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International Research Journal of Finance and Economics ISSN 1450-2887 Issue 16 (2008) EuroJournals Publishing, Inc. 2008 http://www.eurojournals.com/finance.

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Intra-Industry Variations of Capital Structure in Pharmaceutical Industry in India


G. Shanmugasundaram Department of Commerce, Kanchi Mamunivar Centre for PG Studies Lawspet, Pondicherry, South India - 605008 E-mail: sundaram_g2003@yahoo.com; drsundaramg@yahoo.co.in Tel: 91-413-2256805, 91-9843953698

Abstract
This study attempts to explain the variations in the capital structure in the pharmaceuticals companies between process patent period and the transition period. On the basis of capital structure theories and to see if there is any shift in the capital structure in the same period. The results are broadly consistent with the capital structure theories. The most important explanatory variable for the capital structure pattern is asset type measured by the proportion of fixed assets to total assets. This explanatory variable showed a positive significant relationship with debt equity ratio in domestic pharmaceutical companies, an insignificant relation in the case of multinational companies and a significant relation in the case of the pooled pharmaceutical companies during the transition period consistent with the static trade off theory. The other important explanatory variables namely profitability measures adjusted to total assets and that adjusted to net sales showed negative relations consistent with the pecking order theory in the case of domestic pharmaceutical companies and positive relation consistent with the static trade off theory in the case of MNCs. Growth rate of total assets showed positive relation consistent with the pecking order theory in the case of domestic companies while MNCs showed the reverse but at an insignificant level. MNCs showed a negative relation with risk, consistent with the static trade off theory. Further the comparison of the two pairs of regression models between the process and transition period has shown significant structural shift in the debt ratio of Indian, foreign and pooled companies in India after change of policy, favoring product patent in the place of process patent. This is because pharmaceutical companies started manufacturing high-risk products from 1st January 1995 compared to the low-risk products previously. This is consistent with static trade off theory. Keywords: Process patent, product patent, transition period, intra-industry variations, Indian pharmaceutical companies, Multinational pharmaceutical companies.

I. Background
In June 1991 the Government of India, under the Honble Prime Ministership of Shri P.V.Narasimha Rao, initiated a programme of macro-economic stabilization and structural adjustment supported by the International Monetary Fund and International Bank for Reconstruction and Development, in view of the Balance of Payment crisis. This major structural adjustment was being taken in all the industries in India. Apart from internal changes, the Governments commitment to the World Trade Organisation

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(WTO) agreement led to policy changes, which posed challenges to the Indian industry. One among these challenges is TRIPS. It was built on the existing international convention in dealing with Intellectual Property Rights (IPRS). Its provisions applied only to seven such rights. They are Patents, Copyrights and related rights, Trademark, Industrial design, Layout design of integrated circuits geographical indications, Trade sector and Undisclosed information. Among different intellectual property rights that are mentioned above, the patent rights mainly affected the Indian Pharmaceutical Industry. However, the Government of India also brought out some important reforms in the financial sector to help the Indian industries to compete in the world market, namely the reduction in bank rates by RBI from 12.7 % on 10th October 1991 to 6.25% on 29th October 2002. Correspondingly the lending rate was also reduced in order to reduce the input cost. The CRR was reduced from 14.5% on April 17, 1993 to 4.75 % on November 16th 2002. This situation increased the bank availability of funds at low interest. In addition, the corporate tax was reduced considerably from 50% to 30% in the same period. On the other hand the capital market reforms also influenced the industry capital structure with a view to implementation of free pricing policy that was announced by Security Exchange Board of India (SEBI) with effect from May 1992. With the introduction of Free pricing policy, the Industries have gone to public with high premium to offset the debt finance. All these factors made the Indian pharmaceutical Industry to adopt some changes in the capital structure.

II. An Overview of the Pharmaceutical Industry


Since independence, the pharmaceutical industry was dominated by Multinational Companies (MNCs). The market share of Multinational Companies was almost cent percent at the time of Independence. This was because of product design act (Product patent). Considering the healthcare of the Indian Public, the Govt. of India encouraged the domestic pharmaceutical companies in India. When the international norms recognized the product patent, the government of India enacted the Indian Patent Act in 1970 (process patent), with the objectives of allowing the domestic companies to grow. The Indian Patent Act recognized the Process to manufacture a product and not the end Product. Indian companies took advantage of the Patent Act and succeeded in producing molecules, which were under Patent Production else where, at a cost that was lower than the original research cost. By taking the cost advantages, the Indian Pharmaceutical companies fixed their prices lower than the prices fixed by the Multi
Market share of corporates
100% Percentage 80% 60% 40% 20% 0% 1947 1970 100 80 33 1991 25 2002 0

20 67 75 Indian companies MNCs

Year

National Companies manufacturing the drugs. Apart from the Indian Patent Act 1970, DPCO, FERA and increased imports tariffs also helped the growth of the domestic pharmaceutical companies. With a view to the above effect, the Multinational Companies market share, decreased from 100% in the year 1947 to 80% and 33% in the years 1970 and 1991 respectively with corresponding increase in domestic companys market share.

