The determinants of capital structure: evidence

from selected ASEAN countries

Ng Chin Huat
Bachelor of Accountancy (Hons)
The Northern University of Malaysia
Sintok, Kedah
Malaysia
1995

Submitted to the Graduate School of Business

Faculty of Business and Accountancy
University of Malaya in partial fulfillment
of the requirements for the Degree of
Master of Business Administration

December 2008

The determinants of capital structure: evidence from selected

ASEAN countries
By Ng Chin Huat

Abstract
Corporate structure is an important research area in corporate finance and it remains
the core of literature studies for academicians. However studies had focused on firms
in developed countries and little attention on how firms in developing and emerging
market decide on their capital structure strategy. Therefore this study attempts to fill
the gap by analyzing the capital structure for listed firms in the ASEAN region.

The sample comprises 155 listed companies from four selected ASEAN main stock
exchange index-links components for the period from 2003 to 2007.

The study found profitability and growth opportunities for all selected ASEAN
countries exhibit statistical significant of inverse relationship with leverage whereas
non-debt tax shield has significant negative impact on leverage as for Malaysia index
link companies only. Firm size gave a positive significant relationship for Indonesia
and Philippine index link companies. As for the four country-effect factors; stock
market capitalization and GDP growth rate show significant relationship with
leverage while bank size and inflation indicate insignificant impacts on leverage.

ii

Acknowledgements

To my beloved family and friends, who have constantly been supportive and
understanding throughout my MBA study, I owe great thanks. Specifically, I owe the
greatest debt to my parents who have been an important motivation for this thesis and
who continually provide role models. This work is devoted to them.

It has also been an enormous challenge to maintain motivation, quality and innovation
within a balanced research dissertation. I would like to record my sincere thanks and
appreciation to my supervisor, Mr. Gurcharan Singh A/L Pritam Singh, for his prompt,
constructive guidance, and continued support given to me during my dissertation
work. Special thank to Dr. Rubi binti Ahmad, my second examiner for her positive
comments.

Finally, I also wish to extend my gratitude and special thanks to the lecturers and staff
of Graduate Business School, University of Malaya for their valuable coaching and
insights throughout my MBA course.

iii

Table of Contents
Abstract ..........................................................................................................................ii
Acknowledgements.......................................................................................................iii
List of Tables ...............................................................................................................vii
List of Symbols and Abbreviations ............................................................................viii
CHAPTER 1: INTRODUCTION..................................................................................1
1.1
Background....................................................................................................1
1.1.1 Overview of ASEAN .................................................................................3
1.2

Problem Statement.........................................................................................4

1.3

Research Questions/Objectives of the Study .................................................6

1.4

Purpose and Significance of the Study ..........................................................8

1.5

Scope of the Study .........................................................................................9

1.6

Limitations of the Study ..............................................................................11

1.7

Organization of the Study ............................................................................12

CHAPTER 2 : LITERATURE REVIEW ..................................................................13

2.0

Chapter Overview ........................................................................................13

2.1

Introduction..................................................................................................13

2.2
Capital structure in a perfect market............................................................15
2.2.1 The Modigliani and Miller Propositions..................................................15
2.3
Capital structure in the real world................................................................16
2.3.1 Trade-off theory.......................................................................................16
2.3.2 Asymmetric information..........................................................................18
2.4.3 Agency Costs ...........................................................................................22
2.4
New development in capital structure .........................................................24
2.4.1 Shocks to the capital structure and adjusting behavior............................24
2.4.2 Dynamic adjustment to target leverage and adjustment speed ................25
2.4.3 Major real investments.............................................................................26
2.4.4 Macroeconomic shocks............................................................................27
2.4.5 Rating.......................................................................................................27
2.4.6 Behavioral corporate finance ...................................................................28
2.5

Related literature on the international capital structure ...............................30

iv

2.5.1 Capital structure around the world: The roles of firm- and countryspecific determinants by De Jong et al. (2008)....................................................30
2.5.2 The determinants of capital structure: evidence from the Asia Pacific
region by Deesomsak et al. (2004). .....................................................................31
2.5.3 Determinants of Capital Structure: Evidence from the G-7 Countries by
Aggarwal and Jamdee (2003). .............................................................................32
2.5.4 Capital structure in developing countries by Booth et al. (2001). ...........34
2.6
Determinants of capital structure.................................................................35
2.6.1 Country-specific determinants.................................................................36
2.6.2 Firm-specific determinants ......................................................................40
2.7

Chapter Summary ........................................................................................45

CHAPTER 3 : RESEARCH METHODOLOGY ......................................................46

3.0

Chapter Overview ........................................................................................46

3.1
Development of Hypotheses ........................................................................46
3.1.1 Profitability ..............................................................................................46
3.1.2 Growth opportunities ...............................................................................47
3.1.3 Non-debt Tax Shield................................................................................48
3.1.4 Firm size ..................................................................................................48
3.1.5 The size of the banking industry and stock market development............48
3.1.6 GDP growth rate. .....................................................................................49
3.1.7 Inflation....................................................................................................49
3.2
Selection Measures ......................................................................................50
3.2.1 Leverage...................................................................................................50
3.2.2 Size of the banking industry and stock market ........................................51
3.2.3 GDP growth rate ......................................................................................52
3.2.4 Inflation....................................................................................................52
3.2.5 Profitability ..............................................................................................52
3.2.6 Firm growth .............................................................................................52
3.2.7 Non-debt Tax Shield................................................................................53
3.2.8 Firm size ..................................................................................................53
3.3

Sampling Design..........................................................................................53

3.4

Data Collection Procedure ...........................................................................56

3.5

Data Analysis Techniques ...........................................................................57

3.6

Chapter Summary ........................................................................................58

CHAPTER 4 : RESEARCH RESULTS ....................................................................59

4.0

Chapter Overview ........................................................................................59

4.1

Summary Statistics ......................................................................................59

4.1.1 Dependent variable (Leverage)................................................................59

4.1.2 Firm-specific independent variables ........................................................60
4.1.3 Fixed country effects analysis of the determinants of leverage in the
selected ASEAN ..................................................................................................62
4.2
Analyses of Measures ..................................................................................63
4.2.1 Test of non-stationary ..............................................................................63
4.2.2 Test of multicollinearity...........................................................................65
4.2.3 Test of autocorrelation .............................................................................66
4.2.4 Test of heteroskedasticity ........................................................................67
4.3
Testing of Hypotheses .................................................................................68
4.3.1 Cross-sectional results for individual countries and firm-specific effects
over the whole sample period ..............................................................................68
4.4

Chapter Summary ........................................................................................74

CHAPTER 5 : CONCLUSION..................................................................................75
5.0

Chapter overview.........................................................................................75

5.1
Discussion and Conclusion..........................................................................75
5.1.1 Summary of findings ...............................................................................75
5.2

Suggestions for Future Research .................................................................79

5.3

Policy implication ........................................................................................80

5.4

Chapter Summary ........................................................................................81

References....................................................................................................................82
Appendix 1: List of Companies Selected ....................................................................91
Appendix 2: Description of Variables and Data Sources ............................................94
Appendix 3: Unit Root Test.........................................................................................95
Appendix 4: Autocorrelaton Test ..............................................................................102
Appendix 5: Decision Rules of Durbin-Watson d Test .............................................105
Appendix 6: Multicollinearity Test............................................................................106
Appendix 7: Whites Heteroskedasticity Test (With Cross Terms) ..........................108
Appendix 8: Final Multiple Regression Results ........................................................109
Appendix 9: Summary of Predictions........................................................................112
Appendix 10: Summary of Hypotheses Testing Results ...........................................113

vi

List of Tables

Table 1.1

Selected Basic ASEAN Indicators

Table 3.1

List of Stock Exchanges in Selected ASEAN Countries

53

Table 4.1

Statistics of Leverage Ratio

59

Table 4.2

Statistics of Firm-specific Independent Variables

60

Table 4.3

Statistic of Country-specific Determinants

62

Table 4.4

Summary Result of Unit Root Test Using ADF

64

Table 4.5

Pairwise Correlation Matrix Between Explanatory Variables

65

Table 4.6

Summary of Durbin-Watson Test

66

Table 4.7

Summary of Whites Test (Cross Terms)

67

Table 4.8

Firm Specific Analysis of Determinants of Leverage

69

Table 4.9

Country Effects Analysis of Determinants of Leverage

72

Table 5.1

Summary of Firm-specific Determinants

75

Table 5.2

Summary of Country-specific Determinants

77

vii

List of Symbols and Abbreviations

ADF

Augmented Dickey-Fuller

ASEAN

Association of South-East Asian Nations

BANK

Private credit by deposit bank over GDP

BLUE

Best linear unbiased estimator

CEO

Chief executive officer

CFO

Chief financial officer

EBIT

Earnings before income tax

EBITDA

Earnings before income tax, depreciation and amortization

G-7

Group of Seven (Canada, France, Germany, Italy, Japan,

United Kingdom and United States of America)

GDP

Gross Domestic Product

GDPRATE

Gross Domestic Product growth rate

GROWTH

Firms growth opportunities

LEVRATIO

Leverage ratio

MM

Modigliani and Miller

NDTS

Non-debt tax shield

INF

Annual inflation rate

OECD

Organization of Economic Co-operation and Development

OLS

Ordinary least square

NPV

Net present value

PROFIT

Profitability

R&D

Research and development

ROA

Return on assets

SIZE

Firm size

STKMKT

Stock market capitalization over GDP

U.S.

United States of America

viii

CHAPTER 1: INTRODUCTION

1.1

Background

For the past fifty years after the influential irrelevance theory of Modigliani and
Miller (1958) on capital structure, academicians have debated rigorously on this
capital structure theory through many empirical studies (example in Harris and Raviv,
1991 in their article The theory of capital structure). In order to approve or dispel
the irrelevance theory, others have studied the determinants of firms capital structure
choices with frictions such as agency signaling costs (Heinkel, 1982; Poitevin, 1989),
bankruptcy (Ross, 1977), taxes (Leland and Toft, 1996), institutional and historical
characteristics of national financial systems (La Porta et al., 1997, 2006; Rajan and
Zingales, 2003), but the understanding of the determinants of national and
international capital structure is still limited and vague (Aggarwal and Jamdee, 2003).

In the early years, firms in United States were the primary source of these research
studies and the coverage was extended to Europe and Japan in mid of 1980s (Kester,
1986; Rajan and Zingales, 1995; Cornelli et al., 1996). In the aftermath of the Asian
financial crisis in 1997, efforts were focused on emerging countries to shed some light
on the factors that caused the turmoil in the region. Despite of this attempt, however,
there have been only a few studies thus far because of the constraints on corporate
financial data in the region (Fan and Wong, 2002; Deesomsak et al., 2004; Driffield et
al., 2007). Moreover, still very little is understood about the determinants of the
firms financial structure outside the United States and major developed countries,
with only a few researches analyzing international data (Rajan and Zingales, 1995;
1

Booth et al., 2001; Antoniou et al., 2002; De Jong et al., 2008). Undoubtedly, there
is not enough evidence on how theories formulated for firms operating in the major
developed markets can be applied to firms outside these markets coupled with
differential in institutional and legal frameworks. Consequently, incomprehensive
conclusions and puzzling questions are left either partially or completely unanswered
in the area of international capital structure. With the pressing globalization trend,
managers of today need to be readily equipped with in-depth knowledge of
international capital structure in strategizing crucial capital structure decisions and
this remains one of the key success factors of their firms survival.

The knowledge of capital structures has mostly been derived from data from
developed economies that have many institutional similarities. The purpose of this
paper is to analyze the capital structure choices made by companies from developing
countries that have different institutional structures. The prevailing view, for example
Mayer (1990) seems to be that financial decisions in developing countries are
somehow different. For example, Mayer (1990) is the most recent researcher to use
aggregate flow of funds data to differentiate between financial systems based on the
"Anglo-Saxon" capital markets model and those based on a "Continental-GermanJapanese" banking model. However, because Mayers data comes from aggregate
flow of funds data and not from individual firms there is a problem with this
approach. The differences between private, public, and foreign ownership structures
have a profound influence on such data, but tell nothing about how profit-oriented
groups make their individual financial decisions.

1.1.1

Overview of ASEAN

The Association of South-East Asian Nations (commonly known as ASEAN) is a

geopolitical and economic organization of ten countries located in South-East Asia,
which was formed on 8 August 1967 by five founding members, namely Indonesia,
Malaysia, Philippines, Singapore and Thailand. Subsequently other member states
joined ASEAN - Brunei (1984), Vietnam (1995), Laos and Myanmar (1997) and
Cambodia (1999). Its main objectives are to accelerate economic growth, social
progress and cultural development in the region; and promote regional peace and
stability. As of 2007, the ASEAN has a population of about 575 million, a total area
of 4.5 million square kilometers, a combined gross domestic product of almost
US$1,282 billion, and a total trade of about US$1,405 billion as shown in Table 1.1.

Table 1.1
Selected Basic ASEAN Indicators

Total land
area
2

km
Country
Brunei
Cambodia
Indonesia
Lao PDR
Malaysia
Myanmar
Philippines
Singapore
Thailand
Viet Nam
ASEAN

Total
population

Growth
rate of
GDP
At
constant
prices

at current
prices

Exports

Imports

Total trade

US$ million

US$ million

GDP

Merchandise trade

Thousand

Percent

US$ million

US$ million

2007
5,765
181,035
1,890,754
236,800
330,252
676,577
300,000
704
513,120
329,315

2007
396
14,475
224,905
5,608
27,174
58,605
88,875
4,589
65,694
85,205

2007
0.6
10.1
6.3
6
6.3
5.6
7.4
9.3
4.8
8.5

2007
12,317.00
8,662.30
431,717.70
4,128.10
186,960.70
12,632.70
146,894.80
161,546.60
245,701.90
71,292.10

2006
7,619.40
3,514.40
100,798.60
402.7
157,226.90
3,514.80
47,410.10
271,607.90
121,579.50
37,033.70

2006
1,488.90
2,923.00
61,065.50
587.5
128,316.10
2,115.50
51,773.70
238,482.00
127,108.80
40,236.80

2006
9,108.30
6,437.40
161,864.10
990.2
285,543.00
5,630.30
99,183.80
510,089.90
248,688.30
77,270.50

4,464,322

575,525

6.5

1,281,853.90

750,708.00

654,097.80

1,404,805.80

(Sources: ASEAN Finance and Macro-economic Surveillance Unit Database and ASEAN Statistical Yearbook 2006, ASEAN
Trade Database as of 18 July 2007, IMF World Economic Outlook Database as of October 2007)

1.2

Problem Statement

Capital structure decision remains one of the important strategies to corporate

manager because it affects firms value. For instance, Damodaran (2001) states that if
the objective in corporate finance is to maximize firm value, then firm value must be
linked to the three decisions: investment, financing and dividend.

Ross (1977)s model suggests that the values of firms will rise with leverage, since
increasing leverage increases the markets perception of value. Suppose there is no
agency problem, i.e. management acts in the interest of all shareholders, the manager
will maximize company value by choosing the optimal capital structure: highest
possible debt ratio. High-quality firms need to signal their quality to the market, while
the low-quality firms managers will try to imitate. According to this argument, the
debt level should be positively related to the value of the firm.

McConnell and Servaes (1995) find that high-growth firms corporate value is
negatively correlated with leverage, whereas for lowgrowth firms corporate value is
positively correlated with leverage.

Stulz (1990) argues that debt can have both a positive and negative effect on the value
of the firm. He develops a model in which debt financing can both alleviate the overinvestment problem and the under-investment problem and assumes that managers
have no equity ownership in the firm and receive utility by managing a larger firm.
The power of manage may motivate the self-interest managers to undertake negative
present value projects. To solve this problem, shareholders force firms to issue debt.

But if firms are forced to pay out funds, they may have to forgo positive present value
projects. Therefore, the optimal debt structure is determined by balancing the optimal
agency cost of debt and the agency cost of managerial discretion.

From the above discussion, it is proven that capital structure is one of the main drivers
for firms value.

However many empirical studies are done in the developed

countries such as United States, Europe and Japan (Rajan and Zingales, 1995;
Cornelli et al., 1996) and only a few research are in the Asia region (Fan and Wong,
2002; Deesomsak et al., 2004; Driffield et al., 2007). Hence the question whether the
capital structure determinants in the developed countries could also be replicated to
developing countries remains ambiguous due to differences in institutional and
historical environments (Jack and Ajit, 2003).

