Economics, 8, 59-67.
Danbolt, J., Hirst, I. and Jones, E. (2000) Measuring Growth Opportunities, University of Glasgow,
Department of Accounting and Finance, Working Paper 2000/6.
Harris, M. and Raviv, A. (1991) The theory of capital structure, Journal of Finance, 46(1), pp. 297-355.
Jensen, M. and Meckling, W. (1976) Theory of the firm: managerial behavior, agency costs and capital
structure, Journal of Financial Economics, 3, 305-60.
Kester, C. W. (1986) Capital and ownership structure: a comparison of United States and Japanese
manufacturing corporations, Financial Management, 5-16.
Modigliani, F. and Miller, M. H. (1958) The cost of capital, corporate finance, and the theory of
investment, American Economic Review, 48, 261-97.
Modigliani, F. and Miller, M. H. (1963) Corporate income taxes and the cost of capital - a correction,
American Economic Review, 53(3), 433-43.
Miller, M. H. (1977) Debt and taxes, Journal of Finance, 32(2), 261-75.
Myers, S. C. (1984) The capital structure puzzle, Journal of Finance, 34(3), 575-92.
Myers, S. C. and Majluf, N. S. (1984) Corporate financing and investment decisions when firms have
information that investors do not have, Journal of Financial Economics, 13, 187- 221.
Rajan, R. G. and Zingales, L. (1995) What do we know about capital structure? Some evidence from
international data, Journal of Finance, 50(5), 1421-60.
Toy, N., Stonehill, A., Remmers, L., Wright, R. and Beekhuisen, T. (1974) A comparative international
study of growth, profitability and risk as determinants of corporate debt ratios in the manufacturing
sector, Journal of Financial and Quantitative Analysis, 875-86.
Titman, S. and Wessels, R. (1988) The determinants of capital structure choice, Journal of Finance,
43(1), 1-19.
Tukey, J. W. (1962) The future of data analysis, Annals of Mathematical Statistics, 33, 1-67.
Van der Wijst, N. and Thurik, R. (1993) Determinants of small firm debt ratios: an analysis of retail
panel data, Small Business Economics, 5, 55-65.
15