Article

A Study of Determinants of Capital Structure through

Panel Data Analysis of Firms Listed in NSE CNX 500

Barnali Chaklader1
Deepak Chawla2

Abstract
Vision 20(4) 267277 2016 MDI
SAGE Publications sagepub.in/home.nav DOI: 10.1177/0972262916668700 http://vision.sagepub.com
This study contributes to the capital structure literature by investigating the determinants of capital structure of firms listed in
NSE CNX 500. The period of the study is 20082015, the period starting from the year of global slowdown. This study is an
attempt to study the capital structure of firms listed in National Stock Exchange in the post liberalization period. The
objectives of the study are to study the impact of independent variables such as growth, profitability, tangibility, liquidity, size
and non-debt tax shield on financial leverage and also to find out whether the results are in line with the pecking order theory
or the trade-off theory of capital structure. Size is taken as a control variable. Our study supports the trade-off theory for all
variables such as growth, profitability, size tangibility and non-debt tax shield. Liquidity is the only independent variable that
goes in accordance with the pecking order theory. Thus, this study is more inclined towards the trade-off theory.

Key words
Capital Structure, pecking order theory, trade off theory, financial leverage
Introduction
Capital structure decision is one of the important manage- rial decisions and influences shareholders returns and risks and hence
the market value of the share. Capital structure is a way by which a firm finances its assets through a combination of debt and
equity. Whenever funds are raised for any project, it involves a capital structure decision as there is either addition in
shareholders equity or an addition to debt. Both the sources of finance have an effect on the earning per share. Firms that raise
fund all through equity do not get the benefits of deducting interest and the tax benefit on it from its earnings before interest and
tax (EBIT). Debt holders have superior claim over the assets of the company and the shareholders have a residual claim over
them. A firm can increase its earnings per share by including debt capital in the capital structure. This is known as trading on
equity. The firm has to be careful in determining EBIT level that it must have to include the debt capital that it plans to have in its
capital structure.
Leverage ratio affects the cost of capital. Firms can choose alternative forms of capital structure to maximize overall
market value. A very crucial managerial decision is that what should be the source of finance? Whether it should be
complete debt or equity or a mix of both. In case it is a mix then what should be the optimal mix? It is important for
the firm to find a combination of debt and equity that maximizes its overall market value. The level of debt that is
acceptable for one industry or line of business can be highly risky in another because different industries and line of
business have different characteristics. The higher the firms business risk, the more cautious the firm is in estab-
lishing its capital structure (Gitman, 2008). There are many research works done on determination of optimal capital
structure which maximize the firm value with lowest cost of capital as capital structure of a firm have a direct effect
on firm value (Barbuta, 2009; Nadem et al., 2012). The optimal structure of the capital is the structure which ensures
an optimal balance between risk and return to max- imize the enterprise value.
1Professor (Finance and Accounting), International Management Institute, New Delhi, India.
2Distinguished Professor and Dean (Research), International Management Institute, New Delhi, India.

Corresponding author:
Barnali Chaklader, Professor (Finance and Accounting), International Management Institute, B 10, Qutab Institutional Area,
New Delhi 110016, India. E-mail: barnali@imi.edu
 268Vision 20(4)
Theoretical Framework through Review of Literature
The major theories of capital structure are the trade-off theory, pecking order theory, signalling theory, agency
theory and the market timing theory. We have tried to limit the analysis and findings of this study to the pecking
order theory and trade-off theory.

Trade-off Theory
According to the trade-off theory, capital structure choices are determined by a trade-off between the benefits and costs of debt
(Kraus & Litzenberger, 1973; Miller, 1977). Benefit is in terms of interest deduction on debt from revenue for taxation purpose,
disciplinary role of debt and reduction in free cash-flow problems (Gonzales & Gonzales, 2007). The costs associated with it are
bankruptcy and agency costs. Thus, according to this theory, there should be an optimum level of debt and all firms must
deliberately work towards achieving this target level of debt. Therefore, the static trade-off theory states that an optimal capital
structure balances the tax benefit of debts and cost of financial distress. Whereas the dynamic trade-off theory proposes that firms
may deviate from their target capital structure but they will exhibit an adjustment behaviour towards that target. Abdeljawad et al.
(2013) conducted a study on speed of adjustment of Malaysian firms using system Generalized Methods of Moments (GMM)
approach. They found that firms that are far from the target exhibit faster adjustments than firms close to the target, and firms that
are overlever- aged exhibit faster adjustment than underleveraged firms. Their results were consistent with the dynamic trade- off
theory. Mukherjee and Mahakud (2013), in their study of capital structure of Indian manufacturing sector during the period
of 19921993 till 20072008 found that the trade-off and pecking order theories are complimentary to each other to determine
the capital structure and therefore, suggested that companies financing behaviour is best explained by the modified pecking order
theory. They also found that Indian manufacturing companies have target lev- erage ratios and the adjustment speed towards the
target has been around 40 per cent.

