Capital structure is a part of financial structure and it is something that needs extra planning and sufficient research before it can be used as a company's financial policy. Capital structure or financial structure have two forms of capital namely equity and debt, and capital structure can be defined as the specific mixture of long-term debt and equity the firm uses to finance its operations.
Capital structure is important for the survival for many firms in the long run. Its importance is derived from the fact that it is closely related to the ability of a firm to satisfy stakeholders. Also, it is important to make a capital structure planning in any business entailing for investment. Any financial manager in a firm will know which source of funds will be needed for investment after taking into consideration many factors influencing capital structure of specific firms in Mauritius. Many listed firms have different ways of managing their capital structure. For instance, there are 3 types of decisions pertaining to capital structure namely investment, financing and dividend policy in which financial managers have to manage in order to maximize the value of the firm.
1.1 Aims and objectives
The aims and objectives of this study are:
To identify the determinant factors of capital structure on listed firm of Mauritius.
To identify if the determinant factors of capital structure have a positive or negative impact on listed firms in Mauritius.
To assess whether the factors affecting capital structure decision in other developing countries also apply for the case of Mauritian listed firms.
To distinguish whether or not if capital structure have an impact on performance of listed firms on SEM (Stock Exchange of Mauritius).
1.2 Problem statement
Numerous studies conducted in different countries to identify the determinants of capital structure of firms had proved to result to different outcomes from different researchers. Based on theoretical and empirical studies carried out we notice that determinant factors of capital structure of firms vary depending on the firm's asset size, profitability, growth, tangibility, cost of financial distress.
However does these factors relevant in Mauritian context? Can new factors of capital structure due to evolving business development structure have a major impact on listed firms' value in Mauritius or it is insignificant to it? Do we have the necessary data to carry out such research? All these are questions to be cleared out after carrying out the study. We will also try to determine whether or not the past theoretical studies have an implication on the performance of listed firm in Mauritius. For instance, any deduction cannot be made based on the question I have asked pertaining the performance of listed firms in Mauritius as it is just a statement.
Theoretical studies on capital structure:
Different theories had been carried out during the past decade to explain the process and involvement of capital structure within a firm. There are 4 major theories which is attached to the capital structure.
Four theoretical approaches of capital structure can be distinguished namely:
Modigliani and Miller theories(1958)
Static Trade-off theory, Kraus and Litzenberger (1958)
Agency cost theory, (1976)
Pecking order hypothesis, Myers(1984)
Each theory is inter-linked and followed a flow of research and empirical evidence carried out by different researchers. Each researcher try to prove their arguments based on assumptions or through quantitative research. Elaboration will be made on each of these theories.
Review on empirical studies:
This section will be concern on the measure and determinant of capital structure in which most research had been carried out in developed countries.
Determinant of capital structure
There are 7 factors which influence a firm when determining its capital structure. These determinants are:
Profitability
Size of a firm
Growth opportunity
Asset's structure
Cost of financial distress(volatility)
Tangibility
Tax shield
Most analysis will be based on the article of ' Determinant of capital structure: evidence from China' from Samuel G.H Huang and Frank M.Song.
Profitability:
To discuss on the relationship between profitability and leverage. Also pecking order hypothesis and agency cost theory will be discussed here as each of the researchers have different viewpoint on the use of retained profit by a firm. I will also discuss on how most empirical studies show that leverage is negatively related to profitability.
Size of firm:
Discussion will be made on the positive relation between leverage and size of firms carried out by Marsh(1982), Fama and Jensen(1983), Rajan and Zingales (1995), Wald and Booth et al.
Growth opportunity:
To discuss on the research made by Jung, Kim and Stulz (1996) showing the negative relationship between growth opportunities and leverage. Other researchers Kim and Sorensen (1986), Smith and Watts (1992), Wald (1999) , Rajan and Zingales (1955) and Booth et al. will also be included in this context.
