3.7.2 Dependent variables (Measuring the leverage)
There are some issues regarding the definition of Leverage of the firms. In other words there is no clear-cut definition of leverage in academic literatures. For the definition of leverage its Depends on the objective of researcher by which is the study is being conducted. Previous studies suggest that the level of leverage depends upon the definitions of the leverage, several research studies have used both market and book value based measured of leverage (Rajan, R. and Zingales, L, 1995). Through capital structure theories consider long term debt as a substitute for financial leverage, we take the total debt to total equity ratio as a proxy for the financial leverage because in Pakistan firms have mostly short-term financing as the average firm size is small, which makes access to the capital market difficult in terms of cost of capital (Shah & Hijazi, 2004). The main sources of debt in Pakistan have been commercial banks, which do not persuade long term loans.
3.7.3 Independent Variables
Size (SZ) of the firm is measured by the taking natural log of the sales to smoothen the variation over the periods considered. With respect to the pecking order theory, (Rajan, R. and Zingales, L, 1995) argued that this relationship could be negative. For the static order approach, the large firms, the greater the possibility it has of issuing debt, resulting in positive relationship between debt and size. In another research (Shah & Hijazi, 2004) found that there is a positive relationship between and size of the firm. In this study we expect the same relationship between size and leverage.
Given the pecking order theory that the firms tend to use internally generated funds first and then they can go to the external financing. This implies that profitable firms will have less amount of leverage (Myers, S. & N. Majulf, 1984). So this study expects a negative relationship between profitability and leverage of the firms. We will calculate the profitability ratio of net income after taxes divided by the total assets of the firm.
A firm with lager amount of fixed assets can borrow at relatively lower rate of interest by providing the security of these assets to the creditors. Having the incentive of getting of debt at lower interest rate, a firm can expect to borrow more as compared to a firm whose cost of borrowing is higher because of having less fixed assets. Thus we expect a positive relationship between tangibility of assets and leverage of the firms. The calculation of tangibility ratio will be by taking net amount of fixed assets divided by total assets.
According to the agency cost theory, agency cost is likely to be higher for growing companies having wider choice of future investment. Hence, growing rate of is negatively related with long-term debt financing. According to the trade-off theory of capital structure,...