In terms of profitability, the trade-off theory predicts that more profitable firms should mean more debt-
serving capacity and more taxable income to shield; therefore a higher debt ratio will be anticipated. Under trade-
off theory, the firms with high growth opportunities should borrow less because it is more likely to lose value in
finan- cial distress (Xiaoyan Niu, 2008). Ratio of bankruptcy cost decreases with increase in size of firms.

Pecking Order Theory

Pecking order theory proposed by Dolandson (1961) and modified by Myers and Majluf (1984), claims that firms prioritize their
sources of financing by internal funds, debts
and issue of equity shares respectively. Myers (1984) has explained how asymmetric information could account for
pecking order financing preferences of financial managers. This theory says that a firm prioritizes the financing
options. It prefers finance which is readily available to it, that is, retained earnings and then moves on to other
sources of finance, that is, debt and equity, respectively. The reason for going for debt financing over equity is that
debt has tax advantage as well as brings in an amount of discipline in the firm. Since it is assumed that managers
have more information about the firm than other investors, therefore, managers tend to issue shares when they are
overvalued. This dilutes earnings per share and ownership of existing investors. Therefore, issue of equity capital is
less preferred over debt.

Studies Related to Pecking Order Theory

Most studies found a negative relationship between profit- ability and debt financing (Daskalakis & Psillaki, 2008;
Kouki & Said, 2012; Myers & Majluf, 1984; Vasiliou, Eriotis, & Daskalakis, 2009). Kakani and Reddy (1996) and
Kakani (1999) disclosed profitability, non-debt tax shield and capital intensity as major factors of capital structure.

Singh (1995) did a comparison of capital structure of developing countries with that of the developed countries
and observed that companies of developing countries financed their capital structure through new equity issues more
than the corporations of developed economies. Thus, the study supports that developed economies follow pecking
order theory.
 Nadem et al. (2012) investigated the determinant factors of capital structure on companies listed in Tehran Stock Exchange for
the period of 2002 till 2012. Based on the pecking order theory, they investigated the effect of return on investment, tangible
fixed assets, net working assets, firm size and profitability index on debt ratio. They conducted the study on both static and
dynamic capital structures. The findings show that in static version of peck- ing order, all variables have significant relationship
with capital structure. But, in dynamic version of pecking order, fixed assets have positive relationship and net working assets
have negative relationship with capital structure.
Kouki and Said (2012) inferred that size has a positive effect on debt ratio. It goes with pecking order theory that
due to information asymmetry, large companies have easier access to capital markets and prefer to issue shares and
have access to debt too. Smaller firms prefer to finance through debt financing as they have limited access to equity
market. They also concluded that tangibility, profit- ability and growth had a positive impact on debt ratio.
Tongkong (2012) has conducted a study on a homoge- neous panel of 39 Thai companies in real estate industry
listed in the Stock Exchange of Thailand (SET) during the
Chaklader and Chawla 269
period 20022009. His findings indicate that firms lever- age is positively related to median industry leverage.
Furthermore, firm size and growth opportunities have positive relationship with firm leverage, whereas profit-
ability and leverage are negatively associated. The results support pecking order theory as higher profitability firms
tend to have less debt and firms with higher growth oppor- tunities tend to have greater leverage.
Chakraborty (2010) conducted a study on 1,169 non- financial firms listed in Bombay Stock Exchange and
National Stock Exchange for the period of 1995 till 2008. She had fairly strong evidence in favour of the hypothesis
that the leverage of Indian non-financial firms has a long- run equilibrium relationship with its determinants,
irrespec- tive of model specifications. She applied both the Fully Modified Ordinary Lease Square (FMOLS) and
Generalized Methods of Moments (GMM) and showed that profitabil- ity, size of the firm are negatively related to
leverage while tangibility and non-debt tax shields are positively related to leverage. Her study was in consistent
with the pecking order theory where she observed that low-profit firms use more debt.
Chakraborty (2013) conducted a study of the effect of group affiliation on Indian corporate firms capital struc- ture based on
a sample of 875 Indian non-financial firms for the period 20022010. GMM was the most appropriate method. The author
concluded that the group-affiliated firms are found to be lower leverage than stand-alone firms.
Mei Qui and Bo La (2010) conducted a study on 367 Australian firms for 15-year period starting from 1992.
They found a positive association between debt ratio and tangibility and the remaining variables, such as profitabil-
ity, growth and business risk, had a negative association with the debt ratio. They concluded that the levered firms
are more concerned about agency cost, signalling effects and costs of issuing new securities but do not care much
about the tax advantage of debt financing. Their results were more in consistent with the pecking order and the
contradicted trade-off theory.
Purohit and Khanna (2012) have found that for Indian manufacturing industries growth of assets, R&D and prof-
itability are negatively related to long-term debt. They also found that business risk is not a significant determinant
of borrowing of Indian manufacturing companies. Their find- ings are in conformation with the pecking order theory
of capital structure.
Ganguli (2013) had conducted a study on impact of ownership study on capital structure of midcap companies listed in India.
He found that the ownership structure impacts capital structure but not the other way round. Consistent with theoretical
prediction empirical results of the study revealed that the leverage is positively related to concentrated shareholding and has a
negative relation with diffuseness of shareholding after controlling for profit- ability, risk, tangibility, growth and size. His
findings are consistent with pecking order theory of capital structure.
Choudhry and Sundaram (2013) tested pecking order theory on Indian firms with special emphasis on the high-
growth Indian firms for the period 19912009. Their study contradicted the empirical evidence and suggested that
the implications of pecking order theory as per Myers (1984) does not quite hold true in the Indian scenario.

