How do they adjust their capital structure along their life cycle? An empirical study about capital structure over life cycle of Pakistani firms
| Published date | 01 August 2016 |
| DOI | https://doi.org/10.1108/JABS-06-2015-0080 |
| Pages | 276-302 |
| Date | 01 August 2016 |
| Author | Tanveer Ahsan,Man Wang,Muhammad Azeem Qureshi |
| Subject Matter | Strategy,International business |
How do they adjust their capital structure
along their life cycle? An empirical study
about capital structure over life cycle of
Pakistani firms
Tanveer Ahsan, Man Wang and Muhammad Azeem Qureshi
Tanveer Ahsan is a PhD
Candidate at the School
of Accounting, Dongbei
University of Finance and
Economics, Dalian,
People’s Republic of
China. Man Wang is
Professor at the School of
Accounting, Dongbei
University of Finance and
Economics, Dalian,
People’s Republic of
China. Muhammad
Azeem Qureshi is
Associate Professor at
the School of Business,
Oslo and Akershus
University College of
Applied Sciences, Oslo,
Norway.
Abstract
Purpose –The purpose of this study is to explain the adjustment rate made to target capital structures
by listed non-financial firms in Pakistan during the courses of their life cycles and to determine what
factors influence their adjustment rates.
Design/methodology/approach –The study used multivariate analysis to classify 39 years
(1972-2010) of unbalanced panel data from listed non-financial Pakistani firms in terms of their growth,
maturity and decline stages. Further, it used a fixed-effects panel data model to determine the factors
that influence capital structure and adjustment rates during the life-cycle stages of firms.
Findings –The study observed a low–high–low leverage pattern during the growth, maturity and
decline stages of businesses in line with tradeoff theory. Furthermore, the study observed an adjustment
rate for growing firms of between 49.3-37.9 per cent, for mature firms of between 35.5-17.5 per cent and
for declining firms of between 22.2-15.1 per cent toward their respective leverage targets. Furthermore,
it was found that growing firms have higher leverage adjustment rates because, by having more
investment opportunities, these firms can alter their capital structures easily by changing the
composition of their new issues.
Practical implications –Erratic economic conditions in Pakistan have created an uncertain business
environment. Therefore, even mature Pakistani firms remain skeptical about the sustainability of positive
trends among current economic indicators. Furthermore, to avoid uncertainty, Pakistani firms grab
short-term opportunities by using quickly available short-term debt as a main financing source.
Government should introduce long-term policies that will stabilize the business environment and
strengthen the financial, as well as the judicial, institutions of the country so that these firms may benefit
from long-term investment opportunities and access more options for raising external financing. The
results of this study will also help policymakers for other Asian economies where the capital markets are
underdeveloped and where firms have higher leverage ratios, such as Thailand, Indonesia and
Malaysia.
Originality/value –This is the first study in Pakistan that has used a multivariate approach to classify
firms into their different life-cycle stages and to discover the leverage adjustment rates of firms during
those life-cycle stages.
Keywords Pakistan, Panel data analysis, Adjustment rate, Firm life cycle, Target capital structure
Paper type Research paper
1. Introduction
This study examines the capital structure dynamics of non-financial firms listed in Pakistan
over the courses of their corporate life cycles by using large panel data, and it tries to
improve understanding about the capital structure choices that firms in developing
countries make during their different life-cycle stages by taking Pakistan as a sample case.
The pioneering theory of capital structure irrelevance (Modigliani and Miller, 1958)
JEL classification – C23, G32,
P16
Received 20 June 2015
Revised 7 September 2015
2 November 2015
Accepted 13 November 2015
This paper is a part of a PhD
thesis submitted at the School
of Accounting, Dongbei
University of Finance and
Economics, Dalian, People’s
Republic of China.
