Academic journal article Journal of Financial Management & Analysis

Empirical Testing of Pecking Order Hypothesis with Reference to Capital Structure Practices in India

Academic journal article Journal of Financial Management & Analysis

Empirical Testing of Pecking Order Hypothesis with Reference to Capital Structure Practices in India

Article excerpt

Introduction

In the wake of liberalisation and globalisation of economic policies world across, the business scenario in developing countries is undergoing a domestic metamorphosis. Investment opportunities have expanded, financing options have widened and, above all, dependence on capital market has increased. As a matter of fact one of the most significant international financial developments of the 1980s and 1990s has been the gradual opening of the capital markets of the developing countries to the rest of the world. The scenario is tending to become more competitive in view of the multinational corporations' entry and foreign capital inflow into the developing nations. Despite these trends, it is only recently that the Indian financial market, has received much aattention from academic researchers.

Capital structure decisions assume vital significance in corporate financial management due to their influence both on return and risk to the shareholders. Opting for more debt initially may trigger off a high interest burden, devour away at profits and depress the earnings per share and, above all, may endanger the very survival of the corporate firm. On the other hand, a conservative policy may deprive the corporate firm of its advantage in terms of magnifying the rate of return to its equity-owners as a higher equity component results in alow earnings per share.

This paper deals with the Indian private corporate sector finance manager' views on the financial/capital structure decisions. To understand the rthetoric and the reality, a survey was conducted among the corporaate finance managers' of the private corporate sector in India, to look close at each factor to measure its influence over capital structure decisions.

Methodology Used

The scope of the study is limited to nongovernment, public limited companies listed on the Bombay Stock Exchange. Sample companies -were selected by stratified random sampling from the official directory of the Bombay Stock Exchange: the sample companies listed on the Bombay Stock Exchange, given its national character, can be said to be fairly representative as it constitutes hub of the stock market activity in India and the Bombay Stock Exchange still represents a sizeable part of the quoted companies in India.

The relevant data were collected directly from the sample companies through the questionnaires sent by mail. To fill in the gaps in some of the cases and to have better insight regardding capital structure practices, personal visits to the selected corporate firms were also made. Most of the data used in this study are original. The questionnaire contained objective type questions, mostly multiple choice, keeping in view of the time availability at the disposal of the decision makers. Questions designed were simple and specific relating to objectives, policies and techniques. Opinion based and subjective information was kept at low key in order to keep the study more objective and scientific.

Questionnaire was firmed up after incorporating suggestions and improvements from various academicians, practising consultants/professionals in the field and executives from a few corporate firms around Delhi. The pilot-tested questionnaire was sent to a sample of 1300 companies selected on the basis of stratified random sampling ll-om the official directory of the Bombay Stock Exchange.

Thus, the analysis of this study is based on the capital structure practices of 91 companies. This point should be borne in mind while interpreting the results. The response, though not very high, represents fairly a good cross section of various industry groups and size groups. This apart, the response level of companies needs to be seen in the light of sensitive nature of information sought for the purpose of the study: moreover, it needs to be seen in the previous Indian studies in finance which covered much less number of sample companies in their work (Table 1). …

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