Studies Related to Trade-off Theory

Rajan and Zingles (1995), Jordon, Lowe and Taylor (1998), Wiwattanakantang (1999) and Hirota (1999) found a
positive relation between tangible assets and debt. Their findings are in consistent with the trade-off theory.
Babu and Jain (1999) found that Indian corporate firms were traditionally more inclined towards debt which
changed post liberalization when the Indian corporate firms reduced its debt to equity ratio from traditional norm of
2:1 to 1.5:1 or lower. Thus, their findings support the trade-off theory and show a less preference for debt during
post liberalization associating it with high cost of distress.
Bhaduris study (2002) disclosed that in a developing country, optimal capital structure is strongly influenced by
factors such as size, asset structure, profitability and finan- cial distress cost. His results had a positive association of
profitability, size and growth with leverage.
Pandeys study (2005) conducted a study on Malaysian companies. The results of the study showed that debt ratio
had a positive relationship with size and tangibility, and a negative relationship with growth, systematic risk and
ownership.
Kaur and Rao (2009) conducted a study on Indian cotton textile industry and revealed that profitability, asset
struc- ture, size, liquidity and business risk have a positive rela- tion with leverage where as growth opportunities
have a negative association with it. Their results were more in line with the trade-off theory than the pecking order
theory. As per the static trade-off theory, profitability should have a positive relation with debt ratio as highly
profitable firms will have more debt service capacity and would like to take advantage of tax shield through debt.
High growth firms would detest from going for more debt in order to avoid financial distress cost. As per this theory,
a firm is sup- posed to maintain an optimal debt ratio which balances the cost and benefits of issuing debt. Larger
firms have more debt service capacity as compared to smaller ones.