No study has been done using

specifically the ASEANs firms to analyze the capital structure and its determinants.
Even though there are studies focused on national level [Wiwattanakantang (1999) for
Thailand; Suto (2003) for Malaysia; Prasad et al. (2003) for Thailand and Malaysia],
there is no study on cross-country comparison between ASEAN countries.

1.3

Research Questions/Objectives of the Study

In this research, in line with the problem statement as above, a few objectives are
outlined as the guiding principle to this study. The focus of this paper is to on
answering the three questions:

1. Do corporate leverage decisions differ significantly between developing and

developed countries?

Previous studies have mainly focused on the developed countries in analyzing the
capital structure decision but researches in the developing countries are limited. Thus
one of the objectives of this study is to analyze corporate leverage decisions in
ASEAN region as they are in the emerging and developing market. Thereafter the
comparison between developed and developing countries will be done to examine any
significant different in their corporate leverage decisions.

2. Are the factors that affect individual countries capital structures similar between
developed and developing countries?

In this objective, the factors that influence the capital structure in the developed
countries are extended to the developing countries in order to observe any significant
differences among them (Rajan and Zingales, 1995; Booth et al., 2001). In this
context, comprehension of the linkages between both categories will benefit managers
in deciding capital structure strategy in era of globalization.

3. Are the predictions of conventional capital structure models improved by knowing

the nationality of the company?

In this objective, this study tries to determine whether the predictions of capital
structure decisions can be improved by linking the nationality of the company with
the conventional capital structure models. With this knowledge, managers will have a
competitive advantage in formulating their capital structure strategy by knowing the
nationality of the company, particularly in ASEAN members.

In order to answer the above questions, the objectives are geared toward the
following:

(a)

To examine the country-specific determinants such as size of banking

industry, stock market, and GDP growth and inflation in relation to the capital
structure.

(b)

To examine the firm-specific determinants such as profitability, growth

opportunities, non-debt tax shield and size in relation to the capital structure.

(c)

To determine which of the capital structure theories are pertinent to ASEAN

listed companies in order to adopt a more efficient financing mix.

1.4

Purpose and Significance of the Study

The purpose of this study is to examine the determinants of capital structure at both
country and firm levels to further the understanding of the different characteristics of
capital structure in the selected ASEAN countries (Malaysia, Indonesia, Philippines
and Thailand). As each country has its own uniqueness, the results of this study will
be useful in understanding which theories of capital structure are robust to such
differences.

The main contribution of this study is to provide valuable knowledge of cross border
comparison of the capital structure determinants in the context of developing and
emerging markets, in general; and specifically ASEAN to academicians and
practitioners. This is to complement the abundant literatures of capital structure done
in developed countries such as United States and Europe (Auerbach, 1985; Titman
and Wessels, 1988; Rajan and Zingales, 1995; Cornelli et al., 1996; Wald, 1999; Hall
et al., 2004).

In addition, with the most recent data available in this study, the development of
capital structure after the Asian financial crisis could also be evaluated in view of the
changing in financial markets and economic conditions.

Previous studies using Asia Pacific companies are limited and almost none
concentrating in ASEAN countries (published studies include Wiwattanakantang,
1999 for Thailand; Fan and Wong, 2002 and Driffield et al., 2007 for East Asia; Suto,
2003 for Malaysia; Prasad et al., 2003 for Thailand and Malaysia; Cassar and Holmes,
8

2003 and Zoppa and McMahon, 2002 for Australia; Deesomsak et al., 2004 for Asia
Pacific region; Fattouh et al., 2005 for South Korea). Hence this study intends to fill
this gap by analyzing capital structure determinants based on ASEAN countries.

Lastly, the findings of this study may provide valuable insights in term of the
complexity and robustness of capital structure decisions to the corporate managers in
the global market.

1.5

Scope of the Study

In the area of any study, its expected to encounter numerous issues such as the
concentration of field study, data collection and others which are constraint by
available resources like timeframe, monetary and availability of information. This
study is of no exceptions where the scope is limited to the study of capital structure in
the corporate finance field, the sample size and lastly the time period of study. The
detailed of the scope of this study are as follows:

(a)

The sample companies will be selected from the main stock indexes from four

Stock Exchanges in the ASEAN region. The entire population of listed companies in
the four Stock Exchange is 2,131 with total market capitalization of US$837,119
million as at 31 December 2007 (World Federation of Exchanges 2007). However the
sampling is from 275 companies, merely a 13 percent of population but representing
over 70 percent of total capitalization except for Philippine being only 54 percent.

(b)

Four countries representing ASEAN are selected, namely Malaysia, Indonesia,

Philippines and Thailand out of ten countries. The choice of countries is motivated by
several factors. Firstly, they are all being the emerging market where the literature on
determinants of capital structure is limited. Secondly, they are hit severely in the
Asian financial crisis in 1997.

Thirdly, they share the common attributes in

accounting practices, corporate governance and corporate control.

(c)

As for companies selected, only non-financial firms were used. This is due to

the reasons that financial firms such as banks and insurance companies leverage are
strongly influenced by investor insurance schemes. Furthermore, their debt-like
liabilities are not strictly comparable to the debt issued by non-financial firms.
Finally, regulations such as minimum capital requirements may directly affect capital
structure.

(d)

The sample companies are not categorized into industry classification due to

the small sample size.

However as the listed companies are index-linked stocks,

there is requirement for sector representation; hence no further work is performed on

the industry classification effect.

(e)

The study period for the study is five years from year 2003 to 2007. They

represent the most current data available and are obtained from the Bloomberg,
Financial Times and Reuters database. The financial information for last five years
will be extracted for the 155 index link companies from selected ASEAN countries.

10

1.6

Limitations of the Study

As for the limitation, the following are expected:

(a)

The study is restricted to the sampling from stock indexes of the Stock

Exchanges in the four ASEAN countries; the result may be biased towards big and
well established firms and may not be a good representative for the population of the
firms in ASEAN countries taking into account of the fact that there are many small
and medium-sized companies. However this reflects a better representation as having
high percentage in asset capitalization of the firms listed.

(b)

This study has not taken into account the difference in accounting policy

adopted by various countries, in particular the depreciation charges (proxy for nondebt tax shield variable).

However as the companies are public listed companies,

they generally follow the internationally accepted accounting standard in their

accounting policy as required by their reporting country authorities.

(c)

This study has not employed country dummy variables when analyzing the

country-specific factors as to reduce the complexity of the multiple regression

equation as there are four countries involved and to mitigate this problem, pooling of
all listed companies in four countries is used.

(d)

The study period may be too short, i.e. from the year 2003 to 2007.

Nevertheless, this study is to see the immediate effect of the capital structure
decisions after the Asian financial crisis.

11

1.7

Organization of the Study

The remainder of the paper proceeds as follows: Chapter Two will review the main
theoretical framework such as country-specific factors (macroeconomics); and firmspecific determinants affecting capital structure. Chapter Three provides the research
methodology along with the description of the database, data structure, hypotheses
and analysis techniques. In Chapter Four, the results and analysis of this study are
presented. Chapter Five concludes this dissertation as well as suggestions for future
study and policy implementation.

12

CHAPTER 2 :

2.0

LITERATURE REVIEW

Chapter Overview

This chapter will introduce the literature on capital structure. Various theories
associated with capital structure in the perfect market and real world such as
Modigliani and Miller Propositions, Trade-off, Asymmetric Information and Agency
Costs theories will be presented. New developments in the capital structure are also
discussed. Furthermore, two types of determinants of capital structure: countryspecific and firm-specific variables are later discussed.

2.1

Introduction

In corporate finance, capital structure refers to the way a firm finances its investments
through some combination of equity, debt, or hybrid securities (Ross et al., 2007,
page 426). A firm's capital structure is then the composition or the structure of its
liabilities. For example, a firm that sells RM20 million in equity and RM80 million in
debts is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of
debt to total financing is 80% and is referred to as the firm's leverage. In reality,
capital structure may be highly complex and comprises of many sources (Frecka,
2005).

A firm's capital structure has an important influence on the financial

performance and firm efficiency (Ghosh, 2008; Margaritis and Psillaki, 2007).

13

Well, then how should a firm choose its debt to equity ratio? And, what is the optimal
capital structure for a firm? Whether or not an optimal capital structure do exists is an
issue in corporate finance (Myers, 1984; Hatfield et al., 1994).

A firm can choose any capital structure as it wishes. It is the result of deliberate
choice on the corporate management, investors attitudes and market conditions for
long-term funds. A firm could increase or decrease its debt/equity ratio by either
issuing more debt to buy back stock or issuing stock to pay debt. The objective of
managing capital structure is to mix the financial sources used by the firm in a way
that will maximize the shareholders' wealth and minimize the firm's cost of capital.
This proper mix of funds sources is called optimal capital structure (Ross, et al.,
2005).

Haugen and Senbet (1988) argue that capital structure is strongly related to the choice
between internal and external financial instruments. Thus, optimal capital structure
will be impacted by the expected costs of financial distress either direct cost, such as
the costs in the case of bankruptcy, or indirect costs, such as lost of sales. Therefore,
financial distress is an important criterion for capital structure decisions

14

2.2

Capital structure in a perfect market

2.2.1

The Modigliani and Miller Propositions

The Modigliani-Miller (MM) theorem (1958) formed the basis for modern thinking
on capital structure.

Assuming in a perfect capital market (no transaction or

bankruptcy costs; perfect information); firms and individuals can borrow at the same
interest rate; no taxes; and investment decisions aren't affected by financing decisions.
It does not matter if the firm's capital is raised by issuing stock or selling debt and
what the firm's dividend policy is. Therefore, the MM theorem is also often called the
capital structure irrelevance principle.

Modigliani and Miller made two findings under these conditions. Their first
proposition was that the value of a company is independent of its capital structure.
Their second proposition stated that the cost of equity for a leveraged firm is equal to
the cost of equity for an unleveraged firm, plus an added premium for financial risk.
This implies that the firm's debt to equity ratio does not influence its cost of capital. A
firms value is only determined by its real assets, and it cannot be changed by pure
capital structure management. Consequently, it means that there is no optimal capital
structure exists (Ross et al. 2007, pp. 433-440)

However, there is a fundamental difference between debt financing and equity

financing in the real world with corporate taxes as dividends paid to shareholders
derive from the after-tax profits and interest paid to bondholders is out of the beforetax profits commonly recognized as interest tax shield (Graham, 2000; MacKieMason, 1990). Moreover, firms (or their managers) themselves do not believe in the

15

irrelevance of capital structure. For instance, in Graham and Harvey (2001) and
Brounen et al. (2006)s survey on chief financial officers of U.S. and Europe firms
illustrate that the majority of firm managers consider capital structure decisions
important for firm value and that firms have some target debt-equity ratio.

2.3

Capital structure in the real world

The theories below try to address some of the imperfections by relaxing assumptions
made in the MM model such as no taxes, no transactions or distress costs, common
objectives among decision-makers (value maximization) and perfect information.

2.3.1

Trade-off theory

The trade-off theory of capital structure refers to the idea that a company chooses how
much debt finance and how much equity finance to use by balancing the costs and
benefits. It states that there is an advantage to financing with debt, the tax benefit of
debt and there is a cost of financing with debt, the costs of financial distress including
bankruptcy costs of debt and non-bankruptcy costs (e.g. staff leaving, suppliers
demanding disadvantageous payment terms, bondholder/stockholder infighting, etc).
The marginal benefit of further increases in debt declines as debt increases, while the
marginal cost increases, so that a firm that is optimizing its overall value will focus on
this trade-off when choosing how much debt and equity to use for financing (Ross et
al., 2007; Barnea et al., 1981).

16

The empirical relevance of the trade-off theory has often been questioned (Frank and
Goyal, 2003). Miller (1977) and Graham (2000) argue that the tax savings seem large
and certain while the deadweight bankruptcy costs seem minor. This implies that
many firms should be more highly levered than they really are. Myers (1984) was a
particularly fierce critic to trade-off theory because it seemed to rule out conservative
debt ratio by taxpaying firms. Welch (2002) has argued that firms do not undo the
impact of stock price shocks as they should under the basic trade-off theory and so the
mechanical change in asset prices that makes up for most of the variation in capital
structure.

Empirical evidences in the tradeoff theory are extensive. For instance, Bradley et al.
(1984) find that firms optimal leverage is inversely related to the expected costs of
financial distress and to the amount of non-debt tax shields. They also find the highly
significant inverse relation between firm leverage and earnings volatility. According
to Myers (1993), the evidence against the tradeoff theory is the inverse correlation
between profitability and financial leverage and the same finding is substantiated by
Rajan and Zingales (1995) for G7 countries. Titman and Wessels (1988) find a
significant negative relationship between profitability and debt ratios. However, the
tradeoff theory predicts the opposite relationship unless profitable firms incur more
agency costs than less profitable firms as the debt ratio increases. Titman and Wessels
(1988) find no relationship between debt ratios and a firms expected growth, nondebt tax shields, volatility, or the collateral value of its assets.

17

2.3.2

Asymmetric information

Firm managers or insiders are assumed to possess private information about the
characteristics of the firm's return stream or investment opportunities. In one set of
approaches, capital structure is designed to mitigate inefficiencies in the firm's
investment decisions that are caused by the information asymmetry. This branch of
the literature starts with Myers and Majluf (1984) and Myers (1984). In another,
choice of the firm's capital structure signals to outside investors the information of
insiders. This stream of research began with the work of Ross (1977) and Leland and
Pyle (1977). Various approaches to the asymmetric information are discussed in the
following subsections.

2.3.2.1

Pecking order theory

Myers and Majluf (1984) showed that, if investors were less well-informed than
current firm insiders about the value of the firm's assets, then equity may be mispriced
by the market. This underinvestment could be avoided if the firm could finance the
new project using a security that was not so severely undervalued by the market. For
example, internal funds and/or riskless debt involve no undervaluation, and, therefore,
would be preferred to equity by firms in this situation. In addition, Myers (1984)
stated that companies prioritized their sources of financing according to the law of
least effort or resistance. This pecking order theory maintained that businesses adhere
to a hierarchy of financing sources and prefer internal financing when available, and
debt was preferred over equity if external financing was required (Myers, 1984).
18

Pecking order theory tries to capture the costs of asymmetric information. Hence
internal debt is used first, and when that is depleted debt is issued, and when it is not
sensible to issue any more debt, equity is issued. Thus, the form of debt a firm
chooses can act as a signal of its need for external finance. The pecking order theory
was popularized by Myers (1984) when he argued that equity is a less preferred
means to raise capital because when managers (who are assumed to know better about
true condition of the firm than investors) issue new equity, investors believe that
managers think that the firm is overvalued and managers are taking advantage of this
over-valuation. As a result, investors will place a lower value to the equity issuance
as evidenced by equity issue announcements are met with a negative market reaction
(Asquith and Mullins, 1986) and the markets reaction to security issue announcements
are more negative for issues of riskier securities (Hadlock and James, 2002).

The evidences of pecking order theory are as follow. Kester (1986), in his study of
debt policy in U.S. and Japanese manufacturing corporations, finds that the return on
assets is the most significant explanatory variable for actual debt ratios. MacKieMasons (1990) result suggests that the importance of asymmetric information gives a
reason for firms to care about who provides the funds (e.g., between public and
private debt) because different fund providers have different access to information
about the firm and different ability to monitor firm behavior. This is consistent with
the pecking order theory implied by Myers and Majluf (1984) since private debt will
require better information about the firm than public debt. Shyam-Sunder and Myers
(1999) show that firms follow the pecking order in their financing decisions where
firms with a positive financial deficit (a function of dividend payments, net capital

19

expenditure, net changes of working capital and operating cash flows after interest
and taxes) are more likely to issue debt.

The pecking order is found to be much more binding force for small firms and nondividend paying firms, supporting the hypothesis that small firms are more likely to
follow the pecking order because of the difficulty in accessing external financing
sources (Byoun and Rhim 2003).

Tests of the pecking order theory have not been able to show that it is of first-order
importance in determining a firm's capital structure. However, several authors have
found that there are instances where it is a good approximation of reality. Fama and
French (2002) found that some features of the data were better explained by the
Pecking Order than by the Trade-Off Theory. Frank and Goyal (2000) showed, among
other things, that Pecking Order theory fails where it should hold, namely for small
firms where information asymmetry is presumably an important problem.

