Determinants of Capital Structure : An Empirical Study of Indian Companies

Factors influencing capital structure of a firm is a debatable issue which has engaged academicians for decades. Several theories have been put forward on this subject, after the landmark studies of Modigliani and Miller (1958, 1963) that established capital structure irrelevance and tax shield advantages. Amongst the several theories advanced to explain capital structure of firms, there are three major theories in the Corporate Finance literature, namely, Trade‐off theory, Agency Cost theory and Pecking‐Order theory that highlight different determinants of corporate capital structure. In an attempt to study the determinants of capital structure in Indian scenario and to verify whether any of the above mentioned theories can characterize the Indian corporate financing, this paper makes an empirical study of the capital financing pattern of 300 private sector Indian firms for the period 1999‐2008, the period of unprecedented growth of Indian economy. The study finds out that financing with internal funds, as suggested by pecking‐order theory has emerged as a major feature of corporate capital structure. Indian companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means “of last resort.” Hence internal funds are used first, and when that is depleted debt is issued, and when it is not sensible to issue any more debt, equity is issued. Some other determinants, however, have patterns of influences that match with the postulates of other two theories. The analysis finds out that the capital structure pattern on an average portends well for long term development of Indian corporate sector