Analysis of Firm-specific and Macroeconomic Determinants of Capital Structure with Financial Distress Cost and Non-debt Tax Shield Effect: Empirical Evidence from Bangladesh
Md. Badrul Alam*
Chowdhury Golam Kibria**
Abstract: The present study attempts to identify the implication of pecking order theory and static trade-off theory in capital structure decisions of pharmaceuticals companies in Bangladesh. In this regard, along with some previously studied firm specific and macroeconomic factors, the present study incorporated financial distress cost and non-debt tax shield into the model, which appears to make the study more compelling in the context of Bangladesh. The dataset used by this paper covers a period of 2013-2018 with 20 pharmaceutical and chemical companies in Bangladesh, including some new companies and excluding some previously studied companies. This study examined the same set of macroeconomic variables which includes GDP growth, inflation, interest rate and stock market development, while addressing five firm-specific factors such as debt coverage, growth of total assets, firm size, non-debt tax shields, and cost of financial distress. The present study used a modified model through including two relatively less addressed firm-specific variables, namely, financial distress cost and non-debt tax shield and excluding three firm-specific variables, namely, liquidity, tangibility and profitability studied earlier. Upon conducting different confirmatory tests, the present study found fixed effect model with Driscoll-Kraay standard error estimates to be the best model explaining the capital structure decisions. The study revealed a positive association of leverage with GDP growth and interest rate, providing evidence in favor of pecking order theory suggesting that firms should go for debt financing to reduce asymmetric information costs of raising capital. However, the study indicated a negative association of leverage with inflation and stock market development, supporting the evidence of static trade-off theory stipulating that firms should issue shares in raising funds to minimize bankruptcy costs. Static trade-off theory is also corroborated by the positive association of leverage with firm size, meaning that large firms are likely to reduce bankruptcy costs through diversifying their businesses. Although results suggest suitability of both static trade-off theory and pecking theory in analyzing capital structure decisions, the empirical findings from the present study claim that static trade-off theory seems to be more dominant than pecking order theory in explaining capital structure choices.
Key words: Dhaka Stock Exchange, Pecking Order Theory, Static Trade-off Theory, Fixed Effect, GDP Growth.
* Lecturer, Institute of Business Administration, Jahangirnagar University, Savar, Dhaka-1342. Bangladesh. E-mail: badrul.ibaju@juniv.edu
** Associate Professor, Institute of Business Administration, Jahangirnagar University, Savar, Dhaka-1342. Bangladesh. E-mail: cgk@juniv.edu