2.4.2.2

Signaling model

The seminal contribution in this area is that of Ross (1977). In Ross' model, managers
know the true distribution of firm returns, but investors do not. The main empirical
result was that firm value (or profitability) and the debt-equity ratios are positively
related. Managers benefit if the firm's securities are more highly valued by the market
but are penalized if the firm goes bankrupt. Investors take larger debt levels as a
signal of higher quality. Since lower quality firms have higher marginal expected

20

bankruptcy costs for any debt level, managers of low quality firms do not imitate
higher quality firms by issuing more debt.

Heinkel (1982) considered a model on return distribution is assumed to be such that

"higher" quality firms have higher overall value but lower quality bonds (lower
market value for given face value), hence higher equity value and therefore high value
firms issue more debt. Since higher quality firms have higher total value, the result
that they issue more debt is consistent with Ross (1977) result. Another model that
uses debt as a signal is that of Poitevin (1989) which involves potential competition
between an incumbent firm and an entrant. The benefit of debt is that the financial
market places a higher value on the debt financed firm since it believes such a firm to
be low cost. The main result is that issuance of debt is good news to the financial
market.

Several studies exploit managerial risk aversion to obtain a signaling equilibrium in

which capital structure is determined. The basic idea is that increases in firm leverage
allow managers to retain a larger fraction of the (risky) equity. The larger equity share
reduces managerial welfare due to risk aversion, but the decrease is smaller for
managers of higher quality projects. Thus managers of higher quality firms can signal
this fact by having more debt in equilibrium (Leland and Pyle, 1977; Blazenko, 1987).

21

2.4.3

Agency Costs

Corporate managers are the agents of shareholders, a relationship form with

conflicting interests. The separation of management and ownership in a firm causes
the agency problems. Because management and shareholders each attempt to act in
their own self- interests, managers may make decisions that are not in line with the
goal of maximization of shareholders' wealth.

Agency theory, the analysis of such conflicts, is now a major part of the finance
literature. The payout of cash to shareholders creates major conflicts that have
received little attention.

Payouts to shareholders reduce the resources under

managers control, thereby reducing managers power, and making it more likely they
will incur the monitoring of the capital markets which occurs when the firm must
obtain new capital (Easterbrook, 1984; Rozeff, 1982). Financing projects internally
avoids this monitoring and the possibility the funds will be unavailable or available
only at high explicit prices.

Managers have incentives to cause their firms to grow beyond the optimal size.
Growth increases managers power by increasing the resources under their control. It
is also associated with increases in managers compensation, because changes in
compensation are positively related to the growth in sales (Murphy, 1985).

22

There are three types of agency costs which can help explain the relevance of capital
structure as discussed by Smith and Warner (1979):

2.3.3.1

Asset substitution effect

As Debt to Equity increases, management has an increased incentive to undertake

risky (even negative Net Present Value, NPV) projects. This is because if the project
is successful, share holders will receive all the upside, whereas if it is unsuccessful,
then debt holders will receive all the downside. If the projects are undertaken, there is
a chance of firm value decreasing and a wealth transfer from debt holders to share
holders (Zhang, 2006; Gavish and Kalay, 1983).

2.3.3.2

Underinvestment problem

If debt is risky (e.g. in a growth company), the gain from the project will accrue to
debt holders rather than shareholders. Thus, management has an incentive to reject
positive NPV projects, even though they have the potential to increase firm value
(Hirth and Uhrig-Homburg, 2007).

2.3.3.3

Free cash flow

Unless free cash flow is given back to investors, management has an incentive to
destroy firm value through empire building and perks (Jensen, 1986).

23

Jensen and Meckling (1976) argue that these relationships between the agency costs
of debt and the amount of the debt may result in an optima1 capital structure. This
optimal capital structure can be achieved in two distinct ways. First, agency costs of
debt may offset the tax advantage of debt financing. There is a trade-off between the
tax benefits and agency costs since both the tax benefits and agency costs of debt are
positively related to the amount of the debt employed. Secondly, an optimum
proportion of outside debt and equity may be chosen in order to minimize total agency
costs. This is the trade-off between agency costs of debt and agency costs of equity,
even in a world without taxes.

2.4

New development in capital structure

After reviewing the above major theoretical ideas of capital structure from MM
Propositions to the three famous alternative theories, Trade-Off, Pecking Order and
Agency Costs, a brief discussion on the new development in capital structure is
outlined in subsection below.

2.4.1

Shocks to the capital structure and adjusting behavior

Since the existence of firm adjustment behavior to capital structure shocks appears as
the main feature that allows for testing the trade-off versus other theories (Myers,
1984), one important way to learn about capital structure issues is to examine firm
behavior after exogenous shocks. The inherent difficulty is to decide on the

24

exogeneity of economic events. One particularly interesting attempt in the literature to

test for adjustment behavior by Welch (2004) relies on market-value-based leverage
shocks due to stock price changes. The market-value based capital structure changes
with the market price of equity, and therefore at almost any given point in time, given
the volatility of todays equity markets. Welch (2004) examines, whether firms adjust
their capital structures after these shocks to maintain some target debt ratio by issuing
and repurchasing debt and equity. The analysis is based on data of publicly traded U.S.
corporations from the period 1962 to 2000. The Welch (2004) study exemplifies the
basic idea of using exogenous shocks to capital structures to test for firm adjustment
behavior.

2.4.2

Dynamic adjustment to target leverage and adjustment speed

In the dynamic version of the classic trade-off theory, target leverage can be timevarying. If there are deviations from the optimal capital structure, the theory states
that there will be adjustment toward the optimal target. Depending on the costs of
adjustment, target leverage will be adjusted at a different pace (Frank and Goyal,
2008; Titman and Tsyplakov, 2007). The major objective of capital structure research
using dynamic partial adjustment models is then to estimate the speed of adjustment.
Flannery and Rangan (2006) analyze whether U.S. firms indeed have long-run target
capital structures and if so, how fast they adjust to this target. In comparison to prior
studies, they put special emphasis on the econometric methods and the model
specification, emphasizing the need to take the panel nature of the data into account.

25

2.4.3

Major real investments

Another strand of the literature analyzes a fundamentally different shock to capital

structures of firms, but in a dynamic context as well. The studies by Mayer and
Sussman (2005) and Elsas et al. (2007) examine dynamic financing patterns of U.S.
firms when undertake major real investments. Mayer and Sussman (2005) consider
equity and debt issues following spikes in firms investment expenditures, while Elsas
et al. (2007) examine jumps (rather than spikes) in capital expenditures. Both studies
pursue the idea that the exercise of very large real investment options allows to
observe major financing decisions by firms. Moreover, if the major real investment is
more driven by the availability of the investment opportunities rather than the
availability of investment funding, it will constitute an exogenous shock to the sample
firms capital structure.

Another novelty of the above studies is that they rely on an event driven framework
that is particularly suited to analyze adjustment behavior. Also, as pointed out by
Leary and Roberts (2005) and Hovakimian et al. (2004), if adjusting capital structures
entails some fixed cost, firms should be closest to their desired capital structure after
major recapitalizations. Mayer and Sussman (2005) show that external funds are used
before internal funds are exhausted, contradicting a strict pecking order of financing,
though the observed debt preference is consistent. Elsas et al. (2007) show in addition,
that even in the event year, the financing of the major investment moves the firm
strongly towards its target capital structure, in the frequent case, where financing is
predominantly based on debt financing Elsas et al. (2007) also show that stock-price

26

run-ups preceding the major investment strongly increase the likelihood of equity
issues, consistent with market timing behavior.

2.4.4

Macroeconomic shocks

One stream of literature is concerned the impact of macroeconomic conditions on

corporate leverage. Macroeconomic shocks are highly exogenous to the single firm in
the economy. Within their analysis, Hackbarth et al. (2006) provide an overview of
recent theoretical works in this area. In an empirical study, Campello (2003) analyzes
the influence of exogenous shocks in the product market environment on capital
structure, using aggregate demand shocks as a proxy. Campello (2003) finds that debt
financing and relative-to-industry sales growth have a negative relationship in
industries with low industry leverage during recessions, but not during booms. This
effect cannot be observed in industries with high industry leverage. In a further
empirical analysis, Korajczyk and Levy (2003) also examine the impact of
macroeconomic conditions on leverage, controlling for firm-specific variables. They
find financially unconstrained firms issue equity pro-cyclically and debt countercyclically, although the underlying economic rationale remains somewhat unclear.

2.4.5

Rating

The study by Kisgen (2006) emphasizes a determinant of capital structure decisions

that has received only little attention before the rating of companies by external
rating agencies like Moodys or S&P. Kisgen (2006) tries to analyze how the

27

financing behavior of firms is affected if firms are near credit rating upgrades or
downgrades. The basic idea is that under both the trade-off and the pecking order
theory the capital structure depends on the (marginal) costs of debt and equity. Since
rating changes might affect the costs of capital, potential rating changes through
financing decisions can alter the target debt level or the marginal benefit of debt over
equity, rendering the corporate rating a potentially important determinant. Arguably,
this effect will increase when a firm is closer to a rating change. Correspondingly,
Kisgen (2006) analyzes firm financing decisions, when firms are close to rating
changes and finds that these firms issue significantly less debt than other comparable
firms. This finding is robust even if one controls for several differing approaches to
take standard capital structure determinants into account
.
2.4.6

Behavioral corporate finance

In behavioral corporate finance, the assumption of fully rational investors (fully

rational behavior means that all agents in the market have rational expectations and
are expected utility maximizers) and managers is abandoned. Beliefs and preferences
may be non-standard and thus allow for irrational behavior, and theories taking this
into account might lead to new determinants that help improving the understanding of
capital structure determinants (Barberis and Thaler, 2003; Baker et al., 2007). In the
behavioral corporate finance literature, two salient approaches have emerged (Neus
and Walter, 2008). In the irrational investors approach, rational managers are facing
irrational investors. The associated literature basically deals with inefficient markets
and rational managers exploiting mispricing, such as the market timing story of Baker

28

and Wurgler (2002). In the irrational managers approach, it is assumed that not fully
rational managers are operating in efficient markets, i.e. facing rational investors.

Most of the literature in the irrational managers approach focuses on deviations from
rational expectations. There is some evidence from social psychology that individuals
and especially managers have biased beliefs. Some possible distortions in managerial
beliefs emphasized in the behavioral corporate finance literature are optimism and
overconfidence (Barberis and Thaler, 2003).

Ben-David et al. (2007) analyze whether CFOs are overconfident and whether this
has an impact on corporate policies, including capital structure issues. The authors
measure managerial overconfidence based upon stock market predictions made by
CFOs. They use a survey of S&P 500 return forecasts of CFOs between 2001 and
2007. They derive several hypotheses on corporate policies that the financing-related
hypotheses state that overconfident managers perceive their firms equity to be
undervalued by the market, that leverage increases with managerial overconfidence,
and that overconfident managers repurchase shares more often. They find that CFOs
are overconfident, i.e. they underestimate the variance of market returns, because
realized market returns are within the estimated 80 percent confidence intervals only
38 percent of the time.

Malmendier et al. (2007) test capital structure-related hypotheses using two

alternative measures of managerial irrationality. The first hypothesis by Malmendier
et al. (2007) is that overconfident managers prefer debt to equity conditional upon
using external financing, because managers perceive the price of newly issued equity

29

as too low in their model. Their second hypothesis is that managers prefer internal to
external financing unconditionally, which might result in using debt too
conservatively, thus not exploiting the tax benefits optimally. Testing the first
hypothesis, the evidence implies that overconfident CEOs are less likely to issue
equity in comparison to their peers, which supports pecking order financing due to
overconfidence. Malmendier et al. (2007) also find support for their second
hypothesis that overconfident CEOs rely more heavily on internal financing.
Furthermore, they find that the longer a firm is managed by overconfident managers,
the higher is the firm's leverage in the long term.

2.5

Related literature on the international capital structure

This section will discuss in summary on the most recent literatures on capital structure
from the international perspective.

2.5.1

Capital structure around the world: The roles of firm- and countryspecific determinants by De Jong et al. (2008).

The study analyzes the importance of firm-specific and country-specific factors in the
leverage choice of firms from forty two countries around the world for the period
from 1997 to 2001. Their analysis yields two new results. First, they find that firmspecific determinants of leverage differ across countries, while prior studies implicitly
assume equal impact of these determinants. Second, although they concur with the
conventional direct impact of country-specific factors on the capital structure of firms,
30

they show that there is an indirect impact because country-specific factors also
influence the roles of firm-specific determinants of leverage.

The standard firm-specific determinants of leverage like firm size (natural logarithm
of total sales), asset tangibility (net fixed assets over book value of total assets),
profitability (operating income over book value of total assets), firm risk (standard
deviation of operating income over book value of total assets) and growth
opportunities (market value of total assets over book value of total assets) are chosen.
Besides that, large number of country-specific variables in their analysis, including
legal enforcement, shareholder/creditor right protection, market/bank-based financial
system, stock/bond market development and growth rate in a countrys gross domestic
product (GDP). One leverage ratio is used as proxy to capital structure: book value of
long-term debt over market value of total assets calculated as book value of total
assets minus book value of equity plus market value of equity. Two ordinary least
squares (OLS) regression analysis techniques are used in this study, i.e. simple pooled
OLS and weighted least squares regression.

2.5.2

The determinants of capital structure: evidence from the Asia Pacific

region by Deesomsak et al. (2004).

The paper contributes to the capital structure literature by investigating the

determinants of capital structure of firms operating in the Asia Pacific region, in four
countries with different legal, financial and institutional environments, namely
Thailand, Malaysia, Singapore and Australia. The results suggest that the capital
structure decision of firms is influenced by the environment in which they operate, as

31

well as firm-specific factors identified in the extant literature. The financial crisis of
1997 is also found to have had a significant but diverse impact on firms capital
structure decision across the region.

The leverage ratio used in this study is debt to capital ratio as calculated by total debts
over total capital (total debts plus market value of equity plus book value of
preference shares). The determinants are tangibility (total fixed assets over total
assets), profitability (EBITDA over total assets), firm size (natural log of assets),
growth opportunities (book value of total assets less the book value of equity plus the
market value of equity divided by the book value of total assets), non-debt tax shield
(depreciation over total assets), liquidity (ratio of current assets to current liabilities),
earnings volatility (absolute difference between the annual percentage change in
earnings before interest and taxes), and share price performance (the first difference
of the logs of annual share prices, matched to the month of firms fiscal year-end).
Seven country-specific variables, namely the degree of stock markets activity, the
level of interest rates, the legal protection of creditors rights, ownership
concentration, and three country dummies are used. The fixed effect panel and
pooled OLS procedures were used to analyze the relationships with leverage.

2.5.3

Determinants of Capital Structure: Evidence from the G-7 Countries by

Aggarwal and Jamdee (2003).

This study builds on the seminal work of Rajan and Zingales (1995) on the
determinants of capital structure in an international setting. Using the same database
with more recent data, an expanded set of leverage determinants, and improved

32

methodology (panel analysis allowing for time-series and cross-sectional analysis),

this study re-examines both country- and firm-level determinants of capital structure
choices across the G7 countries (US, Japan, UK, Germany, France, Italy, Canada).

First, the overall average leverage in 2001 is lower than in 1991. Second, the
determinants of capital structure traditionally found useful in the U.S. lose some of
their explanatory power overseas. Third, book debt ratios seem on average to depend
positively on tangibility of assets, company size, R&D expenses, and protection of
control rights and negatively on the market to book ratio, profitability, bankruptcy
probability, and market access.

These findings should be of much interest to

managers, investors, and policy makers.

Two measures of leverage based on the adjusted debt to capitalization ratio are used
as the dependent variables, i.e., book and market leverages, which are the ratios of
adjusted debt to adjusted debt plus book or market value. For book leverage equity is
measured at book value and for market leverage it is measured at market value.

This paper examines the time series-cross-sectional regression of debt to book and
debt to market equity against fixed assets (Tangibility), investment opportunities
(Market-to-book ratio), firm size (Log of Sales), Profitability (ROA), the probability
of bankruptcy (Z-Score), uniqueness of product (R&D), equity and/or bond market
accessibility (Market Accessibility), measures of investor protection (Legal origin,
Anti-director), and measures of controlling shareholder rights (Cash-flow rights,
Control rights).

33

2.5.4

Capital structure in developing countries by Booth et al. (2001).

