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Capital Structure And Its Product Market Determinants

3294 words - 14 pages

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Asia-Pacific Business Review
Vol. VI, No. 2, April - June 2010 pp. 41-49, ISSN: 0973-2470

Capital Structure and Product Market Determinants: Empirical Evidence from the Indian Automobile Industry
Himanshu Joshi
This paper provides insights into the way in which the capital structure is determined by product market determinants, research and development activity and profitability. This paper is an attempt to test relevance of empirical evidences found in matured markets to the Indian market condition. Automobile industry is taken up for the study because of its oligopoly nature and easy availability of product prices. Some of the results are very different from the similar studies ...view middle of the document...

A few studies report international comparison of capital structure determinants. Similar studies have been conducted in emerging markets of South East Asia that provide evidence on capital structure and its determinants. (Pandey, 2001; Annuar and Shamsher, 1993; Ariff, 1998). The recent focus of the researches on capital structure has been on the interaction between capital structure and product market structure. Brander and Lewis (1986), Bolton and Scharfstein (1990), Maksimovic (1988), and Ravid (1988) offer theoretical framework for linkage between capital structure and market structure. Phillips (1995) provides surveys of the

theoretical and empirical relationship between capital structure and market structure. Chevalier (1993), and Phillips (1995) investigated the empirical relation between capital structure and market structure for US Companies. Rathinasamy, Krishnaswamy and Mantripragada (2000) conducted similar study in the international context using data from 47 countries. Predicted cubic relationship between capital structure and market power and tested it for Malaysia. Present study is an attempt to find out the relevance of capital structure and product market power interaction evidences in the Indian context. This paper tried to answer few important questions: Do Firms in the same industry have same capital structures? Is this the case that more leverage would lead to aggressive production and create Market power to the firm? Do highly leveraged firms tend to indulge in more research and development activities? Empirical studies are conducted to find the relation between variables like Profitability, R&D and sales expenses with Debt- Equity ratio in case of Indian Automobile Industry. Auto mobile industry is chosen because of its oligopoly nature and easy availability of product prices. Some of the results are very different from the similar studies conducted in the developed economies. It is found out that Firms in the same industry can have different capital structures and there is negative correlation between the Profitability and Debt-Equity ratio of the companies. Interestingly no correlation is

Fore School of Management, B – 18 Qutab Institutional Area, New Delhi – 110016, India E-mail: himjoshin@rediffmail.com

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found in R&D expense with Debt-Equity ratio of the company.

Theoretical Framework
Firms raise investment funds in a number of ways. They can borrow from banks and other financial institutions or they can issue various kinds of debt, preferred stock, warrants, and common equity. A firm’s mix of these different sources of capital is referred to as its capital structure. Capital structure could be defined in different ways. In the US, it is common to define capital structure in terms of long term debt ratio. In a number of countries, particularly the emerging markets, companies employ both short term and long term debt for financing their assets, including current assets. For testing the validity of...

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