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Capital Structure Determination of Lather Industries in Bangladesh

M. H. Uddin
Department of Finance and Banking, Patuakhali Science and Technology University, Patuakhali, Bangladesh.

F. E. Moula*
Department of Sociology, University of Chittagong, Chittagong, Bangladesh

M. O. Faruque
Department of Finance, Jogonnath University, Dhaka, Bangladesh

Abstract/ Executive Summary:

This research provides further evidence of the capital structure theories pertaining to lather industries in Bangladesh and to assesses the influences of these determinants on the capital structure decisions. The dependent variable was leverage ratios and the independent variables were profitability, asset tangibility, growth, and firm size. The results of cross-sectional OLS regression show that there was little evidence to support the information asymmetry theory and agency cost theory. The less profitable firms are those mainly financed through external funding. The firms with a bigger proportion of tangible assets have easier access to long-term debt.

Keywords: Capital structure, Trade off theory, Growth, Firm size

Location: In Bangladesh

Start Date:

End Date:

Program Area: Socio-economic and Policy

Commodity: Lather, Leather/tannery

Objectives:

According to Eli Schwartz (1959) optimum capital structure varies for firms in different industries because the typical asset structure and earning stability which determines inherent risk vary for different types of production and thus the borrowing powers of the firm. This paper provides further evidence of the capital structure theories pertaining Lather industries in Bangladesh.

Methodology:

Data: The data set used in the analysis is constructed by lather industry’s balance sheet and income statement information obtained from the Dhaka Stock Exchange. For inclusion in the sample 6 years data, from 2005-2010 is used for five lather industries. The data were averaged over the six years to smooth the leverage and explanatory variables. The sample includes listed general insurance companies of Dhaka Stock exchange in Bangladesh. The criteria used for choosing the companies were the availability and quality of data for a time of 6 years (2005-2010). The sample consists of five lather industries, which are listed, in Dhaka Stock Exchange Ltd.

Explanatory Variables: To test the hypotheses, the relationships between the level of debt and four explanatory variables representing profitability, growth, tangibility and size are examined using ordinary least square regressions. Bevan and Danbolt (2002) point out that capital structure studies examining the determinants of leverage based on total debt may disguise the significant differences between long-term and short-term debt. Therefore, in line with Bevan and Danbolt (2002) and Michaelas (1998) this study decomposes debt into long-term and short-term debt. The debt ratios considered are: total debt to total assets, short-term debt to total assets, and long-term debt to total assets.

The cross-sectional regression used in this study is based on models used in Rajan and Zingales (1995), and Bevan and Danbolt (2002), with some modifications in both the leverage and explanatory measures due to lack of data availability as discussed below.

In line with Rajan and Zingales (1995) tangibility is measured by the ratio of fixed assets to total assets. Rajan and Zingales (1995) use the market-to-book ratio to proxy for growth. Hence, in line with AlSakran (2001), and Um (2001) a company’s growth is measured by the percentage change in the value of total assets. Rajan and Zingales use the natural logarithm of sales to proxy for size but there were more observations for total assets than sales, hence, following Al-Sakran (2001) and Cassar and Holmes (2003) size is measured by the natural logarithm of assets. The ratio of profit before tax to the book value of total assets is used to proxy for profitability in this paper.

Despite the fact that this correlation matrix ignores joint effects of more than one variable on leverage, the tangibility and growth variables have a negative correlation with short-term debt, and a positive and negative correlation with long-term debt respectively. Profitability and size have a positive correlation with short-term debt and a negative correlation with long term debt ratios. This implies that (1) Growing companies and companies with high levels of tangible assets tend to use long -term debt rather than short term debt. (2) Large and profitable companies are more likely to use short term debt rather than long term debt.

Source of Information: Journal of Science and Technology 11(June 2013): 158-163

Article Link (Online Journal):

Funding Source:

Budget:

Total Budget (Tk.) :

Achievement/Findings:

The findings of this paper contribute towards a better understanding of financing behavior in lather industries. Hypotheses, based on comparing the relationships between long and short term debt and four explanatory variables that represent profitability, growth, tangibility and size, were developed to test which capital structure theories best explained lather industries’ capital structure. The results suggest that the information asymmetry theory and Agency cost theory whereas there was satisfactory evidence to lather industries. And static trade-off theory has little support the lather industries of Bangladesh.

In the light of whole debate it is suggested that existing theories of capital structure contribute to some extant in decision-making process though certain aspects of the theories are partially refuted. The definite reason is the fact that the capital structure decision is a complex, multi-dimensional problem; thus capital structure decisions are likely to be the product of multifarious group processes. Simply it is difficult if not impossible to mull over all relevant factors with bounded rationality, at least in the current scenario. The lack of high-quality databases might constitute the major barrier on conducting capital structure research in Bangladesh. Consequently, there is a need to develop validated databases as more data becomes available in future. Using such databases can help examining and identifying additional variables that could influence the financing behavior of Bangladesh lather companies

Knowledge Management: Journal