The study analyzes capital structure choices in ten developing countries: India,
Pakistan, Thailand, Malaysia, Turkey, Zimbabwe, Mexico, Brazil, Jordan, and Korea;
for the largest companies in each country from 1980 to 1990. As for the debt ratio,
three ratios are used:

i.

Total debt ratio = Total liabilities / (Total liabilities + Net worth)

ii.

Long-term book-debt ratio = (Total liabilities Current liabilities) / (Total

liabilities - Current liabilities + Net worth)

iii.

Long-term market-debt ratio = (Total liabilities Current liabilities) / (Total

liabilities Current liabilities + Equity market
value)

The macroeconomic variables used are: stock market value/GDP, liquid

liabilities/GDP, real GDP growth rate, inflation rate and Miller tax term. As for the
firm-specific variables are as follow: tax rate (average tax rate), business risk
(standard deviation of ROA), asset tangibility (total assets less current asset divided
by total assets), size (natural logarithm of sales), return on assets (earnings before tax
divided by total assets) and market-to-book ratio (market value of equity divided by
book value of equity). For data analysis, they use the regression analysis with simple
pooling and fixed-effects model.

They find that the variables that are relevant for explaining capital structures in the
United States and European countries are also relevant in developing countries,
despite the profound differences in institutional factors across these developing
countries. By knowing these factors helps predict the financial structure of a firm
34

better than knowing only its nationality. Their finding is consistent with the PeckingOrder Hypothesis and also supports the existence of significant information
asymmetries.

2.6

Determinants of capital structure

A lot of discussion whether or not an optimal capital structure even exists is raised
among academicians. An important concern for researchers is to investigate the
factors that influence the capital structure position of a firm. If analysts have the
ability to find the major determinants of capital structure, managers can make a sound
decision about the capital structure of the firm with the information of those
determinants (Prasad et al. 1997).

In most previous studies, a firms capital structure was usually represented by

financial leverage. According to Rajan and Zingales (1995), there is no clear-cut
definition of leverage in the academic literature and the specific choice depends on
the objective of the analysis. For instance, the agency problems associated with debt
(Jensen and Meckling 1976; Myers 1977) largely relate to how the firm has been
financed in the past, and thus on the relative claims on firm value held by equity and
debt - the relevant measure is probably the stock of debt relative to firm value. Aghion
and Bolton (1992) have focused on leverage as a means of transferring control when
the firm is economically distressed, from shareholders to bondholders. Here, the
important question is whether the firm can meet its fixed payments, and consequently,
a flow measure like the interest coverage ratio is more relevant.

35

As for the definition of leverage, the ratio of total liabilities to total assets is the
broadest one and is used in many empirical studies (Ross et al. 2007). However,
Rajan and Zingales (1995) point out that this definition is inappropriate for financial
leverage since total liabilities include items used for transaction purposes (e.g.,
accounts payable) rather than for financing.

In this study, two major types of variables are looked into: country-specific and firmspecific determinants, in analyzing the impacts on firms leverage choice.

2.6.1

Country-specific determinants

The following literatures specifically examine only the direct impact of country
characteristics on leverage. In an analysis of ten developing countries, Booth et al.
(2001) find that there are differences in the way leverage is affected by countryspecific factors such as GDP growth and capital market development. They conclude
that more research needs to be done to understand the impact of institutional factors
on firms capital structure choices. The importance of country-specific factors in
determining cross-country capital structure choice of firms is also acknowledged by
Fan et al. (2006) who analyze a larger sample of thirty nine countries. They find a
significant impact of a few additional country-specific factors such as the degree of
development in the banking sector, and equity and bond markets.

In another study of thirty OECD countries, Song and Philippatos (2004) report that
most cross-sectional variation in international capital structure is caused by the

36

heterogeneity of firm-specific, industry-specific, and country-specific determinants.

However, they do not find evidence to support the importance of cross-country legal
institutional differences in affecting corporate leverage. Giannetti (2003) argues that
the failure to find a significant impact of country-specific variables may be due to the
bias induced in many studies by including only large listed companies. She analyzes
a large sample of unlisted firms from eight European countries and finds a significant
influence on the leverage of individual firms of a few institutional variables such as
creditor protection, stock market development and legal enforcement. Similarly, Hall
et al. (2004) analyze a large sample of unlisted firms from eight European countries.
They observe cross-country variation in the determinants of capital structure and
suggest that this variation could be due to different country-specific variables.

2.6.1.1

Size of the Banking Industry and Stock Market

The difference in the development of banks versus financial markets has long been
perceived as a possible determinant of capital structure (Mayer, 1990; and Rajan and
Zingales, 1995).

This indicator of banking or market development may cause

differences in the accessibility to external financing by firms in that the monitoring

activities and controls of firms by financial institutions are more available in bankoriented countries where the weight of the banking sector is heavier than that in the
market-oriented countries. This implies that as equity markets become more
developed, they become a viable option for corporate financing and firms make less
use of debt financing. Similarly, countries with a relatively large banking sector are
more likely to be associated with higher private sector debt ratios.

37

The two indicators are credible measures of the overall ability of the private sector to
access capital. Previous studies appear to agree on the negative relation between the
size of stock market and leverage level (Demirguc-Kunt and Maksimovic, 1998 and
1999; Booth, et al. (2001); and Giannetti, 2003). In the article by Demirguc-Kunt,
and Maksimovic (1999), they reported a positive sign for the relation between the
banking sector/GDP and debt to asset ratios (long term debt and short term debt)
when leverages were regressed on the banking sector/GDP variable alone. However,
negative signs are generated once other institutional variables are added in their
models.

2.6.1.2

Gross Domestic Product Growth Rate

The growth rate of GDP is an important macroeconomic variable. If investment

opportunities in an economy are correlated, there should be a relationship between the
growth rate of individual firms and the growth rate of the economy. Thus, the
aggregate growth rate may serve as a control variable in cross-country comparisons of
firm financing choices. As in the case of the variable of the size of the banking sector,
the relation between GDP growth rate and leverage ratios does not seem clear.
Interestingly, contrary to Demirguc-Kunt and Maksimovic (1998), La Porta et al.,
(1997) argue that although GDP growth rate are positively related to indebtedness of a
country, the statistical significances of these results do not carry over once the legal
system is accounted for.

38

Since economy-wide growth opportunities (GDP growth rate) are closely correlated
with firms growth opportunities, firms with large growth opportunities tend to use
less debt in optimality as argue by Myers hypothesis (1977). An alternative
explanation is that mature firms with large economy-wide opportunities may not
require large amounts of external funds, and thus turn out to have lower leverage
levels. This is consistent with the pecking order theory propagated by Myers (1984).
In the contrast, Booth et al. (2001) find that in developing countries, higher economic
growth tends to cause the increase of total book value of debt and long-term book
value of debt ratios whereas higher inflation causes them to decrease.

2.6.1.3

Inflation

Another important factor to be considered is the effect of inflation on the capital

structure because debt contracts are generally nominal contracts and high inflation is
likely to discourage lenders from providing long-term debt (Fan et al., 2006).
DeAngelo and Masulis (1980) argue that inflation leads to more debt since inflation
lowers the real cost of debt, the demand for corporate bonds increases during
inflationary periods. On the other hand, if corporate bonds return becomes higher
relative to stocks return as inflation decreases, the aggregate demand of corporate
bonds increases.

39

2.6.2

Firm-specific determinants

A large number of studies on capital structure have concentrated on figuring out the
determinants affecting the optimality of capital structure and providing theoretical
explanations of the relationships between firm characteristics and capital structure
(Titman and Wessel, 1988; Harris and Rajiv, 1991; Welch, 2002; Frank and Goyal,
2008). Theories developed to explain the optimality of capital structure have been
mainly driven on the basis of bankruptcy costs, agency costs, asymmetric information
as well as debt tax shield effects (Ross, 1977; Myers and Majluf, 1984; Graham,
2000). If the empirical implications of firm-specific determinants of capital structures
differ across countries, they should result in different features of international capital
structure (Fan et al., 2006). Three possibilities are explained as the reasons for the
variations of international capital structure.

First, the theories underlying capital structure could be applicable only to some
countries. For example, agency theory predicts that leverage increases with a decrease
in profitability (negative relationship) (e.g., Kester, 1986; Friend and Hasbrouck,
1988; Titman and Wessels, 1988), whereas asymmetric information theory posits the
reverse relationship (e.g., Heinkel, 1982; Blazenko, 1987; Poitevin, 1989). Therefore,
the effects of firm-specific determinants of capital structure could be different across
countries, and therefore cause variations in international capital structures.

Second, the variations in international capital structure could be caused by differences

in the levels of the determinants of capital structure. Even though the effects of the
determinants on capital structure work more or less in similar ways across countries,
the observed capital structures would differ across countries if the magnitudes of the
40

determinants differ from country to country. For instance, if the average size of firms
in a country is small relative to another country, the mean leverage of firms may differ
across countries (De Jong et al., 2008).

Third, even if the heterogeneities at the level of firm-specific determinants are

controlled for, the cross-country variations in international capital structure could
survive only if the sensitivities of leverage to the changes in the determinants differ
across countries. In fact, this possibility appears to be closely related to institutional
determinants, especially in legal systems (La Porta et al., 1997). For example, if
agency problem, as mentioned above, is not serious in civil-law countries, where
ownership by large shareholders is more common, this legal environment may affect
the sensitivities of leverage to changes in several firm-specific determinants, and
thereby cause variation in international capital structure. In other words, it should be
noted that firm characteristics could be influenced by legal environments; therefore,
the extent to which firm characteristics affect capital structure choice could vary with
legal systems (Gonzales, 2002).

2.6.2.1

Profitability

Corporate performance has also been identified as a potential determinant of capital

structure. The tax trade-off models predict that profitable companies will employ
more debt since they are more likely to have a high tax burden and low bankruptcy
risk. On the other hand, the pecking order theory of finance proposed by Myers (1984)
prescribes a negative relationship between debt and profitability on the basis that
successful companies do not need to depend so much on external funding. They can,

41

instead, rely on their internal reserves accumulated from past profits. The validity of
the two opposing hypotheses is, thus, another issue that needs to be resolved
empirically.

Profitability is measured by normalizing the firm's earnings before interest and taxes
(EBIT) with total assets. Since retained earnings of companies are expected to be
highly correlated with their past profits, the preceding year's EBIT to measure
profitability is chosen. In this way, the proxy also enables the testing of pecking order
hypothesis.

2.6.2.2

Growth opportunities

Higher growth opportunities provide incentives to invest sub-optimally, or to accept

risky projects that expropriate wealth from debt holders (Deesomsak et al. 2004). This
raises the cost of borrowing and thus growth firms tend to use internal resources or
equity capital rather than debt. In addition, high growth firms whose value comes
from intangible growth opportunities do not want to commit themselves to debt
servicing as their revenue may not be available when needed. Therefore, an inverse
relationship between growth opportunity and leverage is predicted, which is
consistent with the prediction of Myers (1977) that firms with a higher proportion of
their market value accounted by growth opportunity will have lower debt capacity.

42

Growth opportunity is defined as the book value of total assets less the book value of
equity plus the market value of equity divided by the book value of total assets or
market-to-book value of total assets.

2.6.2.3

Non-debt tax shield

According to DeAngelo and Masulis (1980), non-debt tax shields are substitutes for
interest or debt-related tax shields; hence non-debt tax shield should empirically show
a negative sign in relation to the leverage ratios. Accordingly to the trade-off theory,
a negative relationship between leverage and non-debt tax shields is postulated.
Similarly, DeAngelo and Masulis (1980) argue that the marginal corporate savings
from an additional unit of debt decreases with increasing non-debt tax shields. This is
because of the likelihood of bankruptcy increases with leverage.

In contrast, Moore (1986) argues that firms with substantial non-debt tax shields
should also have considerable collateral assets which can be used to secure debt. It
has been argued above that secured debt is less risky than unsecured debt. Therefore,
from a theoretical point of view, one could also argue for a positive relationship
between leverage and non-debt shield. In fact, the empirical evidence is mixed. For
example, Shenoy and Koch (1996) find a negative relationship between leverage and
non-debt tax shield, while Gardner and Trcinka (1992) find a positive one.

Non-debt tax shield is calculated as the annual depreciation charges over total assets.

43

2.6.2.4

Size

The trade-off theory postulates a positive relation between firm size and debt, since
larger firms have been shown to have lower bankruptcy risk and relatively lower
bankruptcy cost. In addition, large firms have lower agency costs of debt; relatively
smaller monitoring costs, less volatile cash flows, easier access to credit market, and
require more debt to fully benefit from the tax shield. Bigger firms could have easier
access to capital markets and borrow at more favorable interest rates, perhaps because
they are more diversified in their investments and therefore have a lower risk of
default than smaller firms (Ferri and Jones, 1979; Smith and Watts, 1992). This
suggests a positive relationship between firm size and leverage.

Firm size is

measured by the natural log of revenue.

44

2.7

Chapter Summary

The revolutionary capital structure irrelevance theory of Modigliani and Miller;

assuming in perfect market, capital structure decisions will not affect a firms value,
has been widely accepted by financial scholars. However, alternative theories to
Modigliani and Miller model have been largely debated to counter the imperfect
market such as Trade-off Theory, Asymmetric Information and Agency Cost. In
Trade-off Theory, a manager tries to strike a balance between the benefit and costs of
issuing debts. As for asymmetric information theory, pecking order and signaling
models are the prominent theories where choices of capital structure are mitigated by
the firms inefficiency due to information asymmetry. Lastly, the agency cost theory
corresponds to the conflict between equity holders and managers; and the conflict
between equity holders and debt holders and how it affects the capital structure
decision-making.

Current development to the capital structure such as adjusting

behavior, dynamic model to target leverage, major real investment effect,

macroeconomics shocks, credit rating and behavioral corporate finance are discussed.

In relation to the above theories, the determinants of capital structure are also widely
researched in reaching an optimal capital structure.

Two types of determinants

discussed in this paper are country-specific and firm-specific variables. As for the
country-specific, the indicators selected are the size of banking industry, stock market,
GDP growth rate and inflation. Firm-specific indicators are profitability, growth
opportunities, non-debt tax shield and size of the firm.

45

CHAPTER 3 :

3.0

RESEARCH METHODOLOGY

Chapter Overview

This chapter discuss on the research methodology used in this study. The following
sections will cover the development of hypotheses, selection of measures, sampling
design, data collection procedure and data analysis techniques.

3.1

Development of Hypotheses

A major purpose of this paper is to estimate the relative importance of factors

affecting ASEAN members choice of capital structure.

Financial theory and

empirical results identify a number of variables that influence a firm's debt position in
the context of country and firm levels (Rajan and Zingales, 1995; Booth et. al., 2001;
Deesomsak et. al., 2004; De Jong et. al., 2008).

In order to establish hypotheses about the determinants of capital structure in the

sample, current capital structure theories and existing evidence are discussed as
below:

3.1.1

Profitability

H1: Profitability has a negative effect on leverage.

46

Myers (1984) suggests that companies may have a 'pecking order' and prefer internal
financing to external financing. In other word, companies will have a hierarchy of
financing from retained earnings (accumulated net profit), debts and equity. Titman
and Wessels (1988) show profitability had a negative impact on the leverage of
United States companies during the period of 1974-1982.

3.1.2

Growth opportunities

H2: Growth opportunities have a significant effect on leverage.

There are two different arguments about how growth rate affects leverage. Since
growth can enhance the firms' borrowing ability in the future, this would suggest that
growth increases firms assets, and therefore higher leverage. Gupta (1969) suggests
that a company with rapid growth will tend to finance the expansion with debt. Thus,
this study suggests that rapidly growing firms should have higher leverage. But
Myers (1977) argue that firms with higher growth rates tend to use less and or short
term debt in their capital structure to reduce the agency costs. Titman and Wessels
(1998) also note that firms usually attempt to invest in suboptimal projects in order to
transfer wealth from bondholders. Since costs related to this type of agency problem
is higher in rapidly growing firms, then firms use less debt in order to avoid this cost.
For this reason, growth rate should have a negative relationship with debt.

47

3.1.3

Non-debt Tax Shield

H3: Non-debt tax shield has a negative effect on leverage.