Afza and Hussain (2011) conducted a study on auto sector. The results show that the firms which are large in size
and having good assets structure should go for debt financing to finance new projects. The results of profitability,
taxes and liquidity were statistically significant and were consistent with the trade-off theory.
Drobetz et al. (2013) have studied the determinants of capital structure decisions using a sample of 115 exchange-
listed shipping companies across different countries. They found that asset tangibility is positively co-related to
lever- age. Thus, their findings support the trade-off theory of capital structure.
 270Vision 20(4)
Studies Related to both Pecking Order and Trade-off Theories
Gonzales and Gonzales (2007) say that both pecking order theory and trade-off theory are not mutually exclusive to
each other. The pecking order theory is assumed based on the assumption of asymmetric informational problem
which is one of the costs in trade-off theory.
Deesomsak, Paudyal and Pescetto (2004) conducted a comparative study of four countries in the Asia Pacific region, namely
Thailand, Malaysia, Singapore andAustralia. Their results suggested that the capital structure decision of firms is influenced by
the environment in which they operate, as well as firm-specific factors identified in the extant literature. Some of the variables
such as profit- ability supported pecking order theory whereas others like size and non-debt tax shield supported trade-off theory.
Shanmugasundaram (2008) conducted a study on pharmaceutical industry in India from 1998 till 2004. His study
on Indian pharmaceutical sector showed a positive significant relationship of asset tangibility with debt ratio.
Profitability had a negative relation and growth had a positive association with leverage in line with pecking order
theory. Size had a positive association with leverage. Positive coefficient of risk in his results was inconsistent with
the static trade-off theory.
Sinha (1993) conducted a study on capital structure by taking the independent determinants as asset type, profit-
ability, risk, growth and size. Asset type had a positive coefficient and profitability had a negative coefficient in
consistent with static trade-off and pecking order theories, respectively. Growth rate had a positive sign as per
pecking order theory. Size and risk had a negative coefficient but results were not significant.
Mallikarjunappa and Goveas (2007) studied capital structure of Indian pharmaceutical companies taking debt equity ratio as
dependent variable and profitability, collat- eral value of assets, growth, debt service capacity, size, tax rate, liquidity and
business risk as independent variables. Pooled regression result showed that debt service capacity, liquidity and business risk are
significant and hence impor- tant determinants of capital structure of pharmaceutical companies in India. Their results revealed
that debt service capacity and liquidity had a negative relation, whereas business risk had a positive relation with leverage.
Sheikh and Wang (2011) studied the capital structure of manufacturing firms in Pakistan and their results suggested that
profitability, liquidity, earnings volatility and tangi- bility (asset structure) are related negatively to the debt ratio, whereas firm
size is positively linked to the debt ratio. Non-debt tax shields and growth opportunities were not significantly related to the debt
ratio. The findings of this study were consistent with the predictions of the trade-off theory, pecking order theory and agency
theory.
Handoo and Sharma (2014), in their study, identified the most important determinants of capital structure of 870
listed Indian firms comprising both private sector compa- nies and government companies for the period 2001
2010. They concluded that factors such as profitability, growth, asset tangibility, size, cost of debt, tax rate and debt
serving capacity have significant impact on the leverage structure chosen by firms in the Indian context.
Banerjee and De (2014) investigated independent variables and observed that impact on the profitability of the
Indian iron and steel industry is business risk, size of the firm (log assets), growth rate, debt service capacity
(interest), dividend payout, financial leverage, degree of operating leverage and firms age. It was further
observed from the study that financial leverage, debt service capacity (interest)and size of the firm (log assets)
were significant factors influencing the profitability of the firms of the Indian iron and steel industry.
Sinha and Samanta (2014) examined the impact of eight firm-specific determinants of capital structure, viz., firm
size, tangibility, growth opportunities, profitability, non- debt tax shields, operating risk, liquidity and firm age for
Indian cement companies listed on NSE from 20072008 till 20112012. They applied quantile regression methodo-
logy on a balanced panel data. The result indicated marked non-linearities in the relationships between leverage and
its firm-specific determinants. They inferred that static trade- off theory outweighs pecking order hypotheses in their
sample of study. In their result, tangibility was positively related, whereas profitability, growth and age were nega-
tively related to leverage.

Research Gap, Identification

of Variables and Formulation of Hypotheses
This study covers the period of 2008 till 2015 to study the capital structure of firms listed in NSE CNX 500. Year
2008 is the year of starting of global slowdown period and the world economy has not recovered since then. There-
fore, this study explores a time period which has not been covered by other studies on capital structure of firms
listed in NSE CNX 500.
 Objectives of the study:

1.To study the impact of growth, profitability, size,non-debt tax shield and liquidity on financial leverage.
2.To study whether the results are in line with thetrade-off theory or pecking order theory.

Dependent Variable: Leverage

We have taken leverage as dependent variable, measured by total book value of total borrowings (sum of current
liabilities and long-term debts) divided by total assets. Debt is taken at book value as debt market is not active in
 Chaklader and Chawla 271
Indian stock exchanges. Therefore, it is not possible to get market value of debt for all companies.

Independent Variables
Growth (GRS)
A growing firm would prefer to issue debt rather than equity if internal finance is insufficient. An announcement of
issue of shares sends a negative signal to the market as the investors believe that there is a probability that the
management is issuing shares as they are overvalued. Investors start selling shares, resulting in a fall in prices of
shares. Thus, in consistent with pecking order theory, a growing firm will be positively related with leverage.
Thus we expect that leverage will have a positive asso- ciation with growth. This is as per the results of research
conducted by Sinha (1993), Shanmugasundaram (2008), Gill et al. (2009), Yang, Lee, Gu and Lee (2010), Sharif,
Naeem and Khan (2012), Tongkong (2012) and Kouki and Said (2012). Therefore, the first hypothesis is:

Hypothesis 1: Growth has a positive relationship with leverage.

Liquidity (LIQ)
Firms that are comfortable in its liquidity position would prefer to finance through internal funds and would not
need outside financing. Mallikarjunappa and Goveas (2007), Kaur and Rao (2009) and Chakraborty (2010) have
taken liquidity as an independent variable. Mallikarjunappa and Goveas (2007) concluded that with a high liquidity,
firms would go for less of debt and would prefer to finance through internal funding. Their finding was in
accordance to pecking order theory, whereas Kaur and Rao (2009) and Chakraborty (2010) got a positive
relationship in their results which was as per trade-off theory which says that a firm needs to have high liquidity to
service high debts. We have proposed our next hypothesis as

Hypothesis 2: Liquidity has an inverse relationship with leverage.

