At the overall degree and in sector wise analysis the information from the sample indicates that an addition in the debt ratio leads to take down profitableness measured by net income before revenue enhancements divided by entire assets. Profitableness is found to be negatively correlated with house ‘s debt ratio and this relationship is statistically important in both sectors. It means that profitable houses in Pakistani banking and insurance sector maintain low debt ratios. To warrant this negative relationship between profitableness and debt ratio of the house we would state that most of the Pakistani houses try to retain its earning for future demands as they prefer to pick internal funding over external funding. Another ground for the negative relationship is that debt translates into higher fixed costs as it must still be paid even if demand diminutions, at low degree of demand, the fixed cost are spread over a smaller base, dejecting profitableness White, Sondhi and Fried ( 1997 ) . This point could assist explicate why an addition in the debt ratio leads to a diminution in profitability-it is possible that the corresponding alteration in gross revenues volume did non counterbalance for the addition in fixed costs. Frydenberg ( 2001 ) describes retained net incomes as the most of import beginning of funding, good profitableness therefore reduces the demand for external debt. And houses in the banking and insurance sector have shown good profitableness during the period of the survey.
This consequence is against the Modigliani and Miller ( 1958 ) position on capital construction and the optimum capital construction theory that postulates that profitableness should be increased by an addition in the steadfast degree of debt. The implicit in premise for all this to keep true is that the houses operate in efficient market environment, and this might non needfully be the instance with the KSE listed companies. The findings are besides inconsistent with the decision of Fama and French ( 2002 ) , Sharma ( 2006 ) , Ward and Price ( 2006 ) all of whom conclude that there is a positive relationship between profitableness and debt ratio. However, the consequence is consistent with the anticipation of Pecking order theory by Myers and Majluf ( 1984 ) that Firms ‘first usage retained net incomes for new investings and so travel to debt and equity if required. The consequence supports the findings of Rajan and Zingales ( 1995 ) who find a negative relationship between profitableness and debt ratio. Frank and Goyal ( 2004 ) conducted an empirical survey in which he found grounds that houses with high profitableness will hold less debt. A possible account for this consequence can be drawn from De Wet ( 2006 ) who showed that important sum of value can be unlocked in traveling closer to the optimum degree of pitching and Modigliani and Miller ( 1963 ) who says that a house cost of equity additions as the house increases its debt. Further our consequence is besides consistent with Titman & A ; Wessels ( 1988 ) . Whereas, the anticipations of tradeoff theory presented by Jensen & A ; Meckling ( 1984 ) are non substantiated. Hence, with extremely important negative relationship between profitableness and debt ratio, we can reason that high profitable houses maintain low debt ratio and they utilize more of their maintained net incomes compared to debt for doing their capital construction. It is therefore proved that picking order theory dominates trade-off theory. Shah and Hijazi ( 2004 ) , Jean-Laurent Viviani ( 2004 ) , Shah and Khan ( 2007 ) Jasir ilyas ( 2008 ) , Abubakar sayeed ( 2010 ) , Joy pathak ( 2010 ) all find negative relationship between profitableness and debt ratio.
In contrast, Fakher Buferna, Kenbata Bangassa and Lynn Hodgkinson ( 2008 ) find that profitable houses will hold high debt ratio, while Fitim Deari and Media Deari ( 2009 ) find negative relation in instance of listed companies and positive incase of unlisted companies.
