Title:

Capital Structure In developing Countries

Abstract:

In this article a study is conducted through different developing countries to know

that capital structure theory is portable across different countries with different
institutional structures. To make the article meaningful we have taken a sample of 10
countries those have different economies and financial structures. Different tools such
as Total debt ratio, long-term debt Ratio, Long-term market debt ratio, turnover ratio,
Regression, Coefficient of Variation, Standard Deviation, Return on asset and asset
tangibility. After that it was concluded that some of the insight from modern finance
theory are portable across countries, much remains to be done to understand the
impact of different institutional features on capital structure choice.

Introduction:

The mix of long-term debt and equity financing maintained by a firm is called
Capita
Structure Different type of work has been done in the past on capital structure such as
the Mayer’s Theory on Developing countries and the most recently the study on G-7
countries by Rajan and Zingales(1995) to understand the capital structure of
developing countries. In his article we have taken a sample of 10developing countries
namely India, Pakistan, Thailand, Malaysia, Turkey Zimbabwe, Mexico, Brazil,
Jordan, and Korea. Five of these countries were under British control in the past. Two
are of American block and three others. The main Focus of this article is to answer
the three questions:
1. Do financial leverage decisions differ significantly between developing and
developed countries?
2. Are the factors that affect cross- sectional variability in individual countries’
capital structures similar between developed and developing countries?
3. Are the predictions of conventional structure models improved by knowing
the nationality of the company?

Material And Methods For Research Methodology:

The main and primary source of data collection is IFC (International Finance
Corporation) The data comprise balance sheets and income statements of all the
countries between the years 1980 to 1990.
For several countries the data for ha same years were not available so their sample
starts from 1980. Common period for all the countries is 1985-1987. The data from
one country represent all companies average result.
Different types of tools were applied on the data set to make the information meaning
full. These tools are: Total debt ratio is, total liabilities divided by the total liabilities
plus net worth. Long-term debt ratio is the total liabilities minus current liabilities
divided by the total liabilities minus current liabilities plus net worth. And the long-
term market-debt ratio is the total liabilities minus current liabilities divided by the
total liabilities minus current liabilities plus equity market value.

Turnover ratio is the value of stock actually trade expressed as a percentage of he

average total value of listed stock. Return an asset and asset tangibility are also
commonly used tools in this research paper.
Regression, Coefficient of variation, and standard deviation are the some others
commonly used tools to interpret the findings of this article in the meaning full way.
Beside all those tools that were used in the article some others factors were also there
those have contributed a lot to make this article comprehensive. These factors
include:
GDP growth Rate of the countries, GNP per Capita, Stock market values Inflation
rate, Corporate tax rate of all he countries, Accounting Standards that are being used
in all the countries, Different financial systems, Government influence and some
others such as the creditors right.

Discussion:

The purpose of this paper was to analyze the capital structure choices made by
companies from developing countries that have different institutional structures.
There are different types of structures such as public, private and foreign ownership
and these have an impact on the data but it may tell us a little about how profit
oriented firms make their decisions. From the data table of total debt ratio varies a lot
among the countries from a very low of 30.3% to a very high of 73.4% in Korea. We
can note that the difference total debt and long-term debt is much more between
developing and developed countries due to lower amounts of long-term debt in
developing countries. There is a drawback that not a specified period of time is used
in the study for all the countries, in some countries it could be a recession period. But
this is not of much importance. The difference may also be due to different
accounting practices among different countries. Because of these differences we
cannot have a comparison between two countries with different financial statements.
There are some economic variables that can also impact debt ratios such as growth
rate in Brazil, Jordan and Mexico is weak where as in Thailand and Korea it is very
strong. In most countries, the ratio of stock market capitalization to GDP increases
over time just like Thailand and Korea has a dramatic jump in stock market
capitalization. Financial Systems in our sample exhibit a variety of models. At one
extreme, commercial banks in Malaysia and Pakistan are universal banks that are
involved in merchant banking as well as commercial landing and at the other extreme
in countries such as in India and Zimbabwe, banking and commerce are different
institutions.
In developing countries, the distinction between bank and market-based financing is
further complicated due to government ownership and regulation of the financial
systems. Creditors rights are different in Brazil and the other 9 countries in which
Brazil have the strong Common-Law and in others there are weakest for our civil
rights. Tax advantages are different for debt financing in all countries. This corporate
tax shield ranges from a very high of 0.55 in Pakistan to a very low of 0.3 in
Thailand.
Miller tax advantage describes that the debt has a great advantage over the equity
financing.
Millers Formula not just take into account the corporate tax but also the interest
income and equity income.
1 - (1-Tc)(1-Te)
(1-Ti)
Another interesting point is that, unlike the United States, although all the countries
allow loss carry forward, none allows loss carry backs. As a result, a succession of
profitable years with significant tax payments could be negated by a succession of
bad years.
Variety of variables is there to explain the capital structure choice. The impact of tax
is there for all countries and we take an average of tax before earning and after tax
earning because it may be positive or zero. These average tax rates vary from a very
low of 13.9% in Brazil to a very high of 40% in Zimbabwe. Agency Cost and
Financial Distress can also affect the choice for capital structure because of conflicts
between shareholders and their management.
Developing Countries also ignore the use of debt financing because of very high
interest rates and the other agency costs that can be there due to the use of debt
financing. Business risk is another factor that influence the debt financing decisions
of a firm. The average of the risk vary from a very low of 3.04% for South Korea and
a very high of 9% for Brazil. In general high profitable firms should generate the
most cash, but less profitable firms fast-growing firms need more external financing.
Return on asset is the profitability measure. Average ROA varies from a low of 3.7%
in South Korea to a very high of 13% in Thailand. Note that the same strict historic
cost accounting and conservatism that produce hidden asset also tend to result in an
understatement of profits.
To a great extent capital structure theory has much to say that it is portable across
countries: total-debt ratio decreases with the tangibility of assets, profitability and the
average tax rate and increase with the size. For long-term debt ratio the measures of
increment are the same as for debt ratio. But the Market-debt ratio is negatively
correlated with average tax rates, profitability, and the market-to-book ratio, and
positively correlated with the tangibility of assets.
There is support for the importance of variables such as profitability, the tangibility of
assets size across all the countries it this data set. Also it should be noted here that
country factors clearly matters as much as financial variables analyzed in this article.
Conclusion:

It is clear that the variables that are relevant in developed countries are also relevant
in the developing countries despite the profound differences in the institutional
factors across these developing countries. More profitable the firm, the lower the debt
ratios. Because the external financing is costly in the countries it is avoided by the
firms. But they can utilize more debt to avoid tax bill. Assets tangibility affects the
total and long-term debts differently. Generally the more tangible the assets mix the
higher the long-term debt ratio, but the smaller the total-debt ratio.
In general debt ratios in developing countries seem to be affected in the same way
and by the same types of variables that are significant in the developed countries.
However there are systematic difference in the way these ratios are affected by
country factors, such as GDP growth rates, inflation rates, and the development of
capital markets.
Knowing the country of origin is usually at least as important as knowing he size of
the dependent variables for both the total and long-term book-debt ratios. Only for the
market-debt ratio is this not true.
 ASSIGNMENT

Capital Structure in Developing Countries

Presented To:

Sir. Kashif Hamid

Presented By:

Atoof Qadir
Roll # 23
Section-B

Department of Business Management and Sciences

University Of Agriculture,
Faisalabad