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Factors Influencing Capital Structure Decisions
1. There are various factors that contribute to the firm’s capital structure strategy which are
Enterprise size: One factor of capital structure is the size of the company. According to previous
studies, larger scale businesses have a higher amount of debt. Because large businesses may have
an edge over smaller businesses when it comes to accessing credit markets and being able to
borrow under better terms. The larger a company gets, the more information about it is expected
to be available, reducing information asymmetries in the market and allowing it to obtain financial
resources from lenders. Smaller businesses are also more likely to incur greater costs for acquiring
external finance due to information asymmetries. It is thought that size and capital structure have
a favorable relationship from this perspective. The natural logarithm of revenue or the natural
logarithm of total asset were used as proxies for business size in this research.
Asset Tangibility: Asset tangibility is thought to be a factor of capital structure. There are
two opposing opinions on the relationship between tangibility of assets and business leverage.
According to the first school of thought, businesses with high tangibility assets can generally
borrow on more favorable terms than businesses with large intangible assets or assets with no
collateral value. Furthermore, moral hazard concerns are lessened when a company offers tangible
assets as security, as this sends a good signal to creditors who may request the sale of these assets
if the company defaults. The second school of thinking holds that asset tangibility and leverage
have a negative relationship. They claim that the country's bond market is still small and in its
early stages, forcing businesses to rely on bank financing. Furthermore, banks in the country prefer
short-term loans with favorable terms to riskier long-term loans, prompting businesses to use short-
term borrowing to fund long-term investments. Güven Saylgan et al. (2006) and Akinlo et al.
(2007) also support this viewpoint (2011). This suggests that capital structure and tangible assets
have a positive or negative connection. Most researchers utilized the value of fixed assets as a
proxy for a firm's physical assets to determine tangibility.
Growth opportunities: Growth opportunities are an aspect to examine when it comes to
capital structure. There are two opposing opinions on the relationship between a firm's growth
potential and leverage. According to the first viewpoint, corporations with strong future
development potential should utilize more equity financing since a heavily leveraged company
may forego advantageous investment opportunities if it believes that taking on new projects will
increase the value of the company's existing debt holders (Myers, 1977). This shows that leverage
2. and growth have a negative relationship. Growth opportunities and capital structure have a good
link. This is founded on the logic that a higher rate of growth indicates a bigger demand for
finances, and thus a greater reliance on external funding via debt. Keshar J. Baral (2004), Güven
Saylgan et al. (2006), and Faris AL- Shubiri all endorse this viewpoint (2010). In terms of this
variable, we believe that growth and capital structure may have a positive or negative connection.
The growth opportunities variable is calculated in most empirical studies as a ratio of revenue
growth or a ratio of total assets growth.
Profitability is another corporate attribute that might have an impact on a company's capital
structure. According to certain empirical investigations, profitability and leverage have a negative
association. They indicate that if a company is lucrative, it is more likely to get funding from within
the company rather than from outside sources. In terms of profit, businesses tend to hold less debt
because internal financing is easier and more cost effective. Keshar J. Baral (2004), Shumi Akhtar
(2005), Güven Saylgan et al. (2006), Shah & Khan (2007), Gurcharan S (2010), Faris AL- Shubiri,
Akinlo et al. (2011), Bilal Sharif et al. (2012) all identified a negative association (2012). This
would imply that capital structure and profitability have a negative connection.
Business risk, or earnings volatility, is another factor that influences capital structure. Almost
all empirical research demonstrates that companies with high earnings volatility are more likely to
have earnings fall below the debt service commitment. This may require businesses to arrange
financing at a high cost to settle their debts or, in the worst-case scenario, file for bankruptcy.
When faced with external financing options, enterprises with high earnings volatility will borrow
the least and choose equity over debt. Booth et al. (2001), Bilal Sharif et al. (2001), and others
agree (2012). As a result, it's reasonable to assume a negative link between business risk and
leverage. In empirical research, standard deviation of the return on sales, standard deviation of
returns on assets, and standard deviation of the percentage change in operating income have all
been employed as indices of volatility.
Liquidity is a factor that influences capital structure. Many empirical studies predict a
negative relationship between a corporation's debt ratio and its liquidity, owing to the fact that a
firm with more current assets can generate more internal inflows, which it can then utilise to fund
its operating and investment activities. Companies with a lot of cash tend to employ less debt.
Nikolaos Eriotis (2007), Yuanxin Liu et al. (2009), and Bilal Sharif et al. (2009) all support this
3. viewpoint (2012). This would imply that capital structure and liquidity have a negative connection.
The current ratio is used to calculate liquidity in empirical investigations. It is calculated by
dividing current assets by current liabilities.
Interest expense: Interest expense is also considered a determinant of capital structure. Marsh
(1982) discovered that there is a strong negative association between interest rate and debt on
equity in his experimental investigation. This is relevant to Trade-off Theory's implication. This
suggests that capital structure and interest expense have a negative connection. Interest expense
capital is used to calculate interest expense in empirical investigations. Dhankar (1996), Marsh
(1982), Walaa Wahid ElKelish (2007) all use this formula to calculate interest payments split by
total loans.
Age of the business: The age of the business is calculated by comparing the current year to
the year in which the business was founded and operated. Much empirical research (Naveed
Ahmed (2010), Nejla Ould Daoud Ellili (2011), Bilal Sharif et al. (2012)) predict that debt levels
decline as a company grows older. Several studies, on the other hand, imply that a reduced
information imbalance leads to higher debt levels. Debt owners will be more likely to lend money
to businesses that they are familiar with rather than businesses that they are unfamiliar with. These
findings suggest that capital structure and enterprise age are likely to have a positive or negative
connection (Ming-Chang Cheng et al., 2011). In terms of this variable, we believe that the age of
the company has a positive or negative relationship with capital structure.