Tangibility of assets
Tangibility, with positive coefficient is significantly related to debt in overall findings. The consequence besides shows important positive relationship between tangibleness and debt ratio in the insurance sector. This indicates that tangibleness is one of the most of import determiners of debt ratio in the insurance sector of Pakistan. The determination is in conformance with the anticipation of Jenson and Meckling ( 1976 ) and Myer ‘s ( 1977 ) version of trade-off theory. The ground for the positive relationship between tangibleness and debt ratio in the insurance sector of Pakistan is rather obvious. The advantage of debt investing is that creditors receive uninterruptible watercourse of income due to debt investing except in instance of bankruptcy. Creditors have no tenseness about the involvement payment by house on their debt, if the house is executing good. But it good be hard for them to continuously supervise the operations and public presentation of the house, therefore they can get the better of this problem by inquiring the security of fixed assets like land, edifice, machinery etc. Thus creditors will be willing to give loans to those houses who provide at that place fixed assets as a security against debt. Therefore houses with less fixed assets can non borrow big sum of debt because of high cost of debt, but on the other manus houses with higher sum of fixed assets in entire assets can borrow more due to take down involvement rate. For illustration companies like EFUG insurance, East west insurance, Pakistan reinsurance and Asiatic insurance who have more fixed assets have high debt ratio, against a low debt ratio of Central insurance and IGI insurance etc who have less fixed assets. Jean-Laurent Viviani ( 2004 ) on Gallic vino companies, Shah and Khan ( 2007 ) on 286 KSE listed non fiscal houses, Jasir ilyas ( 2008 ) on 364 non fiscal houses and Joy pathak ( 2010 ) in his probe into 139 Indian houses besides find important positive relationship between tangibleness and debt ratio. However this determination is in contrast to the earlier determination by Shah and Hijazi ( 2004 ) on 445 non fiscal houses, Fakher Buferna, Kenbata Bangassa and Lynn Hodgkinson ( 2008 ) on a sample of 55 Libyan companies, Fitim Deari and Media Deari ( 2009 ) on Macedonian listed and unlisted companies and Naveed, Zulfiqar and Ishfaq ( 2010 ) in life insurance sector of Pakistan. They found that tangibleness was non significantly related to debt ratio.
The coefficient of the variable tangibleness of assets is negative and is statistically important as for as banking sector is concerned. This consequence is against assorted old research findings. Harmonizing to tradeoff theory and bureau cost theory there is positive relationship between debt ratio and tangibleness of assets. Firm ‘s adoption capableness depends upon assets that have collateralizable value Rajan and Zingales ( 1995 ) , Frank and Goyal ( 2004 ) . The negative relationship between tangibleness and debt ratio in the banking sector support the Pecking order theory, which says that houses with less collateralizable value of assets tends to finance their investings undertakings with external funding and they will prefer debt over equity, most likely short term debt. The debt adulthood construction of the banking system of Pakistan consists of big
sum of short term debt against a really little sum of long term debt. Booth et Al ( 2001 ) in his probe in to 10 developing states including Pakistan and Shah and Hijazi ( 2004 ) on KSE listed houses ; happen that houses have higher use of short term debt in entire debt in Pakistan. They justify this by stating that as bulk of houses are smaller in size therefore their entree to capital market is hard in footings of cost and proficient troubles. There are three possible beginnings harmonizing to World Bank ‘s policy research section study ( 1997 ) that affect on handiness of long term funding:
Macroeconomic factors restricting the long term funding, such as high rising prices and unstable macro policies.
Institutional factors specific to the fiscal sector, e.g ; there most likely be less information about little houses available to fiscal establishments, non merely due some of them will be new but besides because it is dearly-won to obtain such information and size is considerable characteristic of houses that affects on entree to long term funding.
The features of the houses.
In banking sector of Pakistan where short term funding is higher 95 % than long term funding, our consequence ( negative mark ) is important under short term funding and consistent with Pecking order theory. The negative relationship between tangibleness and debt ratio for banking sector suggests that houses in the banking sector do non utilize their fixed assets as collateral for obtaining debt funding. The ground may be that as the authorities has the bulk of ownership in the banking sector, the debt holders take authorities engagement as indirect alternatively of the houses ‘ fixed assets. Harmonizing to Khan ( 1995 ) , Khan and Khan ( 2007 ) ; in Pakistan the banking sector has been dominated by authorities owned establishments, it has accommodated the fiscal demands of the authorities, public endeavors and private sectors. Another ground for negative relationship may be that Companies with few touchable assets are more capable to information dissymmetry jobs, and hence, more willing to utilize debt to finance their activities. In our instance this is true ; because the plus adulthood construction of the banking system of Pakistan consists of big sum of short term assets against a really little sum of fixed assets, and besides houses are evaluated from loaners non merely based on tangibleness of assets, but besides from others positions, i.e. good will etc. In a questionnaire forward to directors of Macedonian companies by Fitim Deari and Media Deari ( 2009 ) , major of them believe that for O.K.ing loans, in their concern program profitableness and growing are onward than tangibleness. Abubakar sayeed ( 2007 ) in energy sector of Pakistan besides find negative relation between tangibleness of assets and fiscal purchase.