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Effect of economic reforms As part of the globalisation programme which is one of the economic reforms India became a signatory to the GATT in 1994 and hence a signatory to the TRIPS. Hence India was under compulsion to introduce product patent by 1st Jan 2005, giving a moratorium period of 10 years from 1st Jan 1995 to 31st Dec 2004. In view of the TRIPS agreement the Indian pharmaceutical companies have gone for major structural changes starting from 1st Jan 1995 in the form of Merger, Acquisition, Consolidation and investing more on Research & Development. All these above measures were taken for the purpose of retaining the current market share, export share, inventing new products, reducing the cost and improving the quality to international levels and betterment of Research and development. Indian Pharmaceutical Industry started thinking internationally and acting globally. It shifted from reengineering to invention of new products, from process to product patent. Hence, there was a conversion of business risk and financial risk into product risk. In this changing situation, a study on the stand of the pharmaceutical industry and the change in capital structure they have undergone in order to face the product patent regime with effect from 1st Jan 1995 is very essential.

III. Capital Structure Theories


Modigliani Millers Provocative irrelevance proposition has resulted in considerable amount of work on the theory of capital structure. Myers (1984) proposed the Static Trade Off Theory of capital structure. According to this theory, a firms optimal debt ratio is viewed as determined by a trade off the costs and benefits of borrowing, holding the firms assets and investment plans constant. The various costs considered in the literature are bankruptcy costs (e.g. Scott, 1977), agency costs (Jensen and Meckling, 1977) and loss of non-debt tax shield (De Angelo and Masulis, 1980). These costs become especially relevant in situations of financial distress and have often been subsumed under Cost of financial distress. As against these costs the major benefit of debt financing is the tax shield of internal expenses. The two important empirical implications developed out of the static trade off theory are: i) The Companies which are having larger proportion of tangible assets and more growth opportunities are likely to hove more debt-ratio. The costs of distress are likely to be higher for firms whose value depends on grow opportunities and intangible assets. Sometimes firms are likely to forego investment opportunity due to financial distress. Moreover, if a default occurs, the loss due to liquidation value of their assets is likely to be more. ii) Companies like pharmaceutical and information technology have high business risk issue and less debt. Because, they would be less certain of generating enough income to utilise their debt tax shields. One important empirical observation inconsistent with the Static Trade Off Theory is that most profitable firms tend to borrow the least. Myers (1984) explains the negative relationship between profitability and the debt equity ratio using what he calls the Pecking Order Theory. This is based on the assumption that the firms have a preference for internal finance. If internal finance is not sufficient, then they first issue debt, followed by hybrid securities such as Partly Convertible Bonds, Fully Convertible Bond and Equity as a last resort. Managers may prefer internal financing because it relieves them from the disciplining effects of the Security Market. Moreover, as shown by Myers and Majluf (1984) an issue of equity also requires Managers to deal with a possible conflict of interest between existing and new shareholders. Finally if one accepts the pecking order theory then more profitable firms would end up with lower debt ratios, because they would be able to finance their investments through the preferred internal sources and do not have to resort to debt financing. The pecking order theory also implies that companies with high rates should have a higher debt ratio since the need for external funds would be higher.

