Proceedings of 3rd Global Accounting, Finance and Economics Conference

5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

Determinants of Capital Structure: Evidence from Thailand

Panel Data
Ramzi E.N Tarazi1
This paper investigates the determinants of capital structure in one of
emerging countries and the impact of Thai stock market development on
the financing choices of firms operating in this market. This study examines
the ability of capital structure a variables and explains the leverage level of
Thailand companies by looking at how Profitability, Firm Size, Growth
Opportunities, Asset Structure, Cost of Financial Distress and Tax Shield
Effects influence total debt to total asset ratio. Also, the main reason to
choose Thailand country for our research is no single published study
which examines the capital structure of all the firms listed in the Thai stock
market and long time period. The sample size for the study is 559
companies, listed on Thai stock exchange as of 2012. Data is collected
during for a period of eleven years, from 2001 to 2011 using panel data.
The results reveal that, among the variables, profitability, growth
opportunities, assets structure and firms size have a dominant role in
explaining the variation in the total debt ratios of Thai companies.
Meanwhile, the tax shield effect is inversely related to the level of leverage.
Lastly, it was found that the cost of financial distress have no significant
influence on capital structure

Keywords: Profitability, Firm Size, Growth Opportunities, Asset Structure, Cost of

Financial Distress, Tax Shield Effects

1. Introduction

The capital structure one of the most mysterious cases in the area of finance since the
beginning of the modern theory of the structure of capital provided (Modigliani and Miller,
1958). The following proposals have been so famous theoretical and empirical work much
but seek to resolve the debt stock option did not produce absolute theory of capital
structure. Part of the literature on the capital structure has attempted to determine the
factors that affect the pattern of capital structure of the companies. The majorities of these
evidences has largely been confined to the United Stated and have produced significant
yet conflicting results.

Capital structure is the mix of debt and equity used by a company which is financing their
assets (Miller and Modigliani, 1958). The decision of capital structure is one of the most
significant decisions made by financial managers. Brigham (2003) points out that factors
which influence the firms capital structure are business risk, tax position, profitability,
managerial conservatism and growth opportunity. Assuming a perfect capital market which
includes no transaction or bankruptcy costs, perfect information, companies and
individuals can borrow at the same interest rate, and no taxes, value of company is not
affected by financing decisions. Modigliani and Miller (1958) made two findings under
these conditions. Their first 'proposition' was that the value of a company is independent of
its capital structure. It does not matter if the firms capital is raised by issuing stock or
selling debt. Therefore, the ModiglianiMiller theorem is also often called the capital

Mr. Ramzi E.N. Tarazi, Department of Accounting and Finance, University of Palestine, Palestine.
Email : Ramzi.tarazi1@gmail.com
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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

structure irrelevance principle. Their second 'proposition' stated that the cost of equity for a
levered firm is equal to the cost of equity for an unlevered firm, plus an added premium for
financial risk. That is, as leverage increases cost of equity increases, reflecting the higher
degree of risk. They are carrying corporate debt funding provides a tax shield, and this tax
shield may lower their faxable income. Hence the capital structure plays the important role
to manage and control the firms cost of capital. The best capital structure is to minimize
the cost of capital and at the same time maximize the firms value.

Moreover, the impact of firm characteristics on a firms financing choices has been
extensively studied across firms and countries; for example, Rajan & Zingales (1995),
Frank & Goyal (2003) studied US firms, while Deesomsak, Paudyal and Pescetto
(2004),andDe Jong, Kabir and Nguyen (2008) studied Asia Pacific firms, and some from
other developed and developing countries. At an aggregate level, firm leverage is similar
across the developed countries, and any differences that exist are not easily explained by
institutional differences (Rajan & Zingales, 1995). Most firms had a convergence in their
capital structure toward industry average (Arvin & Francis, 1999), thus the factors
identified by previous cross sectional studies in the United States to be related to leverage
seem similarly related in other countries as well.

However, the results of those studies and seems to be outdated, as it is the case now,
some studies have found to be affected by the decision capital structure of the companies
through the environment in which they operate. As well as factors specific company that
has been identified in the literature are present, and the decisions of the capital structure is
not only the product characteristics of the company private, but also as a result of
corporate governance, legal framework and institutional environment of the countries that
operate the company (Deesomsak, and Paudyal Pescetto, 2004). Certain determinants of
influence vary between countries and there is an indirect impact, because the country-
specific factors also affect the roles of specific determinants of power (de Jong, big and
Nguyen, 2008).