Similarly, the consequences between liquidness of the houses and its debt ratio show important negative relationship in banking every bit good as in the insurance sectors of Pakistan. Liquidity of the houses is measured utilizing current ratio, which is expressed as current assets divided by current liabilities, demoing the ability of the house to cover with its short term liabilities. Companies with high liquidness tend to utilize less sum of debt, merely because it provides an indicant that houses by and large finance their activities by following “ picking order ” theory. Firms in the banking and insurance sectors maintain high liquidness therefore they are able to bring forth high hard currency influxs and in bend, can use the extra hard currency influx to finance their operations and investing activities. Therefore, they use less debt compared to those houses in the two sectors that have low liquidness as suggested in “ picking order ” theory. As for low liquidness houses, they tend to travel for debt in financing their activities.
The consequence is similar to the findings of Eriotis, Vasilou and Neokosmidi ( 2007 ) in a survey of capital construction of 129 Grecian companies listed in the Athens Stock Exchange, Suhaila, Mat Kila and Wan Mahmood, Wan Mansor ( 2008 ) in a survey of 17 Malayan companies listed in Bursa Malaysia Bhd, Kuala Lumpur, Naveed, Zulfiqar and Ishfaq ( 2010 ) on four companies from life insurance sector in the Karachi Stock Exchange and joy pathak ( 2010 ) on 139 Indian houses.
The relationship between size and dependant variable debt ratio is positive and statistically important for the banking every bit good as the insurance sector. This means that larger houses in the two sectors have high debt ratio. Sing the fact that big houses are more diversified, bear less hazard and hold more consistent hard currency flows, therefore they can afford higher degrees of debt. For illustration Allied bank limited, National bank of Pakistan, Habib bank limited, MCB bank and united bank limited etc which are the largest Bankss has the highest debt ratio as comparison to smaller Bankss like samba bank, first recognition and investing bank and my bank limited etc. and in the insurance sector Adamjee insurance, EFUG insurance, Asian insurance has high debt ratio against a low debt ratio of Central insurance, IGI insurance and Pakistan general insurance. This consequence is supported by tradeoff theory ( bankruptcy cost theory ) that fixed direct costs of bankruptcy consist of a smaller part of the entire value of the house therefore larger houses do non waver to take more debt because of fright of bankruptcy. For larger houses this cost is smaller and it makes easy for them to obtain debt. Further, larger listed houses in the two sectors of Pakistan have province ownership ( partial or complete province controlled ) that facilitates them with less opportunity of bankruptcy and easy entree to debts. Majority of empirical surveies that include the informations from developing states find a positive relation between size and debt ratio. For illustration: Titman and Wessels ( 1988 ) , Rajan and Zingales ( 1995 ) , Booth et Al ; ( 2001 ) , Shah and Hijazi ( 2004 ) , Abubakar sayeed ( 2007 ) , Fitim Deari and Media Deari ( 2009 ) , Naveed, Zulfiqar and Ishfaq ( 2010 ) , provide the grounds of important direct relationship between size and debt
ratio. In contrast Shah and Khan ( 2007 ) and Suhaila, Mat Kila and Wan Mahmood, Wan Mansor ( 2008 ) found that size is non a proper explanatory variable of debt ratio. Since our consequence has a important statistics so we can claim that size does hold important function in doing debt ratio and finding the capital construction of Pakistani houses in banking and insurance sector. Bigger houses use more debt instead than equity to raise their funding.