As predicted by the Trade-off Theory, a major motivation for using debt instead of
equity is to save corporate tax. However, firms can use non-debt tax shields such as
depreciation to reduce corporate tax. Thus, a higher non-debt tax shield reduces the
potential tax benefit of debt and hence it should be inversely related to leverage.
Previous studies that support this relationship can be found in DeAngelo and Masulis
(1980), Rajan and Zingales (1995) and Deesomsak et al. (2004).

3.1.4

Firm size

H4: Firm size has a positive effect on leverage.

The trade-off theory claims a positive relation between firm size and debt, since larger
firms have been shown to have lower risk and relatively lower bankruptcy cost
(Myers, 1984). Therefore, firm size is expected to have a positive impact on leverage
consistent with the studies by Marsh (1982) and Rajan and Zingales (1995).

3.1.5

The size of the banking industry and stock market development.

H5: The size of banking industry has a positive effect on leverage.

H6: Stock market structure has a negative effect on leverage.

There are two sources of financing for a firm, either in debt and equity or hybrid of
both. Hence the above macroeconomic variables are important in determining the
accessibility of fund to a firm. Demirguc-Kunt and Maksimovic (1999) and Booth et

48

al. (2001) reported a positive sign for the relation between the banking sector/GDP
and debt to asset. As for stock market factor, Demirguc-Kunt and Maksimovic (1998,
1999); Booth, et al. (2001); and Giannetti (2003) found a negative correlation
between size of stock market and leverage level.

3.1.6

GDP growth rate.

H7: The GDP growth rate has a significant effect on leverage.

The empirical evidences on the relationship between the GDP growth rate and capital
structure are not definite because some findings show different results. La Porta et al.
(1997) and De Jong et al. (2008) show a positive relationship between GDP growth
rate and leverage. On the contrary, however in Demirguc-Kunt and Maksimovic
(1998), a negative effect of GDP growth on leverage is found.

3.1.7

Inflation

H8: The inflation has a significant effect on leverage.

Empirical studies have found mixed results of the effect of inflation on capital
structure.

For example, Homaifa et al. (1994) find a positive relationship between

leverage and inflation as inflation reduces the real cost of employing debt via the
erosion of the repayment of the principal. However, the studies by Booth et al. (2001)
and Fan et al. (2006) show that insignificant relationship between leverage and
inflation but leverage is positively related to economic development.

49

3.2

Selection Measures

The selection measures for dependent variable (leverage; which is proxy to capital
structure) and independent variables (country and firm-specific) are detailed as below.

3.2.1

Leverage

The broadest definition of leverage is the ratio of total debt to total assets. It provides
insight to a firm's policy for both short-term debt and long-term debt. Ferri and Jones
(1979) used this leverage measure in their empirical studies. They argue that as a firm
increases its use of debt, its financial leverage and risk also increases. This ratio can
also be viewed as a proxy of what will be left for shareholders in the case of
liquidation. However, Rajan and Zingales (1995) argue that total debt may overstate
the level of leverage. Total debt includes accounts payable that may be used for
transaction purpose rather than for financing. Thus, it is not a good indicator of
whether the firm is at risk of default in the near future. According to these authors, a
more appropriate definition of leverage is the ratio of long tem debt to total assets.

Another issue to be considered is whether to use book value or market value.

According to Titman and Wessels 1998, market value of debt is a better measure than
book value of debt. As Harris and Raviv (1991) argue, the choice of measures for
both leverage and the explanatory variables is crucial, as it may affect the
interpretation of the results. Rajan and Zingales (1995) also show that the
determinants of capital structure are sensitive to the measure of leverage. The measure
of leverage based on the market value of equity, rather than the book value, was
50

finally chosen as it gave more theoretically consistent results, in line with

Wiwattanakantang (1999), Suto (2003) and Deesomsak et al. (2004).

In this study, the leverage ratio, the dependent variable, is measured as:

Debt to total asset ratio =

3.2.2

Total debts
Total debts + market value of equity

Size of the banking industry and stock market

BANK = size of the banking industry

STKMKT = size of stock market

The magnitude of banking sector in a given country is measured by the ratio of the
assets of domestic banks to GDP (BANK) [Joeveer, 2006; Song and Philippatos,
2004; Demirguc-Kunt and Maksimovic, 1999].

The variable of size of equity

market used in this research is the stock market capitalization divided by GDP
(STKMKT) [De Jong et al., 2008; Joeveer, 2006; Booth et al., 2001]. The source of
data is taken from The World Bank: A New Database on Financial Development and
Structure.

51

3.2.3

GDP growth rate

The GDP growth rate is defined as the average of annual real GDP growth rate (unit
in percentage) of each country, averaged through 20002007 (Source: Euromonitor
International). [De Jong et al., 2008; Frank and Goyal, 2003; Booth et al., 2001]

3.2.4

Inflation

Inflation rate used in this study is defined as annual inflation rate (in percentage) of
each country (Source: Euromonitor International). [Booth et al., 2001; Jose, 2001 and
Fan et al., 2006]

3.2.5

Profitability

Profitability is measured by normalizing the firm's earnings before interest and taxes
(EBIT) with total assets. [De Jong et al., 2008; Deesomsak et al., 2004; Aggrawal and
Jamdee, 2003; Booth et al., 2001]

3.2.6

Firm growth

Firm growth is defined as the total assets minus book equity plus market equity over
book total assets (or market-to-book value of total assets). [De Jong et al., 2008;
Deesomsak et al., 2004; Aggrawal and Jamdee, 2003]

52

3.2.7

Non-debt Tax Shield

Non-debt tax shield is measured by the depreciation expense over book value of total
assets during the sample period. [Deesomsak et al., 2004; Song and Philippatos, 2004]

3.2.8

Firm size

Firm size defined as the natural logarithm of total revenue. [De Jong et al., 2008;
Aggrawal and Jamdee, 2003; Booth et al., 2001]

3.3

Sampling Design

The sample will be based on the index-linked to the stock exchange of the four
selected ASEAN countries as shown in Table 3.1 which will be discussed as follow:

Table 3.1
List of Stock Exchanges in Selected ASEAN Countries
Country

Stock Exchange
(SE)

Index

Number of
component

Total listed
companies

Total Market
Capitalization
(in USD million)

% of index
from total
market
capitalization

Malaysia

Bursa Malaysia

KLCI

100

983

325,290

70%

Indonesia

Indonesia SE

LQ-45

45

383

211,693

70%

Philippine

Philippine SE

PSEi

30

242

103,007

54%

Thailand

Stock Exchange

SET100

100

523

197,129

80%

of Thailand
(Source: Annual report and statistics 2007, World Federation of Exchanges; Thomson Reuters)

53

Four countries representing ASEAN are selected, namely Malaysia, Indonesia,

Philippines and Thailand out of ten countries. The choice of countries is motivated by
several factors. Firstly, they are all are the emerging market where the literature on
determinants of capital structure is limited. Secondly, they are hit severely in the
Asian financial crisis in 1997.

Thirdly, they share the common attributes in

accounting practices, corporate governance and corporate control.

Brief descriptions of the stock indexes which act as proxy to the stock exchanges are
illustrated as below:

The Kuala Lumpur Composite Index (KLCI) is a stock market index generally
accepted as the local stock market barometer. It was introduced in 1986 to answer the
need for a stock market index which would serve as an accurate performance
indicator of the Malaysian stock market as well as the economy. It contains 100
companies from the Main Board and is a capitalization-weighted index.

LQ 45 is a stock market index for the Indonesia Stock Exchange. The LQ 45 index
consists of 45 companies that fulfill certain criteria, which are: (a) included in the top
60 companies with the highest market capitalization in the last 12 months; (b)
included in the top 60 companies with the highest transaction value in a regular
market in the last 12 months; (c) have been listed in the Indonesia Stock Exchange for
at least 3 months; and (d) have good financial conditions, prospect of growth and high
transaction value and frequency.

It is calculated semi-annually by research &

development division of Jakarta Stock Exchange.

54

The PSE Composite Index, commonly known previously as the PHISIX and presently
as the PSEi, is the main stock market index of the Philippine Stock Exchange. The
PSEi is the most watched index on the PSE and is also home to most major Philippine
companies listed on the PSE. The PSEi is also the PSE's only broad-base index. It is
also one of the indicators on the general state of the Philippine economy.

SET100 is one of the main stock market indexes of The Stock Exchange of Thailand
which is launched for the purpose of accommodating the issuing of index futures and
options in the future, and to provide a benchmark of investment. The index is
calculated from the stock prices of the top 100 listed companies in the SET Index; in
terms of large market capitalization, high liquidity and complies with the requirement
regarding the distribution of shares to minor shareholders, etc. The calculation method
used for this index is the same as that used for the SET Index which is a market
capitalization weighted index.

Besides that, only non-financial companies are selected for the sample from the stock
indexes due to the reasons that financial firms such as banks and insurance
companies leverage are strongly influenced by explicit (or implicit) investor
insurance schemes such as deposit insurance. Furthermore, their debt-like liabilities
are not strictly comparable to the debt issued by non-financial firms. Finally,
regulations such as minimum capital requirements may directly affect capital
structure.

Lastly, only companies with a track record of continuous five years financial data are
selected for the sample companies.

55

3.4

Data Collection Procedure

Firm-specific and country-specific determinants are the two major types of variables
used in analyzing the impacts on firms leverage choice.

The firms in the sample cover four selected ASEAN countries in the emerging and
developing markets, namely Malaysia, Indonesia, Philippine and Thailand. Data for
leverage and firm-specific variables are collected from Bloomberg, Financial Times
and Reuters database. In the sample, financial companies are excluded. Data on
country-specific variables are collected from a variety of sources, mainly World
Development Indicators and Financial Structure Database of the World Bank and
Euromonitor International.

The sample period covers the years 20032007. One of the requirements is that the
firms in the sample must have at least five years of available data over the study
period. This timeframe is selected to gauge the aftermath effect of the Asian financial
crisis in 1997 on the capital structure decisions. The selection of a time-period
involves a trade-off between the number of countries that can be included in the study
and the availability of enough firm-specific data. Whenever needed, some other
sources to collect any missing data are looked into. It is still impossible to obtain data
for each and every variable from all four countries during this time period.

Firstly, all the most recent components of listed companies included in the stock
exchange indexes are collected and initial total sample size is 275 companies.
However, out of this, financial companies make up of forty eight companies are

56

eliminated from the sample which leaves only 227 companies.

Companies not

meeting the requirement of five-years are seventy two companies. The final sample
consists of 155 firms. In the sample, for companies with different fiscal years, the
absolute year is taken into account. Example, companies with a fiscal year of 31
March 2007, and then year 2007 was considered for simplicity purpose.

3.5

Data Analysis Techniques

Ordinary-least-squares (OLS) regressions are employed to determine whether

relations exist between leverage ratio and determinants.

Eviews 6.0 software

developed by Quantitative Micro Software is used to analyze the OLS regressions.

Two regression equations is used to test the hypotheses which are looking at firmspecific determinants (PROFIT, GROWTH, NDTS and SIZE) and later add the
country-specific determinants (BANK, STK, GDP and INF) to the first equation.

The model of regression equation is as follows:

(1) Leverage = + 1 PROFIT + 2 GROWTH + 3 NDTS + 4 SIZE +
(2) Leverage = + 1 PROFIT + 2 GROWTH + 3 NDTS + 4 SIZE +
5 BANK+ 6 STKMKT + 7 GDPRATE + 8 INF +

Where = constant, 1 to 8 = coefficient of explanatory variables,

PROFIT = Profitability; GROWTH = Growth opportunities; NDTS =non-debt tax
shield; SIZE = firm size; BANK = size of banking industry; SKTMKT = size of stock
market; GDPRATE = GDP growth rate; and INF = annual inflation rate. is the error
term

57

The first regression equation is to determine the firm-specific factors influencing

leverage in the individual countries whereas the second regression is to examine the
country effect on the leverage. This approach is consistent with previous studies as in
Deesomsak et al. (2004) and Song & Philippatos (2004).

3.6

Chapter Summary

The hypotheses developed for this study are to analyze the relationship between
capital structure and its determinants such as country-specific (size of banking
industry and stock market, GDP growth rate and inflation rate) and firm-specific
variables (profitability, growth opportunities, non-debt tax shield and firm size). The
final sample companies are taken from the main stock indexes of four selected
ASEAN members Stock Exchanges for the five years period from 2003 to 2007 and
later the data are analyzed using the ordinary least squares regression.

58

CHAPTER 4 :

4.0

RESEARCH RESULTS

Chapter Overview

This chapter will discuss on the results of the study.

Firstly, a brief general

description of the summary statistics on the dependent and independent variables of

capital structure and follows by analyses of measures of determinants of capital
structure.

Secondly, the hypotheses which discussed in Chapter 3 is tested and

examined. The chapter ends with a summary of research results.

4.1

Summary Statistics

This section will analyze the simple statistics description of dependent and
independent variables of the regression model.

4.1.1

Dependent variable (Leverage)

Table 4.1
Statistics of Leverage Ratio

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jacque-Bera
Chi-square at 95% significance

MALAYSIA
0.24
0.19
0.87
0.00
0.20
0.84
2.85
38.81
5.99

INDONESIA
0.20
0.15
0.86
0.00
0.20
1.51
5.36
70.72
5.99

PHILIPPINE
0.28
0.21
0.81
0.00
0.22
0.91
2.85
10.39
5.99

THAILAND
0.30
0.27
0.89
0.00
0.20
0.50
2.54
13.26
5.99

Note: Leverage ratio is market debt-to-total assets ratio which is computed by total debts over market value of total assets (total
assets minus book value equity plus market value equity).

59

From Table 4.1, the leverage ratios for the four selected ASEAN members are
relatively moderate with average ratio ranging from 0.20 to 0.30.

Thailand has the

highest leverage ratio with 0.30, follow by Philippine (0.28), Malaysia (0.24) and
Indonesia (0.20) with standard deviation in the range of 0.20. On the skewness, all
leverage ratios are skew to the right, indicating that the most of the leverage ratios are
on the lower range. As for the kurtosis measure, all countries except Indonesia have
kurtosis value of normal distribution pattern (value at three). Looking at the formal
test of normality (using Jacque-Bera), all leverage ratios show non-normality of error
term and hence transformation of square root is performed for leverage variable.

4.1.2

Firm-specific independent variables

Table 4.2 shows the statistics of all independent variables such as profitability, growth
opportunities, non-debt tax shield and firm size for selected ASEAN countries.

Table 4.2
Statistics of Firm-specific Independent Variables
MALAYSIA
Mean
Median
Maximum
Minimum
Std. Dev.

INDONESIA
Mean
Median
Maximum
Minimum
Std. Dev.

PROFIT
0.11
0.09
0.84
-0.64
0.12

GROWTH
1.98
1.40
20.79
0.40
2.04

NDTS
0.04
0.03
0.44
0.00
0.05

SIZE
5.89
5.85
9.05
2.49
1.31

PROFIT
0.23
0.18
1.03
-0.03
0.19

GROWTH
3.57
2.37
22.29
0.62
3.76

NDTS
0.06
0.05
0.23
0.02
0.04

SIZE
6.57
6.47
8.82
4.21
1.00

60

Table 4.2 continued

PHILIPPINE
Mean
Median
Maximum
Minimum
Std. Dev.

THAILAND
Mean
Median
Maximum
Minimum
Std. Dev.

PROFIT
0.31
0.16
2.71
-0.04
0.49

GROWTH
1.80
1.60
5.48
0.52
1.12

NDTS
0.06
0.06
0.18
0.00
0.04

SIZE
5.94
6.03
8.71
3.27
1.51

PROFIT
0.12
0.10
0.49
-0.31
0.11

GROWTH
2.06
1.52
9.72
0.40
1.40

NDTS
0.06
0.05
0.29
0.00
0.05

SIZE
5.68
5.50
10.49
1.82
1.41

Note:
PROFIT is operating income over total assets. GROWTH is the growth opportunities, calculated by market-tobook total assets. NDTS is the non-debt tax shield, calculated by depreciation over total assets. SIZE is natural
logarithm of total revenue.

From Table 4.2, among the selected ASEAN countries, the ranking for profitability,
which is computed by operating income over total assets, from most profitable to least
profitable is Philippine (0.31), Indonesia (0.23), Thailand (0.12) and Malaysia (0.11).
As for the growth opportunities, measured by market to book of total assets, Indonesia
is the highest having a mean of 3.57 mean follow by Thailand 2.06, Malaysia 1.98
and Philippine 1.80. As for the non-debt tax shield, being measured by depreciation
expense over total assets, all countries have a ratio of ranging from 4 to 6 percent. As
for the size as it is measured in natural logarithm of revenue, all countries have a
means of approximately 5.68 to 6.57, which translated into revenue of approximately
of USD300 to 700 million.