Theory analysis suggests that corporate capital structure selection is closely correlated
with agency cost, pecking order, and static trade-off. These theories have been
investigated in the perfect completely market economy, providing perfect profitable use to
reference for emerging markets capital structure. On the basis of theory analysis, a series
of empirical analysis have been conducted in terms of listed companys capital structure of
emerging markets (Dong, 2000; Huang, Shaoan and Gang Zhang, 2001; Chen, 2003).

According to static tradeoff models, there exists an optimal capital structure. A company is
regarded as setting a target debt level and gradually moving towards it. The optimal
capital structure of a company contains the trade-off among the influence of corporate and
personal taxes, bankruptcy costs and agency costs (Modigliani & Miller, 1958; Kraus and
Litzenberger, 1973; Jensen and Meckling, 1976, Miller, 1977; Kim, 1978; Bradley, Jarrel,
and Kim, 1984; Jensen, 1986; Diamond, 1989; Stulz, 1990; Chang, 1999).

The evidence suggests that the application of the various theories for different conditions
and periods, and thus achieve the capital structure options selected and continues to be
an important topic. Apparently, few studies have been conducted to investigate the capital
structure options in Thailand companies, and therefore it is necessary to conduct ongoing
investigation into the pattern of capital structures.

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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

The rest of the paper is organized as follows. The next section provides an overview of the
evolution of literature and our hypotheses. Section III explains the data and methods used
in our analysis. Section forth the result of empirical analysis and discussion of the
conclusions that can be drawn from the results. Finally, we summarize our findings in the
last section

2. Literature Review
For a number of years, there has been a sizeable research in relating capital structure. In
addition, many factors have been used to determine the capital structure. The following
section discusses the determinants of capital structure; namely, growth opportunity,
profitability, firm size, asset structure, Cost of Financial Distress and tax shield.

Jensen and Meckling (1976) find a significant negative relationship between growth and
leverage, which is consistent with the agency cost. Genxiang (1999) also find the negative
relationship between growth and debt to asset ratio. However, some researchers find the
positive correlation between growth and leverage. Titman and Wessels (1988) find that
there is a positive relationship between growth opportunity and leverage. Wald (1999)
shows a positive relationship between growth opportunity and leverage in developing
countries.

Under pecking order theory, management prefers internal to external financing and debt to
equity if it issues securities (Myers 1984). The pecking order theory suggests growing
companies will have a higher proportion of debt compared to stagnant. Chung (1993),
Chaplinsky and Niehaus (1990) show the evidence related to the pecking order theory.
However, Wan Mursyidah (2005) find no significant relationship between the growth
opportunity and leverage.

In recent years, more and more researchers find that there is a negative relationship
between profitability and leverage ratio. (Seetanah, Padachi and Ronoowah, 2004; Wan
Mursyidah, 2005). Most companies prefer to use debt to equity because issuing more debt
allowed them to have lower tax payment (Modigliani and Miller, 1963)

However, the static trade-off theory states that the low level of debt capital of risky firms
(Myers and Majluf 1984). The higher profitability of firm implies the higher debt capacity
and the less risky to the debt holder. It means the capital structure and profitability
correlated positively. But the pecking order theory explains that there will be a negative
relationship between the profitability and capital structure. Most studies support the
pecking order theory (Titman and Wessels, 1988; Hasbrouck, 1989). Only the few studies
show that the evidence agrees with the static trade-off hypothesis issues (Myers and
Majluf, 1984).

Big firms are more diversified and therefore have lower variance of earnings, making
them to sustain the high debt ratios (Castanias, 1983; Titman and Wessels, 1988; and
Wald, 1999). Smaller companies on the other hand, may find it relatively more costly to
resolve information asymmetries with lenders, thus, may present lower debt ratios
(Castanias, 1983). Lenders to larger firms are more likely to get repaid than lenders to
smaller firms, reducing the agency costs associated with debt. Thus, the big firms will
have higher debt. Another explanation for smaller firms having lower debt ratios is if the
relative bankruptcy costs are an inverse function of firm size (Titman and Wessels, 1988).
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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

Larger firms face lower unit costs of bankruptcy than smaller firms, as shown in Prasad et
al. (2001).