Non-debt Tax Shield (NDTS)
One of the reasons why a company issues debt is that it gets a tax shield on interest. However, this is attractive to
com- panies only when a firm has sufficient taxable income to enjoy interest deductibility. Tax shield is the
reduction in taxable income that a firm achieves due to depreciation, amortization, research and development
expenditure etc. which are non-debt tax shield contrary to interest payment on loan which is the tax shield due to
debt. Presence of non-debt tax shield weakens the tax shield motive of issuing debt (De Angelo & Masulis, 1980).
Thus, the
trade-off theory predicts an inverse relationship between NDTS and debt. DeAngelo and Masulis (1980) said that
NDTS are substitute of the tax shields on debt financing. So firms with larger non-debt tax shields are expected to
use less debt in their capital structure. Sanjay Rajagopal (2011) got a negative association between non-debt tax
shield and leverage where as Bradley et al. (1884), Mall- ikarjunappa and Goveas (2007) and Kaur and Rao (2009)
got a positive association against their expectations. The contradictory results of researchers for NDTS support
pecking order theory in some and trade-off in others. Empirical findings are mixed on this issue.
We have framed our hypothesis as per pecking order theory which says:

Hypothesis 3: Non-debt tax shield has an inverse relationship with leverage.

Profitability (ROE)
As per pecking order theory, a highly profitable firm would prefer to finance through internal fund rather than going
for debt. Thus, profitability and total debt ratio have an inverse relation (Daskalakis & Psillaki, 2008; Kakani, 1999;
Kakani & Reddy, 1996; Kaur & Rao, 2009; Mei Qui & Bo la, 2010; Myers & Majluf, 1984; Sinha 1993; Vasiliou et
al., 2009). However, as per the trade-off theory, highly profitable firms prefer to go for debt as it provides a tax
 shield on interest payment (De Angelo & Masulis, 1980; Sheikh & Wang, 2011; Titman & Wessels, 1988). Our
hypothesis is:

Hypothesis 4: Profitability has an inverse relationship with leverage.

Control Variable
Size (SIZ)
Size of the firm is an important variable of firms leverage as size of the firm might affect the easy availability of
debt. Hence, this variable is introduced in the study as control variable. Ramaswamy (2001), Frank and Goyal
(2003) and Ebaid (2009) suggest that the larger firm may have more capacity and capabilities and hence might
influence its performance. Based on the literature, we have framed our hypothesis as:

Hypothesis 5: Size has a positive relationship with leverage.

Tangibility (TANG)
Tangibility of assets is the ratio of fixed assets to total assets. Company can go for higher debts if it has a high
tangibility ratio. A high tangibility ratio will likely to have low financial distress cost. This goes as per the trade-off
 272Vision 20(4)
theory. If profitability is sufficient to finance, growth and companies still use debt for financing, tangibility will be
positively related to leverage bankers will give low rate of interest to firms with higher tangibility ratio. Tangibility
has a positive influence on debt ratio (Afza & Hussain, 2011; Bhaduri, 2002; Mallikarjunappa & Goveas, 2007;
Pandey, 2005; Shanmugasundaram, 2008). Study con- ducted by Booth et al. (2001) had conducted a study for firms
in Brazil, India, Pakistan and Turkey, and the result showed a negative relationship between tangibility and debt
ratio. Other studies have also reported a negative rela- tionship between tangibility and debt ratio (Bauer, 2004;
Karadeniz et al., 2009; Mazur, 2007). Ferri and Jones (1979) in their findings say that tangibility generally fall from
lower leverage classes to higher leverage classes. Firms with high proportion of fixed assets to total assets fall in the
low leverage classes.
Our hypothesis is:

Hypothesis 6: Tangibility has a positive relationship with leverage.

Measurement of Variables
Leverage (DER): Total book value of total borrowings (sum of current liabilities and long-term debts) divided by
total assets.
Growth (GRS): Percentage change in sales in the current year as compared to the previous year.
Liquidity (LIQ): Current assets divided by current liabilities.
Non-debt tax shield (NDTS): (Depreciation + Amortization) divided by Total assets.
Profitability (ROE): Return on equity = Net profit after tax divided by total equity.
Size (SIZ): Log of total assets.
Tangibility (TANG): Fixed assets divided by total assets.

