1) The document summarizes a research paper that examines the determinants of capital structure for Chinese listed companies using market and accounting data up to 2000. 2) The findings show that leverage is negatively correlated with profitability but positively correlated with firm size, volatility, tangibility, growth, and dividends. Leverage is also negatively correlated with non-debt tax shields and intangibility. 3) These results are consistent with predictions from both the tradeoff theory and pecking order theory of capital structure. Larger, more tangible firms with growth opportunities tend to have higher leverage, while more profitable firms with non-debt tax shields tend to have lower leverage.

1. 1

2. Abdullah Shahzad
Roll. No. 203
BBA 7th (M)
GC University Fsd.

3. DETERMINANTS OF
CAPITAL STRUCTURE:
EVIDENCE FROM CHINA
Samuel G.H Huang And
frank M. Song

4.  Introduction
 (These Slides concepts are According to the
Article)

5. Capital Structure
 The question of capital structure has received a
lot of attention from economists for quite
sometime.
 The publication by Modigliani and Miller (1958)
is believed to have triggered the beginning of
corporate finance as a discipline.
 Jensen and Meckling (1976), Miller
(1977), Myers (1984), Jensen (1986), Titman
and Wessels (1988), Harris and Raviv
(1991), among others.

6. Capital Structure
 Financing overall operations and growth using
different sources of funds
 “Proportion of debt instruments and preferred
and common stock on a company’s balance
sheet”

7. Abstract
 This paper employs a new database
 It contains the market and accounting data from
more than 1000 Chinese listed companies up to
the year 2000
 To document the characteristics of these firms in
terms of capital structure.
 As in other countries:
leverage in Chinese firms increases with firm
size, non-debt tax shields and fixed assets.
Decreases with profitability and correlates with
industries

8. Hypothesis:
Relationship Between Financial Leverage and
Determinants Of Capital Structure

9. Capital Structure Theories:
 Trade off
 Pecking order
 Agency cost
 Leverage: Ratio of total loans and net total
assets

10. Trade off Theory
 Proportion of debt and equity finance to
balance cost and benefits
 Corporateand personal taxes
 Bankruptcy cost
 debt  tax liability  after tax cash flow
 debt  Risk of default  cost of debt
 Tradeoff - Optimum capital structure
Max value of firm

11. Trade off Theory

12. Pecking Theory
 Inverse relationship between profitability and debt
ratios
Follows Law of Least Effort
 Firms prefer internal financing
 Adopt target dividend payout ratios
 External Financing
 Debt like convertible bonds
 Equity
 Issue costs
 Internal funds : Least
 Debt : Low
 Equity: Highest

13. Factors affecting leverage
 Profitability
 Size of the firm
 Non debt tax shield
 Growth Opportunities
 Tangibility
 Dividend
 Risk
 Intangibility

14. Profitability
 Trade off theory
 Positivecorrelation
 Increased capacity to bear interest costs
 Bankruptcy cost of large firm is less
 More the profit, greater the need for tax shield
 Pecking-order theory
 Negative correlation
 Greater profits  greater retained earnings 
internal funding  reduced leverage

15. Size of the firm
 Trade off theory
 Size of firm & bankruptcy cost – Inverse relation
 Positive correlation – size and leverage
 Pecking order theory
 Lessinformation asymmetry for large firm
 Negative correlation

16. Non-debt tax shield
 If there are other non debt options available
for tax shields  low leverage
 Negative correlation

17. Growth Opportunities
 Trade off theory
 Strong incentive to avoid under investment
 Equity can be issued at higher market price
 Negative correlation
 Pecking order
 Growing firm will not have internal reserves in
abundance
 Positive correlation
 Growth in sales

18. Tangibility
 Trade off Theory
 Proportion of debt increases with increased fixed
assets
 Collateralization – Improved guarantee of
repayment
 Positive correlation
 Pecking order
 Firms with few tangible assets are more sensitive
to informational asymmetries
 Negative correlation
 Tangibility : Ratio of Book value of fixed assets

19. Risk
 Standard deviation of Returns
the larger the variations you can expect to see in
returns.
 Increased information asymmetry
 Shareholders reluctant to invest
 Resort to debt
 Positive Correlation

20. Dividend
 Dividend paid / BV of equity
 Less internal funds
 Better potential to repay debt
 External Funding – Debt
 Positive correlation

21. Intangibility
 Ratio: Intangible assets and total assets
 Increased information asymmetry
 Shareholders reluctant to invest
 Resort to debt
 Positive correlation

22. Literature Review
 In 1958, First Scientific Research by Modigliani
and Miller (MM) proved irrelevance of capital
structure on firms value assuming no taxes.
 In 1963, MM proved tax shield benefit of
leverage leading to increase in value of firm.
 In 1977, Scot proposed Tradeoff theory.
 In 1984, Myers and Majluf proposed Pecking
order theory

23. Literature Review
 In 1995, Rajan & Zingles found positive
correlation of tangibility and sales with leverage
and negative correlation of market to book ratio
and profitability.
 In 2003, Drobetz & Fix took six determinants-
tangibility, size, market to book
ratio, profitability, volatility, uniqueness of
products and non-debt tax shield. They found
tangibility and size positively correlated and
profitability and growth negatively correlated
with leverage.

24. Literature Review
 In 2004, Shah & Hijazi studied non-financial
firms listed on KSE and took
tangibility, size, profitability and growth as
determinants.
They found positive impact of tangibility and size
and
negative impact of profitability and growth
 In 2007, Shah & Khan studied the no-financial
firms listed on KSE and took six variables-
size, profitability, volatility, growth, tangibility and
non debt tax shield. They found the only one
significant result, negative relationship between
profitability and leverage

25. Research Design
 Sample:
For 1000 Chinese Listed
Companies
 Population :
China Stock Exchange
 Time:
Up To The Year 2000.

26. Research Design
 Data Source:
School Of Economics And Finance Center
For
China Financial Research (CCFR).
The University Of Hong Kong
Huang’s Email: huangg@hkusua.hku.hk Tel: (852)
2857-8637
Song’s Email: fmsong@econ.hku.hk Tel: (852) 2857-
8507
 Model:
Regression Model

27. Technique:
Qualitative
 Data:
Secondary Data
(Tell What is Qualitative Data and Secondary
Data)

28. Findings
Variable Correlation with Leverage
Profitability Negative
Volatility in Return Positive
Size of Firm Positive
Tangibility Positive
Growth Positive
Non Debt Tax Shield Negative
Intangibility Positive
Dividend Positive

29. Conclusion
 Companies with greater profit use internal
reserves or raise equity for funding
 Investors are less interested for investing in
companies with high return volatility
 Large firms are favored by creditors due to
their less bankruptcy cost
 Firms with huge fixed assets can attract more
lending due to collaterals

30. Conclusion Cont…
 Companies with high growth perspective find it
easy to raise fund through borrowings
 Companies with other modes of tax
exemption/benefit are less interested in tax
benefit on interest paid on debt
 Investors are highly sensitive to information
asymmetry
 High dividend paying firms show more
potential to repay debt

31. THANK YOU