The asset structure of a firm plays a significant role in determining its capital structure. The
degree to which the firms assets are tangible should result in the firm having greater
liquidation value (Titman and Wessels, 1988; Harris and Raviv, 1991). Bradley et al.
(1984) claim that firms invest heavily in asset structure will also have higher financial
leverage since they borrow debt with the lower interest rates if their debt is secured with
such assets. It is assert that debt may be more readily used if there are durable assets to
serve as collateral (Wedig et al., 1988). However, other studies specifically represent a
positive relationship between asset structure and long-term debt (Cassar and Holmes,
2003 and Esperanca et al., 2003;). Marsh (1982) also maintains that firms with few fixed
assets are more likely to issue equity, which means Mash (1982) find there is positive
relationship between asset structure and debt to equity ratio. In a similar work, MacKie-
Mason (1990) concludes that a large amount of plant and equipment (asset structure) in
the asset base makes the debt choice more likely. Booth et al. (2001) indicate that the
relationship between tangible fixed assets and debt financing is related to the maturity
structure of the debt.

Green, Murinde and Suppakitjarak (2002) observe that tax policy has an important effect
on the capital structure decisions of firms. Corporate taxes allow firms to deduct interest on
debt in computing taxable profits. This suggests that tax advantages derived from debt
would lead firms to be completely financed through debt. This benefit is created, as the
interest payments associated with debt are tax deductible, while payments associated with
equity, such as dividends, are not tax deductible. Therefore, this tax effect encourages
debt use by the firm, as more debt increases the after tax proceeds to the owners
(Modigliani and Miller, 1963; and Miller, 1977).

Deesomsak et al. (2004) find a negative relationship between the tax shield and leverage
of companys capital structure. However, Jarrel and Kim (1984), Harris and Raviv (1990)
show that there is a positive relationship between the tax shield and leverage. Bardley et
al. (1995) measures the non-debt tax shield by the total of annual depreciation divided by
annual earnings before interest and tax. The results show that there exists a positive and
significant relationship between non-debt tax shield and leverage.

3. The Methodology and Model

3.1 Data Collection

This study is conducted with an extended review relating to academic journals and usage
of secondary data from relevant financial statements of companies.

The data in this study is made up of market data of public listed companies of Thailand,
from 2001 to 2011. There are 559 listed companies which are listed on Thailand stock
market. The data used in this study is a secondary data which is retrieved from Data
Stream. The data are taken from balance sheet and income statement Applying EVIEWS
6, regression and correlation results are obtained to test the hypotheses between
dependent and independent variables.

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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

3.2 Model Specification and Multiple Regressions

In statistics, multiple regression analysis includes any techniques for modelling and
analysing several variables. The focus is on the relationship between a dependent variable
and one or more independent variables. More specifically, multiple regression analysis
helps one understand how the typical value of the dependent variable changes when any
one of the independent variables is varied, while the other independent variables are held
fixed. Most commonly, multiple regression analysis estimates the conditional expectation
of the dependent variable given the independent variables. The multiple regressions are
used to examine how much the variance in the dependent variable is explained by a set of
predictors. The regression model to be estimated is:

Lev = + + + + TANG + EVOL + NDTS

Where:

Profitability is EBITDA / total assets.

Size is LN total assets.

= Growth Opportunities is LN total asset /Total Asset Growth

.
TANG = Asset Structure is Tangible Asset / Total Asset

EVOL =Cost of Financial (EVUL) is ABC (OPERATING INCOME t - OPERATING

INCOME t-1).

NDTS =Tax Shield Effects (NDTC) is Depreciation / Total Asset

This study examine the relation between the whole set of predictors and the dependent
variable. In this model, all independent variables enter the regression equation at once.
The aim of this analysis is to determine which of the independent variables are significant
in determining the capital structure.

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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

4. The Findings
Regression analysis is conducted to identify which among the independent variables
explained the dependent variable the most. The results are shown in Table II.