PAGE 276 JOURNAL OF ASIA BUSINESS STUDIES VOL. 10 NO. 3, 2016, pp. 276-302, © Emerald Group Publishing Limited, ISSN 1558-7894 DOI 10.1108/JABS-06-2015-0080
provided a solid foundation for the development of a number of different theories that
explained corporate capital structure behavior and, subsequently, a variety of empirical
research has emerged to prove or disprove these theories. However, corporate capital
structure is still puzzling. One of the reasons for that may be that firms evolve and progress
through different stages during their life cycles and the financial preferences of firms may
vary because of their changing conditions and according to their life-cycle stages (Fluck,
2000,Rocca et al., 2011). There is considerable evidence about the impact of life-cycle
stages on various aspects of firms’ behavior, such as the impact of life-cycle stages on the
demand for financial products (Berger and Udell, 1998), dividend policy (DeAngeloa et al.,
2006) and corporate governance (Connor and Byrne, 2015;Filatotchev et al., 2006).
Therefore, it is important to investigate the impact of corporate life cycles on capital
structures so that policymakers may develop financial policies accordingly. Previously,
empirical studies have been unsuccessful at combining organizational life-cycle stages
with corporate capital structure choices. Later, most empirical studies have used a
univariate approach, such as a firm’s age or its size, to investigate the impact of life-cycle
stages on capital structure behavior (Berger and Udell, 1998). Furthermore, many empirical
studies have demonstrated that a target (optimal) capital structure exists (Bradley et al.,
1984;Bontempi, 2002), and firms have tried to adjust their capital structures to meet the
target (optimal) capital structure (Drobetza and Wanzenried, 2006;Getzmann et al., 2014).
Empirical studies explaining the leverage adjustment rates of firms during their life cycles
are very rare. A recent study carried out in China explained significant variations in
leverage adjustment rates across life-cycle stages and found that this adjustment rate fell
from 68.52 per cent (birth) to 48.78 per cent (decline). Aside from this study, it is hard to find
any other significant work that covers both aspects (adjustment rate and life cycle) of
capital structuring.
Moreover, a recent study carried out in Pakistan found that non-financial firms in Pakistan
do have target leverage ratios (Ahsan et al., 2016). Accordingly, the aim of this study is to
explain the leverage adjustment rate of Pakistan’s listed non-financial firms during different
life-cycle stages. For this purpose, we applied multivariate analysis (Anthony and Ramesh,
1992) to an unbalanced panel data set of 13,375 firm-year observations (1972-2010) to
classify these firm-year observations into different life-cycle stages. Furthermore, we
applied a fixed-effects model (FEM) of panel data analysis to discover the impact of an
extended number of variables (at firm, industry and country levels) on leverage adjustment
rates for Pakistan’s listed non-financial firms during their various life-cycle stages. The
study contributes to the literature by discovering that firms operating in a bank-based
economy, using long-term debt as a minor source of financing, that have limited financing
options and face erratic economic conditions, follow a low–high–low leverage pattern
during their growth, maturity and decline stages as has been indicated by tradeoff theory
(TOT). Furthermore, the study reveals that the adjustment rate of growing firms is between
49.3 and 37.9 per cent of their respective leverage targets; for mature firms, it is between
35.5 and 17.5 per cent; and for declining firms, it is between 22.2 and 15.1 per cent.
Furthermore, we found that growing firms have higher leverage adjustment rates because,
having more investment opportunities, these firms can easily alter their capital structures by
changing the composition of their new issues. Moreover, good economic conditions also
help businesses to accomplish adjustment processes.
1.1 Why Pakistan?
Strong financial institutions provide easy access to reliable information that lowers
transaction costs. However, according to World Governance Indicators (WGI), Pakistan is
something of an institutional void[1]. Pakistan currently has listed capital of around
US$12bn and market capitalization of around US$74bn, whereas its listed debt capital is
only US$150m[2]. These figures clearly suggest that Pakistan is a bank-based capital
market which is underdeveloped, and, as such, raising bank debt is easy for firms
compared to raising equity. Higher leverage ratios in Table VII (mean of 0.799 during
VOL. 10 NO. 3 2016 JOURNAL OF ASIA BUSINESS STUDIES PAGE 277
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