The Determinants of Capital Structure of FTSE 100 Firms in the UK: A Fixed Effect Panel Data Approach

Abstract

This study explores the determinants of capital structure of UK FTSE 100 firms. The aim is to examine the impact of profitability (ROA), non-debt tax shield (NDTS), tangibility (TANG), liquidity (LIQ), growth(GR) and size on the choice of debt in the capital structure of firms. The study uses a panel data fixed effect approach to examine the determinants of capital structure over a ten year period, from 2003 to 2012. The results show that profitability has a negative relationship with the long term debt, short term debt and total debt, consistent with the Pecking Order Theory (POT) of capital structure which states that a firm's desire to use leverage is driven by internal forces and information asymmetry and thus, managers rely on internal funding or retained earnings to finance assets or investment opportunity. Size and NDTS show a positive relationship. The Non debt tax shield rejected the Trade-off Theory (TOT) of capital structure. However, the positive effect of size is consistent with the prediction of the TOT which states that firms determine their capital structure by trading off the benefit and the cost of debt. Accordingly, the firms in the FTSE 100 are considered as big firms and bigger firms are viewed as less risky and well diversified by lenders. The remaining variables showed mixed impact on gearing. Generally, the coefficient of ROA, NDTS, TANG, LIQ and SIZE were statistically significant but the coefficient of growth was insignificant. Overall, the results of the research show some support for both Pecking Order Theory and Trade off Theory of capital structure. Evidence also supports Agency Cost Theory of capital structure

Keywords: Capital Structure, Determinants, FTSE 100