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Gorden (1962)1 found that as gearing increased with size, return on investment was negatively related to debt ratio. He also confirmed the negative association between operating risk and debt ratio. Baxter (1967)2 reported that leverage would depend on the variance of net operating earnings. Since business with relatively stable income streams are less subject to the possibility of ruin, they may find it desirable to rely relatively heavily on debt financing. On the other hand, firms with risky income streams are less able to assume fixed charge sources of finance. Hence he concluded negative association between variance of net operating earnings and leverage. Gupta (1969)3 conducted a study on the financial structure of American Manufacturing Enterprises. The focus of the study was analyzing the industry effect and the growth effect on the financial structural relationship of American Manufacturing Enterprises. It was a cross sectional study for the year 1961-62. The study confirmed that total debt ratios were positively related to growth and negatively related to size. He also found significant industry effect on debt ratio. He further observed that family pattern of ownership is an important determinant of leverage in the paper and allied product industry. Toy et al (1974)4 reported that higher the operating risk companies showed, higher is the debt ratio. They found that debt ratios were positively related to growth typically measured as sales growth and return on investment was negatively related to debt ratio. They also concluded that the corporation size and the industry class do not appear to be determinants of debt ratio. Carelton and Siberman (1997)5 concluded that higher the variability in rate of return on invested capital, lower will be the degree of financial leverage adopted. Hence it is the variance, not the rate of return that is the ultimate determinant of leverage. They also found return on investment to be negatively related to debt ratio. Ferri and Jones (1979) 6 examined the determinants of financial structure. The objective of their study was to investigate the relationship between a firms financial structure and its industrial class, size, variability of income and operating leverage. They found that the industry class was linked to the firms leverage, but not in a direct manner as was suggested in other researches. Secondly, a firms use of debt is related to its size, but the income could not be shown to be associated with the firms leverage. Finally, operating leverage does influence the percentage of debt in a firms financial structure and the relationship between these two types of leverage is similar to the negative linear form which financial theory suggests. Bhat (1980)7 studied the impact of size, growth, business risk, dividend policy, profitability, debt service capacity and the degree of operating leverages on the leverage ratio of the firm. He used multiple regression models to find out the contribution of each characteristic. Business risk (defined as earning instability), profitability, dividend payout and debt service capacity were found to be significant determinants of the leverage ratio. He used a sample of 63 companies from engineering industry. Venkatesan (1983)8 investigated the determinants of financial leverage by analysing the relationship between seven different variables and the financial structure of the firms. The variables included industry categorization, size, operating leverage, debt coverage, cash flow coverage, business risk, and growth ratio. Industry influence has been examined on the grouping of firms in various
1 2 3

IV. Review of Literature

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Gorden . M. J.; The Investment, financing and valuation of corporation; Homewood III; Irwin; 1962. Baxter, N.D.; Leverage, Risk of ruin and the cost of capital; Journal of Finance; Vol.22; Sep.1967; pp. 395-403. Gupta, M.C,; The effect of size, growth and industry on financial structure of manufacturing companies; Journal of Finance; Vol. 24; No. 3; June 1969; PP. 517-529. Toy.N., Stonehill A., Rammers.L. and Beekhuisen.T.; A Comparative International Study of Growth, Profitability and Risk as determinants of corporate debt ratio in the manufacturing sector; Journal of Financial and Quantitative Analysis; Vol.9; No.1974. pp.875-886. Carelton. W.T. and Siberman.I.H.; Joint Determination of rate of return and capital structure; An econometric analysis; Journal of Finance; Vol.32; June 1977; pp.811-821. Ferri. M.G. and Jones.W.H. Determinants of Financial Structure; A new methodological approach; Journal of Finance; Vol.34; No.3; June 1979; pp.631-644. Bhat. K. and Ramesh. K. Determinants of financial leverage: Some further evidence; The Charted Accountant; Vol.9; No.9; 1980; pp.451-456. Venketesan. S; Determinants of financial leverage: An empirical extension; The Chartered Accountant; 1983; pp. 519-527.

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leverages classes and he found a statistical relationship between industry class and leverage, but the relationship could not be significant and conclusive. The impact of the remaining independent variables on the dependent variable was examined in two sample classifications, viz. Intra-industry and Inter-industry through multiple regression analysis. In summation, only debt coverage ratio was found to be the important variable significantly affecting the financial structure of the firm. Mathew (1997)9 has made an attempt to analyse the relationship between ownership structure and financial structure with a view to know whether the former has any impact on the latter. The analysis was based on three hypothetical relationships that exist between ownership structures on one hand and unsystematic risk, non-manufacturing expenses and profit appropriation policies on the other hand. He concluded that wherever the management stake is high, leverage will be low and vice versa and there exists a significant relationship between ownership structure and financial structure of firms. Ram Kumar Kakani (1999)10 in his paper entitled Determinants of Capital Structure attempted to find out the determinants of the capital structure and its maturity in India and he has analysed measure of short-term and long-term debt rather than an aggregate measure of total debt. And he also analysed the empirical implications of liberalizations of the Indian Economy on the determinants of capital structure of the firms. Kotrappa (2000)11 slacked that the success of a corporation greatly depends upon sound financing. When the original financing has been sound, a co-operation has less fear for the future, provided it is given by a competent management. In this write-up, he attempts to sketch the factories responsible for reduced proportion of debt capital in the total capital employed. However, the choice between debt and equity sources of capital for a corporate borrower is greatly influenced by these factors.1) Taxes on Corporate Incomes 2) Inflation 3) Controlling Interest 4) Capital Market Reforms. Bradley, Jarroll and Kim (2002)12 found that debt to asset ratio is negatively related to both the volatility of annual operating earnings and advertising and Research and Development expenses. Mohanty (2003)13 found that leverage is negatively related with profitability and value of the firm both within an industry as well as within the Indian Economy. It has been found that companies that spend a large sum of money on advertisement and Research and Development expenditure are the least levered.