Asset's structure:
Discussion will be based on the two type of conflicts of interest:
Conflict between share holders and managers
Conflict between shareholders and debtholders.
Also discussion will be made on the correlation between ownership structure and leverage based on the research made by 'Leland and Pyle (1977), Berger, Ofek and Yermack (1997), Friend and Lang (1988).
Cost of financial distress:
Discussion will be based on the financial distress which is negatively related with leverage.
Discussion will also be made on several studies made by researchers such as ( Booth et al. , 2001) , Bradley et .al(1984) , Chaplinsky and Niehaus(1993) and Wald (1999).
Tangibility:
Discussion will be base on the relationship of leverage and that of tangible assets within a firm. Infact ,there is a positive correlation between these two variables. Empirical studies will be provided based on research made by Marsh(1982), Long and Malitz (1985), Friend and Lang (1988) , Rajan and Zingales (1995) , Wald (1999).
Tax-shield:
To discuss on the pro and con's of tax shield which are arguable between different researchers. Modigliani and miller approve the use of more debt whereas Mackie-Mason(1990) disagree with such argument.
1.3 Proposal methodology
As research are needed for this study , secondary data will be used in this study and it involves both economic and accounting data. This set of data will be retrieved from public Annual reports of listed firms online itself and from registrar of Port-Louis.
Also variables will be needed for the assessment of the firm performance and this includes variables such as debt value, asset value, liability value, revenue, and profitability of the firm.
Second set of data are to determine the ownership structure of the firm, where ownership structure of the firms are identified. In order to obtain this data, Annual Reports of all targeted listed firms will be downloaded from SEM (stock exchange of Mauritius).
The method of study which will be used will mostly be based on econometrics method and ratios.
Econometrics method:
Econometrics method can be used in this study given its ability to estimate the relationship between debt ratio and determinants of capital structure. Also it will be used to assess firm performance. Econometrics involves mathematics and statistical methods to economic data that aims to give empirical content to economic relations. The basic tool for econometrics is the linear regression model.
Linear regression is an approach to model the relationship between a scalar dependent variable y and one or more explanatory variables denoted X. The case of one explanatory variable is called simple regression. More than one explanatory variable is multiple regression.
In order to estimate regression using the panel data, two types of models will be used in this study.
The first is the random effects model, it is used in the analysis of hierarchical or panel data when one assumes no fixed effects (i.e. no individual effects). The second one is the fixed effect model which is a statistical model that represents the observed quantities in terms of explanatory variables that are treated as if the quantities were non-random.
Ratios also will be used to assess the performance of listed firms such as debt to equity ratio(D/E).
Debt To Equity ratio:
The debt-to-equity ratio is a measure of the relationship between the capital contributed by creditors and the capital contributed by shareholders. It also shows the extent to which shareholders' equity can fulfill a company's obligations to creditors in the event of a liquidation.Its calculation are as follow:
D/E= total debt/total equity.
Firms performance will also be measured by the return on assets(ROA) and return on equity(ROE).
Return On Asset(ROA):
ROA gives an idea as to how efficient management is at using its assets to generate earnings. It can be calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage.
Return On Equity(ROE):
Return on equity measures a firm's profitability by revealing how much profit a company generates with the money shareholders have invested. Its calculation are as follow:
ROCE= net income - preferred dividends / common equity.
*this methodology proposal is based on articles which I had read and also for the purpose of getting a valid result on the aim and objectives in which I had set for this stud
1.4Expected outcome
In this session, we will try to discuss on the result obtained from the calculation of the relevant statistical tool model based on the determinant of capital structure such as profitability, size of firm, growth, tangibility, liquidity, asset structure and tax shield. The main objective is to analyze the outcome and discuss whether it has positive or negative impact with the listed firm performance in Mauritius. Also another motive from the result which will be obtained from ratios and econometric model is to compare whether the result obtained is related to the previous studies carried out in developed countries. Theoretical approaches will also be assessed in order to distinguish if all of them is applicable to the listed firms in Mauritius.