61

4.1.3

Fixed country effects analysis of the determinants of leverage in the

selected ASEAN

This section will analyze the country-specific determinants over leverage and the
detailed analysis is discussed as below. First the description statistic of the countryspecific is shown in Table 4.3.

Table 4.3
Statistic of Country-specific Determinants

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis

BANK
0.86
0.94
1.26
0.17
0.37
-0.87
2.20

STKMKT
0.86
0.68
1.52
0.14
0.50
0.08
1.34

GDPRATE
0.06
0.06
0.07
0.04
0.01
0.18
1.87

INF
0.04
0.03
0.13
0.01
0.03
1.73
6.18

(Source: World Development Indicators and Financial Structure Database of the World Bank, Euromonitor
International,)

From the above Table 4.3, the bank size (BANK) for selected ASEAN countries,
measured by the private credit by deposit money banks to GDP, has a mean of 0.86,
stock market size (STKMKT), measured by stock market capitalization to GDP, mean
of 0.86, GDP growth rate (GDPRATE) ranging from minimum 4 percent to 7.3
percent and inflation rate (INF), in annual growth percentage, ranging from 1 percent
to 13 percent with mean of 4 percent.

According to Gujarati (2003, page 203), several important assumptions need to be met
in order to operate within the framework of the classical linear regression model (or

62

Gauss-Markov theorem) such as zero mean value of disturbance (ui), no serial

correlation, homoscedasticity, zero covariance between ui and each X variables, no
specification bias and no exact collinearity between X variables.

With these

assumptions, the inference from hypotheses testing results will only be valid and
unbiased. The following Section 4.2 will examine whether the regression model from
the study complies with the required assumptions of Gauss-Markov theorem.

4.2

Analyses of Measures

This section will discuss whether the regression model is unbiased by running test of
non-stationary, multi-collinearity, autocorrelation and heteroskedasticity.

4.2.1

Test of non-stationary

As the variables in the regression model are time-series based, hence it is important to
test for non-stationary time series so that the model is unbiased.

The basic

characteristics of stationary is that the mean reverting around a constant long-run

mean and constant variance which time-invariant. The main reason for stationary is
that if the variables in the regression model are not stationary, then it can be proved
that the standard assumptions for asymptotic analysis will not be valid. In other words,
the usual t-ratios will not follow a t-distribution, and hence cannot validly undertake
hypothesis tests about the regression parameters. The unit roots test of Augmented
Dickey-Fuller (ADF) test is performed to assess existence of non-stationary (please

63

refer to Appendix 3 for detail results). A summary result is presented in Table 4.4
below:

Table 4.4
Summary Result of Unit Root Test Using ADF

Variables

Malaysia

Indonesia

Philippine

Thailand

LEVRATIO

Stationary

Stationary

Stationary

Stationary

PROFIT

Stationary

Stationary

Stationary

Stationary

GROWTH

Stationary

Stationary

Stationary

Stationary

NDTS

Stationary

Stationary

Stationary

Stationary

SIZE

Stationary

Stationary

Non-stationary

Stationary

Note:
LEVRATIO is the leverage ratio. PROFIT is operating income over total assets. GROWTHTA is the growth opportunities,
calculated by market-to-book value of total assets. NDTS is depreciation over total assets. SIZE is natural logarithm of total
revenue. , confidence level at 0.05.

From the above, only size variable from Philippine is non-stationary. According to
Gujarati (2003, page 798), if a time series is nonstationary, the study of its behavior is
valid only for the time period under consideration. As a consequence, it is not
possible to generalize it to other time periods and therefore, for the purpose of
forecasting, such nonstationary time series may be of little practical value. Gujarati
(2003, page 820) further suggests to transform nonstationary into stationary time
series by first difference stationary method. Hence further testing of first difference
yields a stationary result, so as for the size variable for Philippine will be taking the
first difference of size as substitute variable.

64

4.2.2

Test of multicollinearity

Multicollinearity means that there is linear relationship between explanatory variables

which may cause the regression model biased (Gujarati, 2003, page 342). In order to
conduct test of multicollinearity, pairwise correlation matrixes between the
explanatory variables are used.

Table 4.5
Pairwise Correlation Matrix between Explanatory Variables

PROFIT

GROWTH

NDTS

PROFIT

MY: 1.00
IJ: 1.00
PM: 1.00
TH: 1.00

GROWTH

MY: 0.64
IJ: 0.81
PM: 0.05
TH: 0.54

MY: 1.00
IJ: 1.00
PM: 1.00
TH: 1.00

NDTS

MY: 0.11
IJ: -0.01
PM: 0.25
TH: 0.48

MY: 0.22
IJ: -0.11
PM: 0.41
TH: 0.48

MY: 1.00
IJ: 1.00
PM: 1.00
TH: 1.00

SIZE

MY: 0.11
IJ: 0.26
PM: 0.18
TH: 0.18

MY: -0.06
IJ: 0.12
PM: 0.07
TH: -0.12

MY: 0.18
IJ: 0.14
PM: 0.41
TH: 0.18

SIZE

MY: 1.00
IJ: 1.00
PM: 1.00
TH: 1.00

Note:
MY = Malaysia, IJ = Indonesia, PM = Philippine and TH = Thailand

From Table 4.5 above, there is no strong pairwise correlation between the explanatory
variables (PROFIT, GROWTH, NDTS and SIZE) except for profitability and growth
in Malaysia and Indonesia.

As a rule of thumb, intercorrelation among the

65

independents above 0.80 signals a possible multicollinearity problem (Leahy, 2000).

However this high correlation is acceptable because a higher profitable firm has
higher growth opportunities due to the fact that the firm can use the internal fund for
expansion. As concluding analysis, all variables have low correlation power and this
implies no multicollinearity problem in selected ASEAN countries.

4.2.3

Test of autocorrelation

Autocorrelation is where a systematic pattern in the errors that can be either attracting
(positive) or repelling (negative) autocorrelation (Gujarati, 2003 pages 441-490). For
efficiency (accurate estimation or prediction) all systematic information needs to be
incorporated into the regression model. For testing autocorrelation, Durbin-Watson
test is employed.

Table 4.6
Summary of Durbin-Watson Test

K, degree of freedom
Durbin-Watson d stat
DL
Du
Conclusion

Malaysia Indonesia Philippine

4
4
4
2.14
1.81
1.98
1.80
1.64
1.54
1.84
1.75
1.71
No autocorrelation

Thailand
4
1.76
1.77
1.82
Mild positive
autocorrelation

Note: , significance level = 0.05

A summary of the Durbin-Watson test is depicted in Table 4.6. From the Table 4.6,
all countries except Thailand have no autocorrelation problem as D-W value is above
du. As for Thailand, since the mild positive first order autocorrelation is detected, no
further adjustment to the regression model is required.

Breusch-Godfrey Serial
66

Correlation LM Test also reaffirmed no serial correlations in the residuals of the

regression equation (refer Appendix 4 for detail test).

Pandey (2002) found

autocorrelation problem affecting the estimates of variables but his basic conclusions
about the effects of variables remain as predicted and generally consistent with the
fixed firm and time effect model.

The remedies for autocorrelation are using

generalized least square method and also to re-specification the regression equation
by include lagged variables and dummies (particularly if working with seasonal data)
[Gujarati, 2003 page 475].

4.2.4

Test of heteroskedasticity

Heteroskedasticity is a systematic pattern in the errors where the variances of the

errors are not constant (Gujarati, 2003 page 387-428). Heteroskedasticity make
ordinary least squares estimators not efficient because the estimated variances and
covariances of the coefficients, are biased and inconsistent and thus tests of
hypotheses are no longer valid.

The method of testing heteroskedasticity is by

Whites Test as presented in Appendix 7.

Table 4.7
Summary of Whites Test (Cross Terms)
Malaysia

Indonesia

Philippine

Thailand

White test statistic, nR2

71.03

50.87

26.43

73.80

At = 0.05, c2 (14)

23.68

23.68

23.68

23.68

Conclusion

Heteroskedasticity detected.

Note:
n = observations, R2 = coefficient of determination, = significant level, c2 = chi-square

67

A summary of the test is shown in Table 4.7. All the regression equations have
heteroskedasticity problem. Hence the remedy is to use the White heteroskedasticity
corrected standard errors regression equations to correct this heteroskedascity
problem.

The non-confirmation of normality was addressed and the results follow are after
considering the correction for the non-normality problem.

4.3

Testing of Hypotheses

This section will discuss the testing of the hypotheses results using the regression
equation model.

First, the firm-specific determinants of capital structure on

individual countries will be discussed. Second, all the firm-specific determinants will
be pooled from all countries including the country-specific determinants to investigate
the country effects on the capital structure.

4.3.1

Cross-sectional results for individual countries and firm-specific effects

over the whole sample period

Table 4.8 shows the multiple regression result for selected ASEAN countries. The
analyses of the firm specific variables are as follows.

68

Table 4.8
Firm Specific Analysis of Determinants of Leverage

Variables
Constant
Profitability
Growth opportunities
Non-debt tax shield
Size
R-squared
Adj. R-squared
Note:
(i)
(ii)
(iii)

Malaysia
0.60 **
(11.30)
-0.16
(-0.83)
-0.04 **
(-3.25)
-0.52 **
(-2.58)
-0.01
(-0.85)
0.24
0.23

Indonesia
0.35 **
(3.29)
-0.67 **
(-4.20)
-0.01
(-1.33)
-0.13
(-0.50)
0.03 *
(2.09)
0.45
0.43

Philippine
0.72 **
(28.40)
-0.05 **
(-2.81)
-0.12 **
(-7.16)
-0.03
(-0.11)
0.04 **
(6.40)
0.76
0.75

Thailand
0.78 **
(22.25)
-0.48 **
(-4.18)
-0.08 **
(-7.94)
-0.19
(-0.79)
-0.01
(-1.03)
0.57
0.56

Dependent variable is square root of leverage ratio

* denotes significant at 5% level and ** denotes significant at 1% level
Parentheses is the t-statistic

Regression equation:
Malaysia:
Leverage = 0.60 0.16 PROFIT 0.04 GROWTH 0.52 NDTS 0.01 SIZE +
(SE)
(0.05)
(0.20)
(0.01)
(0.20)
(0.01)
R2 = 0.24
Indonesia:
Leverage = 0.35 0.67 PROFIT 0.01 GROWTH 0.13 NDTS + 0.03 SIZE +
(SE)
(0.11)
(0.16)
(0.01)
(0.26)
(0.02)
2
R = 0.45
Philippine:
Leverage = 0.72 0.05 PROFIT 0.12 GROWTH 0.03 NDTS + 0.04 SIZE +
(SE)
(0.02)
(0.02)
(0.02)
(0.27)
(0.01)
2
R = 0.76
Thailand:
Leverage = 0.78 0.48 PROFIT 0.08 GROWTH 0.19 NDTS 0.01 SIZE +
(SE)
(0.04)
(0.11)
(0.01)
(0.24)
(0.01)
R2 = 0.57
Note: SE = Standard error, R2 = coefficient of determination

69

4.3.1.1

Profitability with leverage

The relationship between profitability and leverage is found to be negative as

excepted for all countries; statistically significant for Indonesia, Philipine and
Thailand but insignificant for Malaysia.

The negative and significant result is

consistent with the predictions of the pecking order theory, showing that firms prefer
to use internal sources of funding when profits are high. In most previous studies
(Rajan and Zingales, 1995; Booth et al., 2001; De Jong et al., 2008), they report a
significant negative effect of profitability on leverage. Thus, the evidence of this
inverse relationship supports H1 in Indonesia, Philippine and Thailand but rejected in
Malaysia.

4.3.1.2

Growth opportunities with leverage

Growth opportunities have a negative relationship with leverage and statistically

significant for all countries with the exception of Indonesia. It is also consistent with
Deesomsak et al. (2002) except De Jong et al. (2008) who found a positive
relationship with the four countries.

The negative relationship supports the

predictions of the agency theory that high growth firms use less debt since they do not
wish to expose themselves to possible restrictions imposed by lenders. From this
finding, H2 is supported strongly by high t-statistic for all countries except Indonesia.

70

4.3.1.3

Non-debt tax shield with leverage

As for the non-debt tax shield, inverse relationship with leverage is found for all firms
in selected ASEAN countries. Only Malaysia firms show a statistically significant
result on this variable and are consistent with previous study of Deesomsak et al.
(2004). This negative association supports the tax-based model that suggests that the
major benefit of using debt financing is corporate tax deduction. Therefore, firms that
have higher non-debt tax shields are likely to use less debt. Thus, H3 is supported by
the finding of this study in Malaysia but rejected in Indonesia, Philippine and
Thailand.

4.3.1.4

Size with leverage

The relationship between size and leverage is ambiguous as Indonesia and Philippine
give positive correlation whereas Malaysia and Thailand yield negative correlation.
From the Table 4.8, Indonesia and Philippine are found to have statistical significance
results.

In previous studies (Wiwattanakantang, 1999; Booth et al., 2001; Pandey,

2002 and Prasad et al., 2003), they show significant relationship with positive
correlation. The trade-off and agency theories suggest that larger firms tend to have
better borrowing capacity relative to smaller firms. Larger firms tend to be more
diversified and fail less often, so size (computed as the logarithm of revenue) may be
an inverse proxy for the probability of bankruptcy. If so, size should have a positive
impact on the supply of debt. Based on the significant relationship, H4 is supported in
Indonesia and Philippine but rejected in Malaysia and Thailand.

71

Table 4.9
Country Effects Analysis of Determinants of Leverage

Variable

Coefficient

t-Statistic

0.77 *

10.10

PROFIT

-0.10 **

-2.51

GROWTH

-0.05 *

-7.63

NDTS

-0.70 *

-4.95

SIZE

0.01

1.14

BANK

0.06

1.38

STKMKT

-0.10 *

-4.54

GDPRATE

-2.29 *

-2.69

INF

-0.29

-0.66

R-squared

0.35

Adjusted R-squared

0.34

CONSTANT

Note:
(i) Dependent variable is square root of leverage ratio
(ii) * denotes significant at 5% level and ** denotes significant at 1% level

From Table 4.9, two country-specific determinants (STKMKT and GDPRATE) show
statistically significant (at alpha one percent) relationship with leverage. Even though
the R-squared is 35 percent, the F-statistic of 50 indicating the four country-specific
variables as group variables significantly influences the leverage.

Bank size has insignificant relationship with leverage as banks are more prudent in
lending after the financial crisis and this result is consistent with the finding by Fan et
al. (2006). As for the stock market development, it can provide alternative source of
funding to firms other than borrowing from banks or bond market. Hence stock
market size does impact negatively with leverage. This finding is consistent with

72

previous studies by Deesomsak et al. (2004) and Song and Philippatos (2004). Based
on this finding, H5 is rejected and H6 is accepted.

GDP growth rate variable yields a negative impact on leverage and the coefficients
are significant at 1% level.

In contrast to Booth (2001), he found a positive

correlation between real GDP growth rate and total debt ratio but negatively with
long-term market debt ratio in developing countries.

However in Song and

Philippatos (2004) who study the OECD countries, the above relationship is
negatively correlated. This finding indicates that in countries with relatively higher
rate of economic growth, firms are using lower levels of debt to finance new
investments. Evidenced by high t-statistic, H7 is supported

Inflation has yielded insignificant relationship with leverage and hence no conclusion
could be deduced from this finding. As compared to the study by Homaifa et al.
(1994), they find a positive relationship between leverage and inflation as the real cost
of debt is reduced by the inflation effect. In contrast, the finding by Booth et al.,
(2001) in analyzing capital structure in ten developing countries has found
insignificant relationship between leverage and inflation and this finding is consistent
with the study by Fan et al. (2006) on thirty nine developed and developing countries.
As concluding analysis, H8 is not supported by the regression result.