Research Methodology
For the purpose of our study, we have taken the firms listed NSE CNX 500. From 500 firms, we have deleted the firms belonging
to financial sector as financial firms have a capital structure of different nature than the other firms. We have also deleted firms
with negative profits and nega- tive net worth. The period of study was for the calendar year (i.e., 1 January to 31 December)
from 2008 to 2015. We have taken the sample size from the year of starting of global slowdown. We had gathered the data from
CMIE, Prowess data base. Due to non-availability of all relevant financial data of all the variables for the period of study, we had
to delete the firms whose data were unavailable and thus we had the final sample size of 417 firms for a period of 8 years. We
have done a panel data regression analysis
to understand the impact of various independent variables over leverage. The advantage of panel data analysis over
either time series or cross-section modelling is that it cap- tures the differences across individual cross sections much
better. There were 417 cross sections of 8 years resulting into 3,336 firm-year observations for our study.
To investigate the impact of the various variables on capital structure, we have framed the following model for
regression analysis.
DER = b0 + b1 (GRS) + b2 (LIQ) + b3 (NDTS) + b4(ROE) + b5 (SIZ) + b6 (TANG) + f
Where b0 is the intercept of the equation, b1, b2, b3, b4, b5 and b6 are the coefficients of independent variables,
that is, GRS, LIQ, NDTS, ROE, SIZ and TANG, respectively.
f is the error term.

Analysis and Findings

Table 1 presents the results of descriptive statistics for the variables used in the study. The mean value of DER,
GRS, LIQ, NDTS, ROE, SIZ and TANG are 0.48, 4.55, 1.81, 0.02, 0.14, 10.23 and 0.25, respectively. The standard
deviations are 0.20, 87.02, 2.61, 0.02, 0.32, 1.51 and 0.18 for DER, GRS, LIQ, NDTS, ROE, SIZ and TANG,
respec- tively. The coefficients of variations are 0.42, 19.13, 1.44, 0.95, 2.29, 0.15 and 0.72 per cent for DER, GRS,
LIQ, NDTS, ROE, SIZ and TANG, respectively. The statistics show that there is a huge difference between the
minimum and the maximum in growth in sales. That is also supported by coefficient of variation in GRS. Variability
is least for SIZ followed by DER whereas it is highest in the case of GRS. A test for normality of these variables was
carried out using the Jarque-Bera statistics and it was found that at a significance level of 5 per cent none of the
variable follows a normal distribution.
To examine whether the set of independent variables suffer from the problem of multicollinearity, a matrix of
correlation coefficients of the variables was computed and presented in Table 2.
Examinations of the correlation coefficients in Table 2 indicate that none of the correlation coefficient is high.
This shows that there is no multicollinearity among inde- pendent variables. Multicollinearity exists whenever two
or more of the predictors in a regression model are moder- ately or highly correlated. In fact, the maximum absolute
value is 0.606. Therefore, the estimates are not sensitive to minor changes in model and none of the variables are
needed to be dropped. In order to examine whether fixed effect model or random effect model is appropriate for
panel data, Hausman test which follows a chi-square distri- bution was used. The results of the test show that fixed
effect model is the appropriate one (Table 3). So we have presented and discussed the results corresponding to fixed
effect model (Tables 4 and 5).
Chaklader and Chawla 273

Table 1. Results of Descriptive Statistics

Number of observations: 3336
DER GRS LIQNDTS ROE SIZ TANG
Mean 0.48 4.55 1.810.02 0.14 10.23 0.25
Median 0.49 0.11 1.350.02 0.13 10.14 0.23
Maximum 1.72 3193.22 73.130.26 5.16 15.68 0.89
Minimum 0.00 1.00 0.000.00 12.01 0.00 0.00
Standard deviation 0.20 87.02 2.610.019 0.32 1.51 0.18
Coefficient of variation (per cent) 0.42 19.13 1.440.95 2.29 0.15 0.72
Jarque-Bera 10.44 104000000.00 16458625.0030897.34 56550229.00 240.08 186.78
Probability 0.01 0 00 0 0 0
Source: Authors Creation. Results through E views 7.

Table 2. Correlation Matrix

GRS LIQ NDTS ROE SIZTANG
GRS 1 0.00725 0.02335 0.005271 0.028830.021
LIQ 0.00725 1 0.10486 0.03427 0.027370.09639
NDTS 0.02335 0.104861 0.028821 0.130310.606625
ROE 0.005271 0.034270.028821 1 0.06330.02403
SIZ 0.02883 0.02737 0.13031 0.0633 10.04836
TANG 0.021 0.096390.606625 0.02403 0.048361
Source: Authors Creation. Results through E views 7.
Table 3. Hausman Test Result

Correlated Random EffectsHausman Test

Test cross-section random effects
Test Summary Chi-sq. Statistic Chi-sq. d.f. Prob.
Cross-section 35.069507 6 0.0000
random
Source: Authors Creation. Results through E views 7.

