How Firm Characteristics Affect Capital Structure in Banking and Insurance Sectors (The Case of Pakistan)

Abstract

The paper provides further evidence of the capital structure theories pertaining to a developing country and tests the determinants of capital structure for the firms in the banking and insurance sectors of Pakistan, to find that financial pattern of firms in the two sectors follow which capital structure theory. We have found that both the Pecking order theory and Trade-off theory are pertinent theories to the companies’ capital structure in the two sectors, whereas there was little evidence to support the Agency cost theory. The sample consists of 22 banks and 24 insurance companies listed in the, "Karachi Stock Exchange", during 2002-2009. The research was conducted using secondary data sourced from the company’s annual reports and Karachi Stock Exchange. The variable debt ratio (leverage) was the dependent variable. While the explanatory variables were size, growth, liquidity, profitability, non-debt tax shield and tangibility of assets. We have used panal least square regression to determine the affect of firm level characteristics on capital structure. The variables profitability and liquidity were found to have negative impact on debt ratio, while size and growth were positively correlated. Whereas, tangibility has direct positive correlation with leverage in insurance sector but negative in banking sector.

Keywords: capital structure, firm characteristics, KSE, pecking order theory, agency cost theory, trade-off theory.