73

4.4

Chapter Summary

After testing

for the

non-stationary,

multicollinearity,

autocorrelation

and

heteroskedasticity, non-stationary variable (i.e. size variable in Philippine) and

heteroskedasticity problems detected. Remedies to the problems are by using the first
difference method (for non-stationary) and White heteroskedasticity corrected
standard errors (for heteroskedasticity) regression equation respectively. The multiple
regression analysis for both firm-specific and country-specific are presenting
interesting results. Leverage ratio as a whole for selected ASEAN countries has a
mean of between twenty to thirty percent of total assets in market value. As expected,
the firm-specific determinants of capital structure such as profitability, growth
opportunities, non-debt tax shield and firm size do have significant relationship with
leverage (proxy for capital structure) but with varying degree of influence. The
significant relationship between profitability, growth opportunities and non-debt tax
shield and size with leverage indicate the agency cost, pecking order and trade-off
theory are valid in selected ASEAN.

As for the country-specific determinants of capital structure, finding from this study is
stock market development and real GDP growth rate have significant relationship
with leverage but banking size and inflation show insignificant effects on leverage.

74

CHAPTER 5 :

5.0

CONCLUSION

Chapter overview

This chapter will cover the summary of findings and conclusion of this study and
suggestions for future research are also included. Lastly this chapter ends with the
possible implications of this research.

5.1

Discussion and Conclusion

This section discusses the summary of findings and conclusion for this study.

5.1.1

Summary of findings

The discussion on the summary of findings is subdivided into two subsections

comprising firm-specific and country-specific determinants as follow:

5.1.1.1

Firm-specific determinants of capital structure

Table 5.1
Summary of Firm-specific Determinants
COUNTRIES

LEVERAGE

PROFIT

GROWTH

NDTS

SIZE

Malaysia

0.24

0.11

1.98

0.04

5.89

Indonesia

0.20

0.23

3.57

0.06

6.57

Philippine

0.28

0.31

1.80

0.06

5.94

Thailand

0.30

0.12

2.06

0.06

5.68

Note: PROFIT=Profitability, GROWTH=Growth opportunities, NDTS= Non-debt tax shield, SIZE= Firm size

75

From the descriptive statistic (Table 5.1), leverage ratio for the selected ASEAN
countries is moderate, at the range from twenty to thirty percent of total assets. In
summarizing the firm-specific determinants, Philippine firms have the highest return
on asset (31 percent), follow by Indonesia (23 percent), Thailand (12 percent) and
Malaysia (11 percent). As for the growth opportunities, Indonesia rank highest (3.57
times) comparing market to book value of total assets and other three countries have
approximately 2 times market-to-book total assets. The non-debt tax shield (proxy is
depreciation charge) for all countries range from four to six percent of total assets. As
for the size, all firms have averaged revenue of USD300 to 700 million.

The

technique employed to test the hypotheses is by using multiple regression method.

But before testing the hypotheses, in order to obtain the best linear unbiased estimator
(BLUE) numerous tests are conducted such as non-stationary, multicollinearity,
autocorrelation and heterosdecasticity.

In the hypotheses testing, the four countries yield different results in term of their
coefficient and significant level between the independent variables (PROFIT,
GROWTH, NDTS, SIZE) and dependent variable (LEVRATIO).

As for the

profitability (PROFIT), the inverse relationship with leverage is as expected but only
statistically significant for Indonesia, Philippine and Thailand. This finding shows
that higher profitable firms use less debt to finance their investment which means
pecking order theory at work. Firms will use hierarchy of funds such as internal fund,
follow by debt and equity. For the growth opportunities (GROWTH), a negative
relationship with leverage is found for all countries and all show statistically
significant results except Indonesia. This means that higher growth firms tend to use
less debt signaling agency costs theory (asset substitution effect) is an important

76

theory in developing countries. The trade-off theory is also justifiable in developing

countries looking at the non-debt tax shield (NDTS)s negativity correlation with
leverage. As non-debt tax shield has the cost-benefit effect on firms, higher non-debt
tax shield will reduce the impact on debt. Lastly, firm size (SIZE) has ambiguous
relationship with leverage where two countries show positive relationship (Indonesia
and Philippine) and the other two show negative relationship (Malaysia and Thailand)
but only the former show statistical significant.

5.1.1.2

Country-specific determinants of capital structure

Table 5.2
Summary of Country-specific Determinants
DESCRIPTION

BANK

STKMKT

GDPRATE

INF

Mean

0.86

0.86

0.06

0.04

Coefficient

0.06

-0.10

-2.29

-0.29

Probability

0.17

0.00

0.01

0.51

Note: BANK=Banking size, STKMKT=Stock market size, GDPRATE=GDP growth rate, INF=Inflation rate

In analyzing the country-specific determinants, the means of banking size and stock
market capitalization over GDP are both 0.86 and the selected ASEAN countries are
growing at 6 percent annually for five years period. The average inflation rate is at 4
percent.

This study finds that the selected country effect of STKMKT and

GDPRATE have statistical significant relationship with leverage. Larger banking size
(BANK) has insignificant effect on leverage and stock market development as
alternative source of funding to debt gives negative impact on leverage. The real
GDP growth rate (GDPRATE) has negative impact on leverage judging from the high
correlation between firms growth and GDP growth rate.

Due to the marginal

77

differential of inflation rate in selected ASEAN countries, the inflation effect in

reducing the cost of debt for the firm to borrow is at negligible level, hence rendering
inflation (INF) as insignificant factor on leverage.

5.1.1.3

Conclusion

Capital structure remains an important and significant issue for academicians and
corporate managers. This area has been researched by many prominent scholars,
namely Modigliani and Miller, Stewart Myers, Stephen Ross, Michael Jensen and
William Meckling. However capital structure has been studied extensively in the
developed countries but only few researches focus on developing countries. In this
research, the main objective is to study capital structure in the context of selected
ASEAN member states; Malaysia, Indonesia, Philippine and Thailand and to
determine the factors that influence capital structure.

Scholars in trying to understand and decipher capital structure have come out with
many theories. Among the famous theories are Modigliani and Miller propositions,
Trade-off, Asymmetric Information and Agency Costs. After reviewing the theories
involved in capital structure, the determinants of capital structure are also researched
mainly in Titman and Wessels (1988), Harris and Raviv (1991) and Frank and Goyal
(2003). In this study, two types of determinants are examined, namely firm-specific
and country-specific factors in order to understand cross nations comparison. A total
of eight variables are selected from previous studies: profitability, growth

78

opportunities, non-debt tax shield and size [firm specific], bank size and stock market
development, GDP growth rate and inflation rate [country specific].

This study covers four selected ASEANs stock exchanges and only non-financial
firms are selected from their main stock indexes. The index-link are Kuala Lumpur
Composite Index (Malaysia), LQ 45 (Indonesia), PSE Composite Index (Philippine)
and SET100 (Thailand). The final sample size is 155 firms comprising Malaysia (65),
Indonesia (23), Philippine (15) and Thailand (52). The period under review is for five
years from 2003 to 2007. These stock-index link firms are capitalization-weighted
index representing 54 to 80 percent of market capitalization.

As a concluding remark, this research finds that the factors that influence the
developed and developing counties are similar and as predicted by existing theories of
capital structure. However in acknowledging the influence of other pertinent factors
like corporate governance, legal framework and institutional environment of the
countries; capital structure decision is not only the product of firms own
characteristics but also the macroeconomics environment in which the firm operates.

5.2

Suggestions for Future Research

As direction for future research, researcher can assess the real impact of Asian
financial crisis by examining pre- and post-crisis period which will give indication of
any changes in capital structure decisions. In addition, other important variables
could be added besides the firms characteristics like corporate governance, legal

79

framework and managers risk behaviour (in disciple of behaviour finance). Another
suggestion is to include a more representative sample by selecting middle and small
size firms and not only based on capitalization-weight. It will be interesting to
explore the diversity of capital structure decisions in large, medium and small listed
companies.

5.3

Policy implication

The results of the study are deemed to benefit the following primary users:

(a)

External investors and shareholders who will be able to know the main
variables that affect the capital structure and to observe firms performance
before making the decisions of whether or not to buy or sell the stocks.

(b)

Professional managers who can consider these determinants of capital

structure to establish the optimal financing vehicle that helps achieve the
company's objectives.

(c)

Lenders who may find the results useful in evaluating the firms performance
in the light of these variables before giving loans, with particular emphasis on
the level of risk involved.

(d)

Academicians who may have an insight into the management thinking and
their perception of the capital structure, and its major determinants.

80

5.4

Chapter Summary

This section concludes this dissertation with the summary findings of firm-specific
and country-specific determinants of capital structure. Firm-specific determinants
such as profitability, growth opportunities, non-debt tax shield and firm size have
different impact on capital structure of selected ASEAN countries.

As for the

country-specific factors under study: stock market capitalization and GDP growth rate
have revealed significant influence on capital structure with the exception of banking
industry size and inflation rate. A few suggestions for future research on this study
are examining pre and post crisis period of Asian financial crisis, broaden the
explanatory variables spectrum and more representative sample firms. This research
may benefit several groups such as external investors and shareholders; professional
managers; lenders and finally academicians in their related interests such as
investment, financing, lending and knowledge.

81

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Structure: Evidence from European Countries, Working Paper, University of
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90

Appendix 1: List of Companies Selected

MALAYSIA

ANN JOO RESOURCES BHD

MULPHA INTERNATIONAL BHD

BANDAR RAYA DEVELOPMENTS BHD

MULTI-PURPOSE HOLDINGS BHD

BERJAYA SPORTS TOTO BHD

ORIENTAL HOLDINGS BHD

BOUSTEAD HOLDINGS BHD

PADIBERAS NASIONAL BHD

BRITISH AMERICAN TOBACCO (M) BHD

PETRA PERDANA BHD

CARLSBERG BREWERY MALAYSIA BHD

PETRONAS DAGANGAN BHD

DIALOG GROUP BHD

PETRONAS GAS BHD

DIGI.COM BHD

PLUS EXPRESSWAYS BHD

DRB-HICOM BHD

POS MALAYSIA BHD

GAMUDA BHD

PPB GROUP BHD

GENTING BHD

PROTON HOLDINGS BHD

HAP SENG CONSOLIDATED BHD

PUNCAK NIAGA HOLDINGS BHD

IGB CORPORATION BHD

SARAWAK ENERGY BHD

IJM CORPORATION BHD

SCOMI GROUP BHD

IOI CORPORATION BHD

SELANGOR PROPERTIES BHD

KFC HOLDINGS (M) BHD

SIME DARBY BHD

KUALA LUMPUR KEPONG BHD

SP SETIA BHD

KULIM (M) BHD

STAR PUBLICATIONS (M) BHD

KUMPULAN PERANGSANG SELANGOR BHD

SUNRISE BHD

LAFARGE MALAYAN CEMENT BHD

SUNWAY CITY BHD

LANDMARKS BHD

TA ANN HOLDINGS BHD

LINGUI DEVELOPMENT BHD

TAN CHONG MOTOR HOLDINGS BHD

LION DIVERSIFIED HOLDINGS BHD

TANJONG PLC

LION INDUSTRIES CORPORATION BHD

TELEKOM MALAYSIA BHD

MALAYSIA AIRPORT HOLDINGS BHD

TENAGA NASIONAL BHD

MALAYSIAN AIRLINE SYSTEM BHD

TOP GLOVE CORPORATION BHD

MALAYSIAN BULK CARRIERS BHD

UCHI TECHNOLOGIES BHD

MALAYSIAN PACIFIC INDUSTRIES BHD

UMW HOLDINGS BHD

MALAYSIAN RESOURCES CORPORATION BHD

WCT ENGINEERING BHD

MEDIA PRIMA BHD

WTK HOLDINGS BHD

MISC BHD

YTL CORPORATION BHD

MK LAND HOLDINGS BHD

MMC CORPORATION BHD
MTD INFRAPERDANA BHD

91

Appendix 1 (Continued)

THAILAND

AAPICO HITECH PLC

SANSIRI PCL

ADVANCED INFO SERVICE PLC

SC ASSET CORPORATION PCL

BANGKOK DUSIT MEDICAL SERVICES PLC

SHIN SATELLITE PCL

BANGKOK EXPRESSWAY PLC

SIAM CEMENT PCL

BANGKOK LAND PCL

SIAM CITY CEMENT PCL

BANPU PCL
BEC WORLD PCL

SIAM MAKRO PCL

SINO THAI ENGINEERING AND
CONSTRUCTION PCL

BUMRUNGRAD HOSPITAL PLC

SUPALAI PCL

CAL-COMP ELECTRONICS (THAILAND) PLC

THAI AIRWAYS INTERNATIONAL PCL

CENTRAL PATTANA PCL

THAI PLASTIC AND CHEMICALS PCL

CH KARNCHANG PCL

THAI UNION FROZEN PRODUCTS PCL

CHAROEN POKPHAND FOODS PCL

THORESEN THAI AGENCIES PCL

DELTA ELECTRONICS (THAILAND) PCL

TICON INDUSTRIAL CONNECTION PCL

DYNASTY CERAMIC PCL

TIPCO ASPHALT PCL

ELECTRICITY GENERATING PCL

TPI POLENE PCL

GOLDEN LAND PROPERTY DEVELOPMENT PCL

TT&T PCL

HEMARAJ LAND AND DEVELOPMENT PCL

VANACHAI GROUP PCL

HOME PRODUCT CENTER PCL

ITALIAN-THAI DEVELOPMENT PCL
LAND & HOUSES PCL
LOXLEY PCL
LPN DEVELOPMENT PCL
MAJOR CINEPLEX GROUP PCL
PADAENG INDUSTRY PCL
POWER LINE ENGINEERING PCL
PRECIOUS SHIPPING PCL
PTT EXPLORATION & PRODUCTION PCL
PTT PCL
QUALITY HOUSES PCL
RATCHABURI ELECTRICITY GENERATING
HOLDING PCL
REGIONAL CONTAINER LINES PCL
ROBINSON DEPARTMENT STORE PCL
ROJANA INDUSTRIAL PARK PCL

SAHA-UNION CORPORATION PCL

SAHAVIRYA STEEL INDUSTRIES PCL

92

Appendix 1 (Continued)

INDONESIA

PHILIPPINE

ANEKA TAMBANG (PERSERO) TBK

AYALA LAND INC

APEXINDO PRATAMA DUTA TBK

FILINVEST LAND INC

FIRST PHILIPPINE HOLDINGS
CORPORATION

ASTRA AGRO LESTARI TBK

ASTRA INTERNATIONAL TBK
BERLIAN LAJU TANKER TBK

GLOBE TELECOM INC

INTERNATIONAL CONTAINER TERMINAL
SERVICES INC

BIMANTARA CITRA TBK

JG SUMMIT HOLDINGS INC

BUMI RESOURCES TBK

GUDANG GARAM TBK

JOLLIBEE FOODS CORPORATION

LEPANTO CONSOLIDATED MINING
COMPANY A

HM SAMPOERNA TBK

MANILA ELECTRIC COMPANY

INDAH KIAT PULP & PAPER TBK

INDOCEMENT TUNGGAL PRAKASA TBK

MEGAWORLD CORPORATION
PHILIPPINE LONG DISTANCE TELEPHONE
COMPANY

INDOFOOD SUKSES MAKMUR TBK

ROBINSONS LAND CORPORATION

INDOSAT TBK
INTERNATIONAL NICKEL INDONESIA
TBK

SAN MIGUEL CORPORATION A

KALBE FARMA TBK

UNIVERSAL ROBINA CORPORATION

SM PRIME HOLDINGS INC

MEDCO ENERGI INTERNATIONAL TBK

PERUSAHAAN GAS NEGARA (PERSERO)
TBK
RAMAYANA LESTARI SENTOSA TBK
SEMEN GRESIK (PERSERO) TBK
TAMBANG BATUBARA BUKIT ASAM TBK
TELEKOMUNIKASI INDONESIA TBK
UNILEVER INDONESIA TBK
UNITED TRACTORS TBK

93

Appendix 2: Description of Variables and Data Sources

Attributes

Proxy Variables

Expected Relations
with Leverage

Leverage
(LEVRATIO)

Total debts to market

value of total assets

Bloomberg,
2003 to 2007

Profitability
(PROFIT)

Operating income
before tax/total assets

Bloomberg,
2003 to 2007

Growth opportunities
(GROWTH)

Market-to-book value
of total assets

+ or -

Bloomberg,
2003 to 2007

Non-debt tax shield

(NDTS)

Depreciation/
total assets

Bloomberg,
2003 to 2007

Firm size
(SIZE)

Natural Logarithm of
revenue

Bloomberg,
2003 to 2007

Bank industry size

(BANK)

Private credit by
deposit bank over GDP

Stock market size

(STKMKT)

Stock market
capitalization over
GDP

Real growth rate in GDP

(GDPRATE)

Annual real growth rate

in GDP

Inflation
(INF)

Annual inflation rate

(% growth)

Source of Data

The World Bank:

A New Database
on Financial
Development and
Structure
The World Bank:
A New Database
on Financial
Development and
Structure

+ or -

Euromonitor
International

Euromonitor
International

94

Appendix 3: Unit Root Test

MALAYSIA
Null Hypothesis: LEVRATIO has a unit root
Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=16)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Malaysia

t-Statistic

Prob.*

-18.73602
-3.986636
-3.423755
-3.134863

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: PROFIT has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic based on SIC, MAXLAG=16)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Malaysia

t-Statistic

Prob.*

-10.51925
-3.986725
-3.423799
-3.134888

0.0000

t-Statistic

Prob.*

-10.78545
-3.986725
-3.423799
-3.134888

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: GROWTH has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic based on SIC, MAXLAG=16)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level
*MacKinnon (1996) one-sided p-values.