Independent Variable Expected Panel Panel Panel

coefficient Least Squares EGLS EGLS with AR(1)
Profitability [PROFIT] -/+ 0.031186** -0.041071** 0.007746**
Firm Size [SIZE] -/+ -0.028965* -0.003051* 0.012158**
Growth Opportunities -/+ 2.46E-05 5.19E-07 4.27E-5*
[GROWTH]
Asset Structure + 0.257375*** 0.332124*** 0.222154***
[TANG]
Cost of Financial - 9.63E-09 6.86E-11 5.61E-10
Distress [EVOL]

Tax Shield Effects + 1.222508*** 0.552314*** -0.296563*

[NDTS]
Number of 3741 3741 2914
Observations
R-squared 0.012453 0.255469 0.894689
Adjusted R-squared 0.010866 0.255469 0.894689
Prob (F-statistics) 0.000000 0.000000 0.000000
Durbin-Watson stat 0.530193 0.529939 1.858010
Notes: **, *** denote significance levels at 5%, and 1% respectively

Comparing the three panels, we find that R squared in panel EGLS with (AR) is
higher than the ones in panel least squares and panel EGLS. This suggests that panel
EGLS with AR is the best panel which can be used for our analysis.
The R-squared and adjusted R-squared of this panel are 89.49% and 89.46% respectively.
In common, we can use the adjusted R-square to measure the accuracy of the model. It
means that the independent variable (PROFIT, SIZE, GROWTH, TANG, EVOL and
NDTS) can explain the leverage level by 89.46%, while the remaining 10.54% is explained
by other variable that may affect the leverage. In addition, the probability of F-statistic also
shows the significant value of this model, which is found to be significant at 1% level.
Moreover, The Durbin-Watson's statistic shows that this model has no autocorrelation
problem.

According to the results in the table above, it can be observed that there is only five
independent variable that is significant. The first determinant is profitability (PROFIT)
which is very important in measuring the company overall performance. According to the
panel, the coefficient of profitability (0.007746) is significant at 1% confidence level and
positivly correlated with leverage. It means that the increase of the profitability level in the
company would increase the companys debt level by only .77 percentage points. Our
finding is corresponding with jensen (1907).

In this study, find that company size for Thailand listed companies have significant impact
on the level of leverage used. The coefficient of firm size (0.012158) is significant at 1%
confidence level and positively correlated with the debt level. It means that the increase of
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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

the size of company would increase the companys debt level by 1.21 percentage points. It
is generally agreed that size is positively associated with leverage. Our finding is matching
with Michaelas et al. (1999).

In this study, find that growth for Thailand listed companies is weak positive significantly
impact the level of leverage used. Moreover, firms with growth opportunities may invest
sub-optimally, and therefore creditors will be more reluctant to lend for long horizons. This
problem can be solved by short-term financing or by convertible bonds. This should lead to
firms with relatively higher growth having more leverage.

In this study, I find that asset structure (TANG) of the companies is positive significantly
affects the debt level of companies. This study shows that the coefficients of tangibility
(0.222154) of Thailand listed companies is significant at 1% confidence level and positively
impact to level of leverage used. It means the increase of assets structure in the company
would increase the companys debt level by 22.21 percentage points.
In this study, find that tax shield effects are negative significant to the debt consumption of
Thailand firms and it is significant at 1%. It means that the increasing in the tax shield
effects in the company would decrease the leverage level by 29.65 percentage points.

5. Summary and Conclusions

This study investigates the capital structure of 559 Thai companies that are listed on
thailand stock Market for the period of 2001-2011.

The results reveal that company size, profitability and assets structure have dominant role
in explaining the variation in the total debt ratios of Thai companies. Company size, tax
shield effects , growth opportunities , company assets structure and company profitability
play important role in explaining the variation in the long-term debt ratios of Thai
companies. In a nutshell, our study support debt tax benefits theory, bankruptcy costs
theory, asymmetric information theory, and debt agency costs theory of capital structure.

For future study, the researchers might be used the Malaysian, Thai, Singapore and
Philippines stock markets data, for determining the capital structure with the same
variables of this study. Secondly, the data are taken from Data Stream. Thereby, there are
some data which are not available and some annual reports are not standardized. For the
future study, the above information might be useful for research to investigate the
comparing results for Thai listed companies.

Thirdly, researchers future studies can develop some of the more common and important
factors. These variables are effective tax, Business risk, Liquidity. Finally, this study can be
extended further by considering more Asian stock markets and also including other
important countries. By doing so, the results obtained will be more generalized.

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 Proceedings of 3rd Global Accounting, Finance and Economics Conference
5 - 7 May, 2013, Rydges Melbourne, Australia, ISBN: 978-1-922069-23-8

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