ISSN: 1998 - 4162
JISR MSSE Journal Contents
Volume 13, Number 2, July 2015
Capital Structure Theories and Leverage Behaviour of Pakistani Firms
Saqib Sharif - Institute of Business Administration (IBA), Karachi, Pakistan
Muhammad Nadeem Khan - Assistant Professor at Iqra University, Karachi, Pakistan
Abstract
This study examines the applicability of two competing capital structure theories; i.e., Pecking
Order Theory (POT) and Trade-Off Theory (TOT). An extensive panel dataset of 293
non-financial firms listed on the Pakistan Stock Exchange (PSX) for the period 2001 to 2013
is analyzed in three phases. First, we check the leverage behavior of all listed non-financial
firms of Pakistan. Second, we test the applicability of capital structure theories for
manufacturing and non-manufacturing firms; and third, the data is segregated into large and
small firms based on asset size. Two different models are applied to investigate the corporate
leverage behavior. First model suggests negative relationship of profitability, size, and growth
with the firm’s leverage, which confirms that, on average, Pakistani firms follow pecking
order theory (POT). In the second model leverage has positive and significant relationship
with last year dividend, which shows firms with higher dividend payout ratios borrow more in
subsequent year/(s). Overall, the financing behavior is in favor of POT for the non-financial
Pakistani firms. Lastly, this study contributes to the existing literature by testing the
applicability of two traditional theories on two major sectors, i.e., manufacturing and services
sector; and also on small and large firms.
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