Non-debt revenue enhancement shield
The literature on capital construction suggests that non-debt revenue enhancement shields like depreciation cut down the demand for debt to halt net income from traveling to following high revenue enhancement brackets. The variable non-debt revenue enhancement shield is found to be negatively related to debt ratio in all findings but statistically undistinguished. Therefore this consequence is non consistent with the anticipations of trade-off theory of capital construction. One ground for this statistically undistinguished relation between the explanatory variable non-debt revenue enhancement shield and dependant variable debt ratio is that in Pakistan, revenue enhancement rate does non vary with the degree of income. There are three consecutive rates in Pakistan:
One applicable to commercial organisations in authorities ownership
Second to public limited companies
And 3rd to organisations in fiscal sector
Therefore non-debt revenue enhancement shield ( depreciation ) does non work as a replacement to leverage to halt net income from traveling into a following high revenue enhancement bracket. Therefore, in other words the sum or degree of depreciation is non considered in doing capital construction determination. This consequence is consistent with the consequences of Shah and Khan ( 2007 ) , Abubakar sayeed ( 2007 ) , Jasir ilyas ( 2008 ) and Fitim Deari and Media Deari ( 2009 ) who besides find that non-debt revenue enhancement shield is insignificantly related to debt ratio. However, Ozkan ( 2001 ) ; Banerjee, et Al. ( 2000 ) , Huang and Song ( 2005 ) , Flannery and Rangan ( 2006 ) and Ziad Zurigat ( 2009 ) find important negative relationship between NDTS and debt ratio. In contrast Delcoure ( 2007 ) found positive relation between the two, in the context of cardinal and eastern European states.
The growing variable has a important positive impact on the dependant variable debt ratio every bit for every bit banking every bit good as insurance sector is concerned. Therefore our consequence back up the pecking order theory presented by Myer and Majluf ( 1984 ) which predicts that growing variable and debt ratio are positively related, and says that if external financess are required houses will prefer debt over equity due to take down information costs associated with debt, because for a turning steadfast their internal financess might non be sufficient to run into their demands and to finance their positive investing oppurtunities and hence, they are likely to be in demand of external financess and hence, they will utilize debt to finance their investing activities and spread out their concern. Firms in the two sectors achieved a high growing rate in the period 2002-2009. This consequence means that houses with higher growing rate maintain higher debt ratio.
Growth is founded a important factor for make up one’s minding the capital construction determinations in the two sectors of Pakistan and houses with high growing rates borrow more than houses with low growing rates. Myers ( 1977 ) studied growing options, and argues that corporate future investing chances can be considered as options. These growing options value so depends on the chance that the companies will exert them optimally. He farther suggests that a house may go through up some profitable investing chances in the presence of hazardous debt, which is besides called the job of under-investment. However, such jobs will non originate, if houses have more debt of short adulthood in their capital construction, because the house will pay the debt before the growing option expires. Most of the Pakistani houses finance their investing undertakings by short term funding, they has a big sum of short term debt in entire debt as comparison to long term debt Shah and Hijazi ( 2004 ) . Thus the determination is similar to Myers ( 1977 ) anticipation that houses with greater sum of short term debt will hold higher growing options in order to cut down the costs of shareholder-bondholder struggles has been confirmed by empirical surveies. Harmonizing to Garcia-Teruel and Martinez-Solano ( 2007 ) short-run debt is more common in houses with major growing options. Shah and Hijazi ( 2004 ) , Cai et Al. ( 2008 ) , Korner ( 2007 ) and Joy pathak ( 2010 ) besides find similar consequences. In contrast, Fakher Buferna, Kenbata Bangassa and Lynn Hodgkinson ( 2008 ) find negative relationship between growing and debt ratio. Booth et Al, ( 2001 ) argue that there is positive relation between debt ratio and growing in about all states in their sample. Pandey ( 2001 ) besides finds a positive relation in the context of Malaysia.