Macroeconomic Variables, Financial Sector Development and Capital Structure of Indian Private Corporate Sector during the Period 1981-2007

Assuming that firms operate in a perfect and frictionless capital market, Modigliani and Miller (1958) argue that the value of a firm is independent of its capital structure. But other researchers argue that financial leverage depends on firm, industry and country-specific factors. As an economy transforms itself from an agro-based one to an industry and services-based one, the orientation of its financial system may also change. The orientation of the financial system and macroeconomic variables are expected to affect the sources of finance and the costs and benefits associated with different forms of financing. This paper examines the effect of the financial system and macroeconomic variables on the financial leverage of the Indian non-financial private corporate sector during the period 1981-2007. It is found that financial leverage is negatively related to stock market development and positively related to banking sector development, rate of inflation and effective rate of corporate tax