Effect of Macroeconomic Factors on Capital Structure Decisions of Firm-Evidence from a Developing Country

Abstract

The focal theme of this research paper is to investigate the effect of macroeconomic parameters on the capital structure of Pakistani firms. According to the best of our knowledge this is the first study of its kind in Pakistan and it will open new horizons of research in this area ultimately helping practitioners and academicians. Previous researches in the context of Pakistan have taken firm specific variables only while this study considers macroeconomic factors besides company specific variables. A panel data (for a period of 2003 to 2009) for KSE-I 00 (non-financial firms) has been analyzed by using SUR (Seemingly Unrelated Regression) model. The main findings of this study elucidate that macroeconomic variables have varying effects as far as capital structure's measurement is concerned. The market size (stock market development) has a positive effect on debt choice of Pakistani firms. Bank size is directly related with long term debt to equity of these firms. The correlation between inflation rate and financial leverage (long term debt to equity as well) is negative, whereas, it has a positive relation with external financing ratio. GDP per capita is inversely related with all debt ratios. SBP discount rate is though negative but statistically insignificantly related with all debt ratios. All firm level variables, like ROE, ROA, Q ratio, Assets tangibility, Dividend payout policy and risk proved to be significant with all debt ratios. Hence, this research study supports the existing literature related to capital structure, chiefly in the case of company specific variables.