DER = 0.4215 1.40 E(GRS) 0.006 (LIQ) 0.277(NDTS) + 0.010 (ROE)

P value (0) (0.95) (0.00) (0.22) (0.12) 0.004 (SIZ) + 0.147 (TANG)
(0.20) (0.00) R2 = 0.737

The coefficient of growth is negative but insignificant. This means that with growth, the leverage goes down. This result leads
us to the rejection of first hypothesis. The result is in accordance to the study of Mei Qui and Bo La (2010) and Sinha and
Samanta (2014). Firms with growth oppor- tunities may find it difficult and costly to rely on debt for financing, as the degree of
risk may be high for growth oriented investments (Sinha & Samanta, 2014). Growth opportunities which can be thought of as real
options will have associated agency costs making it difficult for a firm to borrow against them than against tangible fixed assets
(Myers, 1977). Our result of growth variable goes with static trade-off theory that a growing firm would not go for
debt capital. The effect of liquidity on leverage is negative and significant as indicated by the negative coefficient of
liquidity and p value of 0.00. This means that liquidity has a negative effect on leverage, there by justifying the pro-
posed hypothesis. This is in accordance to the findings of Deesomsak et al. (2004), Mazur (2007), Mallikarjunappa
and Goveas (2007) and Viviani (2008). Our finding of liquidity variable justifies pecking order theory that a firm
with high liquidity would go for internal financing rather than external sources of financing.
The sign of the coefficient of non-debt tax shield on leverage is negative and insignificant. This is as per the
proposed hypothesis that NDTS has negative effect on leverage. Our result of NDTS goes with DeAngelo and
Masulis (1980), Deesomsak et al. (2004) and Sanjay Rajagopal (2011) who said that NDTS are substitute of the tax
shields on debt financing. So firms with larger non-debt tax shields are expected to use less debt in their capital
structure. This finding is in accordance to trade-off theory.
The coefficient of ROE on leverage is positive and insignificant. This is against the proposed hypothesis.
However, as per the trade-off theory, highly profitable firms prefer to go for debt as it provides a tax shield on
interest payment (Afza & Hussain, 2011; Bhaduri, 2002; De Angelo & Masulis, 1980; Sheikh & Wang, 2011;
Titman & Wessels, 1988; Xiaoyan Niu, 2008). Positive relation- ship of profitability and leverage is as per the trade-
off theory. Panno (2003) explains that leveraging up increases the debt tax shield and thus the gain from leverage is
surely higher for more profitable firms with a higher marginal tax rate. Also, the firm increases the earnings
 274Vision 20(4)

Table 4. Regression Result with Leverage as Dependent Variable

Dependent Variable: DER
Sample: 20082015
Periods included: 8
Cross-sections included: 417
Total panel (balanced) observations: 3336
Variable Coefficient Std. Error t-Statistic Prob.
C 0.4215300.034780 12.11972 0.0000
GRS 1.40E-06 2.34E-05 0.059888 0.9522
LIQ 0.0064070.000921 6.953193 0.0000
NDTS 0.2776470.224936 1.234342 0.2172
ROE 0.0105900.006746 1.569927 0.1165
SIZ 0.0039530.003147 1.256063 0.2092
TANG 0.1468150.027941 5.254475 0.0000

Effects Specification
Cross-section fixed (dummy variables)
R-squared 0.737485
Adjusted R-squared 0.699455
S.E. of regression 0.110107
Sum squared residuals 35.31589
Log likelihood 2852.810
F-statistic 19.39221
Prob (F-statistic) 0.000000
Mean dependent var. 0.482476
S.D. dependent var. 0.200845
Akaike info criterion 1.456721
Schwarz criterion 0.681661
Hannan-Quinn criter. 1.179435
Durbin-Watson stat. 1.449185
Source: Authors Creation. Results through E views 7.