95

Appendix 3 (Continued)

Null Hypothesis: NDTS has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic based on SIC, MAXLAG=16)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Malaysia

t-Statistic

Prob.*

-9.832031
-3.986725
-3.423799
-3.134888

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: SIZE has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=16)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Malaysia

t-Statistic

Prob.*

-18.97079
-3.986636
-3.423755
-3.134863

0.0000

*MacKinnon (1996) one-sided p-values.

INDONESIA
Null Hypothesis: LEVRATIO has a unit root
Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Indonesia

t-Statistic

Prob.*

-10.25692
-4.040532
-3.449716
-3.150127

0.0000

*MacKinnon (1996) one-sided p-values.

96

Appendix 3 (Continued)

Null Hypothesis: PROFIT has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Indonesia

t-Statistic

Prob.*

-9.881290
-4.040532
-3.449716
-3.150127

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: GROWTH has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Indonesia

t-Statistic

Prob.*

-11.30504
-4.040532
-3.449716
-3.150127

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: NDTS has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=12)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Indonesia

t-Statistic

Prob.*

-14.23818
-4.040532
-3.449716
-3.150127

0.0000

*MacKinnon (1996) one-sided p-values.

97

Appendix 3 (Continued)

Null Hypothesis: SIZE has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 6 (Automatic based on SIC, MAXLAG=12)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Indonesia

t-Statistic

Prob.*

-7.337435
-4.045236
-3.451959
-3.151440

0.0000

*MacKinnon (1996) one-sided p-values.

PHILIPPINE

Null Hypothesis: LEVRATIO has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 2 (Automatic based on SIC, MAXLAG=11)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Philippine

t-Statistic

Prob.*

-4.030167
-4.090602
-3.473447
-3.163967

0.0119

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: PROFIT has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic based on SIC, MAXLAG=11)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Philippine

t-Statistic

Prob.*

-4.588642
-4.088713
-3.472558
-3.163450

0.0022

*MacKinnon (1996) one-sided p-values.

98

Appendix 3 (Continued)

Null Hypothesis: GROWTH has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=11)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Philippine

t-Statistic

Prob.*

-11.37433
-4.086877
-3.471693
-3.162948

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: NDTS has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 11 (Automatic based on SIC, MAXLAG=11)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Philippine

t-Statistic

Prob.*

-7.228196
-4.110440
-3.482763
-3.169372

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: SIZE has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 11 (Automatic based on SIC, MAXLAG=11)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Philippine

t-Statistic

Prob.*

-2.148303
-4.110440
-3.482763
-3.169372

0.5093

*MacKinnon (1996) one-sided p-values.

99

Appendix 3 (Continued)

Null Hypothesis: D(SIZE) has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 11 (Automatic based on SIC, MAXLAG=11)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Philippine

t-Statistic

Prob.*

-4.257593
-4.113017
-3.483970
-3.170071

0.0067

*MacKinnon (1996) one-sided p-values.

THAILAND

Null Hypothesis: LEVRATIO has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 9 (Automatic based on SIC, MAXLAG=15)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Thailand

t-Statistic

Prob.*

-6.563194
-3.995189
-3.427902
-3.137310

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: PROFIT has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 2 (Automatic based on SIC, MAXLAG=15)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Thailand

t-Statistic

Prob.*

-11.17386
-3.994167
-3.427407
-3.137018

0.0000

*MacKinnon (1996) one-sided p-values.

100

Appendix 3 (Continued)

Null Hypothesis: GROWTH has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic based on SIC, MAXLAG=15)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Thailand

t-Statistic

Prob.*

-13.39062
-3.993885
-3.427271
-3.136938

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: NDTS has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 4 (Automatic based on SIC, MAXLAG=15)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Thailand

t-Statistic

Prob.*

-7.124791
-3.994453
-3.427546
-3.137100

0.0000

*MacKinnon (1996) one-sided p-values.

Null Hypothesis: SIZE has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic based on SIC, MAXLAG=15)

Augmented Dickey-Fuller test statistic

Test critical values:
1% level
5% level
10% level

Thailand

t-Statistic

Prob.*

-12.80327
-3.994026
-3.427339
-3.136978

0.0000

*MacKinnon (1996) one-sided p-values.

101

Appendix 4: Autocorrelaton Test

1. Durbin-Watson Test
MALAYSIA
Dependent Variable: LEVRATIO
Method: Least Squares
Sample: 1 325
Included observations: 325

PROFIT
GROWTH
NDTS
SIZE
C
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

-0.226092
-0.029627
-0.478385
-0.007529
0.388277

0.107510
0.006590
0.201247
0.007898
0.047689

-2.102987
-4.495439
-2.377101
-0.953288
8.141840

0.0362
0.0000
0.0180
0.3412
0.0000

0.205352
0.195419
0.178319
10.17526
101.7232
20.67356
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.239427
0.198798
-0.595220
-0.537007
-0.571987
2.137931

INDONESIA
Dependent Variable: LEVRATIO
Method: Least Squares
Sample: 1 115
Included observations: 115

PROFIT
GROWTH
NDTS
SIZE
C
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

-0.611794
-0.001941
-0.553181
0.029745
0.190330

0.142001
0.007028
0.393330
0.016031
0.102940

-4.308378
-0.276197
-1.406402
1.855407
1.848941

0.0000
0.7829
0.1624
0.0662
0.0672

0.357862
0.334512
0.162087
2.889933
48.63476
15.32570
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.201762
0.198691
-0.758865
-0.639520
-0.710424
1.811628

102

Appendix 4 (Continued)

PHILIPPINE
Dependent Variable: LEVRATIO
Method: Least Squares
Sample: 1 75
Included observations: 75

PROFIT
GROWTH
NDTS
SIZE
C
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

-0.021542
-0.129649
-0.155956
0.064836
0.145772

0.034055
0.016053
0.445414
0.011876
0.070599

-0.632577
-8.076494
-0.350136
5.459347
2.064804

0.5291
0.0000
0.7273
0.0000
0.0426

0.610359
0.588094
0.139505
1.362324
43.89070
27.41312
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.280392
0.217366
-1.037085
-0.882586
-0.975395
1.976395

THAILAND
Dependent Variable: LEVRATIO
Method: Least Squares
Sample: 1 260
Included observations: 260

PROFIT
GROWTH
NDTS
SIZE
C
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

-0.519659
-0.077195
0.189764
-0.007404
0.551423

0.104378
0.008160
0.228998
0.006669
0.041081

-4.978626
-9.459792
0.828671
-1.110210
13.42292

0.0000
0.0000
0.4081
0.2680
0.0000

0.507624
0.499901
0.140277
5.017803
144.2756
65.72433
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.298721
0.198362
-1.071351
-1.002876
-1.043823
1.763259

103

Appendix 4 (Continued)

2. Breusch-Godfrey Serial Correlation LM Test

MALAYSIA
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

1.913310
1.937675

Prob. F(1,319)
Prob. Chi-Square(1)

0.1676
0.1639

INDONESIA
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

0.864059
0.904453

Prob. F(1,109)
Prob. Chi-Square(1)

0.3547
0.3416

PHILIPPINE
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

0.005432
0.005904

Prob. F(1,69)
Prob. Chi-Square(1)

0.9415
0.9388

THAILAND
Breusch-Godfrey Serial Correlation LM Test:
F-statistic
Obs*R-squared

3.234681
3.269454

Prob. F(1,254)
Prob. Chi-Square(1)

0.0733
0.0706

104

Appendix 5: Decision Rules of Durbin-Watson d Test

(Reproduced from Gujarati (2003), Basic Econometrics, page 469)

105

Appendix 6: Multicollinearity Test

MALAYSIA

Correlation Analysis: Ordinary

Sample: 1 325
Included observations: 325
Correlation
PROFIT
GROWTH
NDTS
SIZE

PROFIT
1.000000
0.638488
0.114045
0.107795

GROWTH

NDTS

SIZE

1.000000
0.217340
-0.065344

1.000000
0.179462

1.000000

GROWTH

NDTS

SIZE

1.000000
-0.112699
0.121646

1.000000
0.137557

1.000000

GROWTH

NDTS

SIZE

1.000000
0.411016
0.070829

1.000000
0.409835

1.000000

INDONESIA

Correlation Analysis: Ordinary

Sample: 1 115
Included observations: 115
Correlation
PROFIT
GROWTH
NDTS
SIZE

PROFIT
1.000000
0.807822
-0.014304
0.265055

PHILIPPINE

Correlation Analysis: Ordinary

Sample: 1 75
Included observations: 75
Correlation
PROFIT
GROWTH
NDTS
SIZE

PROFIT
1.000000
0.054262
0.247970
0.181297

106

Appendix 6 (Continued)

THAILAND
Correlation Analysis: Ordinary
Sample: 1 260
Included observations: 260
Correlation
PROFIT
GROWTH
NDTS
SIZE

PROFIT
1.000000
0.541197
0.483246
0.180146

GROWTH

NDTS

SIZE

1.000000
0.479691
-0.119678

1.000000
0.182121

1.000000

Note: PROFIT is operating income over total assets. GROWTH is the growth opportunities,
calculated by market-to-book value total. NDTS is depreciation over total assets. SIZE is
natural logarithm of total revenue.

107

Appendix 7: Whites Heteroskedasticity Test (With Cross Terms)

MALAYSIA
Heteroskedasticity Test: White
F-statistic
6.192855
Obs*R-squared
71.02973
Scaled explained SS 61.64528

Prob. F(14,310)
Prob. Chi-Square(14)
Prob. Chi-Square(14)

0.0000
0.0000
0.0000

INDONESIA
Heteroskedasticity Test: White
F-statistic
5.665259
Obs*R-squared
50.86656
Scaled explained SS 73.50752

Prob. F(14,100)
Prob. Chi-Square(14)
Prob. Chi-Square(14)

0.0000
0.0000
0.0000

PHILIPPINE
Heteroskedasticity Test: White
F-statistic
2.332414
Obs*R-squared
26.43210
Scaled explained SS 35.50170

Prob. F(14,60)
Prob. Chi-Square(14)
Prob. Chi-Square(14)

0.0121
0.0228
0.0012

THAILAND
Heteroskedasticity Test: White
F-statistic
6.935800
Obs*R-squared
73.79779
Scaled explained SS 68.47941

Prob. F(14,245)
Prob. Chi-Square(14)
Prob. Chi-Square(14)

0.0000
0.0000
0.0000

108

Appendix 8: Final Multiple Regression Results

MALAYSIA
Dependent Variable: @SQRT(LEVRATIO)
Method: Least Squares
Sample: 1 325
Included observations: 325
White Heteroskedasticity-Consistent Standard Errors & Covariance

C
PROFIT
GROWTH
NDTS
SIZE
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

0.604251
-0.163928
-0.042186
-0.520077
-0.007729

0.053463
0.197107
0.012957
0.201428
0.009089

11.30227
-0.831670
-3.255892
-2.581956
-0.850342

0.0000
0.4062
0.0013
0.0103
0.3958

0.235671
0.226117
0.198161
12.56573
67.43337
24.66696
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.434559
0.225259
-0.384205
-0.325993
-0.360973
1.962917

INDONESIA
Dependent Variable: @SQRT(LEVRATIO)
Method: Least Squares
Sample: 1 115
Included observations: 115
White Heteroskedasticity-Consistent Standard Errors & Covariance

C
PROFIT
GROWTH
NDTS
SIZE
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

0.354416
-0.670533
-0.011646
-0.130301
0.035366

0.107609
0.159557
0.008782
0.261356
0.016917

3.293545
-4.202466
-1.326229
-0.498557
2.090594

0.0013
0.0001
0.1875
0.6191
0.0389

0.453271
0.433390
0.178721
3.513540
37.39978
22.79912
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.381942
0.237429
-0.563474
-0.444130
-0.515033
1.658845

109

Appendix 8 (Continued)

PHILIPPINE
Dependent Variable: @SQRT(LEVRATIO)
Method: Least Squares
Sample (adjusted): 2 75
Included observations: 74 after adjustments
White Heteroskedasticity-Consistent Standard Errors & Covariance

C
PROFIT
GROWTH
NDTS
DSIZE
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

0.724464
-0.052959
-0.121204
-0.030291
0.037186

0.025512
0.018841
0.016938
0.266129
0.005807

28.39725
-2.810821
-7.155654
-0.113820
6.404210

0.0000
0.0064
0.0000
0.9097
0.0000

0.765486
0.751891
0.105177
0.763296
64.24298
56.30642
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.487904
0.211155
-1.601162
-1.445482
-1.539059
1.873044

THAILAND
Dependent Variable: @SQRT(LEVRATIO)
Method: Least Squares
Sample: 1 260
Included observations: 260
White Heteroskedasticity-Consistent Standard Errors & Covariance

C
PROFIT
GROWTH
NDTS
SIZE
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

0.782640
-0.483716
-0.084707
-0.190046
-0.006057

0.035173
0.115711
0.010665
0.239074
0.005865

22.25092
-4.180373
-7.942352
-0.794927
-1.032821

0.0000
0.0000
0.0000
0.4274
0.3027

0.574697
0.568026
0.136865
4.776643
150.6787
86.14317
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.505494
0.208239
-1.120605
-1.052130
-1.093077
1.664184

110

Appendix 8 (Continued)

Dependent Variable: @SQRT(LEVRATIO)

Method: Least Squares
Sample: 1 775
Included observations: 775
White Heteroskedasticity-Consistent Standard Errors & Covariance

C
PROFIT
GROWTH
NDTS
SIZE
BANK
STKMKT
GDPRATE
INF
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

Coefficient

Std. Error

t-Statistic

Prob.

0.766081
-0.097594
-0.048358
-0.703609
0.005407
0.056737
-0.104208
-2.291855
-0.294961

0.075884
0.038928
0.006339
0.142076
0.004751
0.041227
0.022933
0.852238
0.444538

10.09547
-2.507077
-7.628432
-4.952335
1.138182
1.376201
-4.543976
-2.689219
-0.663522

0.0000
0.0124
0.0000
0.0000
0.2554
0.1692
0.0000
0.0073
0.5072

0.345805
0.338972
0.182148
25.41430
224.6237
50.61302
0.000000

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.455596
0.224034
-0.556448
-0.502415
-0.535660
1.851754

111

Appendix 9: Summary of Predictions

When a theory is silent or when there is significant ambiguity regarding the

appropriate interpretation the cell is left blank. In some cases different versions of the
theory have different implications as well.

Variable
name
PROFIT

Variable

Market
Timing

Trade-off
Theory

Operating income before

tax/total assets

GROWTH

Pecking
Order

Market-to-book value of
total assets

NDTS

Depreciation/total assets

SIZE

Log of revenue

BANK

Private credit by deposit

bank/GDP

STKMKT

Stock market
capitalization/GDP

GDPRATE

Real growth rate in GDP

INF

Annual inflation rate (%

growth)

112

Appendix 10: Summary of Hypotheses Testing Results

Hypotheses

Malaysia

Indonesia

Philippine

Thailand

H1

Reject

Accept **

Accept **

Accept **

H2

Accept **

Accept **

Accept **

Accept **

H3

Accept **

Reject

Reject

Reject

H4

Reject

Accept *

Accept **

Reject

Collectively

H5

Reject

H6

Accept **

H7

Accept **

H8

Reject

* Significant at 5% level
** Significant at 1% level

113