Table 5. Proposed and Expected Results

Theory as per
Variable Proposed Sign Actual Sign Actual Results
Growth (GRS) + _ Trade-off
Liquidity _ _ Pecking Order
NDTS _ _ Trade-off
Profitability _ + Trade-off
(ROE)
Size + + Trade-off
Tangibility + + Trade-off
Source: Authors Creation. Results through E views 7.
(1999), Hirota (1999), Bhaduri (2002), Pandey (2005), Mallikarjunappa and Goveas (2007), Shunmugasundaram
(2008) and Afza and Hussain (2011). Their findings are in consistent with trade-off theory.
R2 value of the regression equation is 0.737 which indicates that 73.7 per cent of the variations in leverage are
explained by the six independent variables. Further, the value of R2 is significant as indicated by p value correspond-
ing to F statistic. The results indicate that only two hypoth- eses numbering 2 and 6 hold true and are significant.
The two hypotheses numbering 1 and 4 do not hold true. Hypotheses 3 and 5 hold true but relationship is not signifi-
cant at 5 per cent level.
per share by including more of fixed income security in the capital structure. Our result of ROE is positive, although
insignificant but supports the trade-off theory.
 The estimated coefficient of size on leverage is positive but not significant. This is as per the proposed hypothesis
that size is positively related to leverage. Large-sized firms can take the risk of going for more debt due to their large
asset size. The finding is in accordance to the studies of Bhaduri (2002), Pandey (2005) and Kaur and Rao (2009),
and goes as per the trade-off theory.
The coefficient of tangibility in the estimated regression is positive and significant as indicated by the P value of
0.00. This shows that tangibility has a positive relationship with leverage. This goes as per our proposed hypothesis.
This result is in consistence with the studies of Rajan and Zingles (1995), Jordon et al. (1998), Wiwattanakantang
Conclusion
The study analyzes the impact of variables such as growth, profitability, tangibility, liquidity, size and non-debt tax
shield on financial leverage for firms listed in NSE CNX 500 for the period of 2008 till 2015. We have limited the
analysis and findings of this study to pecking order theory and trade-off theory. Our regression equation result indi-
cates that 73.74 per cent of the variations in leverage are explained by the five independent variables. Size is taken
as a control variable. The results indicate that four hypoth- eses of tangibility, liquidity, size and non-debt tax shield
hold true indicating that tangibility and size are positively associated and liquidity and non-debt tax shield are nega-
tively related to leverage. Of these four variables that are in accordance to the hypotheses, liquidity and tangibility
are
 Chaklader and Chawla 275
statistically significant. Growth and profitability are not in accordance with the hypotheses. Five out of six variables,
namely growth in sales, non-debt tax shield, profitability, size and tangibility, are in accordance with the trade-
off theory and only liquidity is in accordance with the pecking order theory. Babu and Jain (1999) also supported
the trade-off theory in their study and opined that post liberali- zation, developing economies do not favour debt due
to high cost of distress. Singh (1995) in his study found that developing economies are more comfortable issuing
equity shares to avoid cost of distress. Our study is also in accord- ance with the study of Choudhry and Sundaram
(2013) which was inclined towards trade-off theory. The results show that our study of 417 firms from NSE CNX
for the period of 20082015 favours the trade-off theory. It means that growing firms will go for fewer debts as it
would lose value due to distress cost. A growing firm would not like go for more debt if there is a variation. Our
study shows that coefficient of variation of growth is the highest among all variables (19.13 per cent). There is high
variation in growth across all firms in the sample. Thus there are uncer- tainties and it is risky to borrow more.
Result of non-debt tax shield in our study indicates that a firm which is high on non-cash charges such as
depreciation and amortization would be more comfortable in cash from operation and thus would not require to go
for debt. A highly profitable firm would be more interested to borrow more as it would be sure of its EBIT and
would have high interest coverage and debt service coverage ratio to repay principal and interest. Firms that have
more tangible assets shall have easy access to loan as they can have tangible assets as collateral. Thus tangibility
shows a positive relation with leverage. Liquidity as per pecking order theory indicates that companies that are
comfortable in liquidity position do not have to borrow as they are comfortable with self- generated fund.

Limitations of the Study and Suggestion for Future Research

The sample of this study focuses on data of NSE CNX 500 from the year 2008 till 2015. Global slowdown started in
2008 and the stock market started improving around 2012 but there have been several ups and downs in the market.
Thus, it may not be sufficient for generalization.
There have been a number of studies on capital struc- ture. But the empirical results are not similar in majority of
the cases to justify the behaviour of capital structure. There is wide scope of future research in this area of corporate
finance, particularly understanding the capital structure of firms. Further research can be done on this topic by
increasing cross sections by including all non- financial listed firms from different sectors. A comparison of capital
structure of different countries can be done (Haron, 2014).
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Authors Bio-sketch
Barnali Chaklader is Professor of Finance andAccounting at International Management Institute, IMI, New Delhi. Her
experience includes 18 and a half years of teaching
in institutes like IMT Ghaziabad, SP Jain Institute of Management, Singapore, Euromed Management University,
France and Kufstein University, Austria. She has widely travelled and has presented research papers at various
national and international conferences in various countries and has published a number of research papers in
refereed journals. Dr Barnali is a corporate trainer and conducts training programmes in Finance for many public
sector and private sector companies. Her in-house and open training modules are Finance for Non Finance
Executives, Financial Statement Analysis for Decision Making and Strategic Cost and Revenue Management.

Deepak Chawla is a Distinguished Professor at the International Management Institute (IMI), New Delhi. His areas
of interest are Business Statistics, Research Methodology, Marketing Research, Business Forecasting and Applied
Econometrics. He has published extensively both in national and international journals, conducted training
programmes for middle and senior executives in India and abroad. He has undertaken a number of research and
consulting assignments, guided PhD scholars and is also a reviewer to a number of top international journals. He is
also the co-author of a book on Research Methodology published by Vikas Publishing House Pvt. Ltd.