V. Empirical Representatives
Capital structure variable The measures of financial leverage used in this study are based on data collected from the Bombay Stock Exchange Directory and CMIE. The capital structure variable used here is debt equity ratio where debt comprises of all borrowings from (1) Financial Institutions (2) Bankers (3) Debentures 4) Mortgages and other deposits. This measure of debt therefore effectively includes both long-term and short-term debts. Equity comprises of paid up capital (ordinary shares, preference shares, deferred shares, etc.) forfeited shares, share premium and all reserves. The measures of debt-equity ratio are therefore based on book values. Determinants The following variables are used in order to explain the intra-industry variations of capital structure in pharmaceutical industry.

9 10 11 12

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Mathew T. Optional financial leverage the ownership factor finance India, Vol.5; No 2; June 1991;pp. 195-201. Ram Kumar Kakani. The Determinants of capital structure - An econometric analysis; Finance India; Vol. XII; No.1;March 1999; pp.51-69 Kotrappa. G; Contemporary in business finance by Omprakash Kajipet; Discovery Publishing House; New Delhi; 1st Edn;2000; pp.70-75. Bradley, Jarell and Kim; A Review of Research on the practices of corporate finance; South Asian Journal of Management; vol.9; No.4; July-Sep 2002; pp.29. Mohanty; A Review of Research on the practices of Corporate finance; south Asian Journal of Management; vol.9; No.4; July -Sep 2002; pp.29

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Fixed Assets
This is measured by the proportion of gross fixed assets to total gross assets. The theory predicts that higher the proportion of fixed assets, higher is the debt-equity ratio since the fixed assets have high collateral value for these firms resulting in lower costs of financial distress.

Profitability
This can be measured by two ways: 1) The operating income as measured by total assets and 2) the operating income as measured by net sales. The first method can be interpreted as return on investment and the second method as margin on sales. The static trade off theory would predict a positive relationship since higher profitability implies higher debt capacity. However, the peeking order theory predicts a negative relationship since higher profitability implies a greater reliance on internal funds and a correspondingly lower use of debt.

Growth
This is measured by the compound growth rate of total assets for four years lag. While the static trade off theory makes no definite prediction, according to the pecking order theory, there should be a positive relationship since a higher growth implies a higher demand for funds and a greater reliance on external financing through the preferred source of debt.

Size
The natural log of total gross assets is taken into account for any possible size effect.

Risk
This is measured by the standard deviation of the growth rate of gross profit. The static trade off theory predicts a negative relationship with the debt equity ratio.

VI. Methodology
Sample selection The Indian pharmaceutical industry is a highly fragmented one. Of the total 250 units in the organised sector, only 6 from Indian companies and 4 from Multinational National Companies were selected which represent 30% of the population and contribute 30 % of the market share. The criteria for selection were (1) Public Limited Companies (2) Manufacturing drugs more than 75% (3) Manufacturing both bulk drugs and formulations. Period of study The present study covers a period of 16 years starting from 1988-89 and ending in 2003-04 which is divided into two: 1) Process patent period: Process patent period of 10 years was planned. However, allowing a lag period of four years for calculating compound growth rate of total assets and risk resulted in a process period of six years extending from 1988-89 to 1993-94 and 2) Transition period from 1994-95 to 2003-04 when the pharmaceutical industry scenario was totally different because of India signing in the Trade Related Intellectual Property Rights (TRIPS) agreement on 31st December, 1994 coming into effect from 1st January 1995 in order to introduce the product patent with effect from 1st January 2005. Tools used for empirical analysis Correlation Coefficient was used to test the relationship among the variables. Multiple Regression was used to see how far the explanatory variables were related with capital structure variable and see the

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fitting of equation with the help of F value. To test whether the capital structure variable has shifted from process patent period to transition period, chow test has been used.

VII. Empirical Results


A) Indian Pharmaceutical Companies
Table 1: Position of Indian Pharmaceutical Companies during Process Patent and Transition periods Number of companies = 6
Process Patent 36 85.19 174.67 135.63 0.49 18.12 18.15 11.89 Transition period 60 38.20 796.84 857.99 0.46 14.51 29.28 28.12

Variable Number of observations Average Debt Ratio (%) Average Sales (Rs.Crore) Average Total Assets (Rs.Crore) Gross Fixed Assets/Total Assets Growth Rate of Total Assets Operating Income/Sales (%) Operating Income/Total Assets (%)

Note: Process period is from 1988-89 to 1993-94 and transition period is from 1994-95 to 2003-04

(a) (b) (c) (d) (e) (f) (g)


Table 2:
Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk

Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk

= = = = = = =

Debt/Equity Gross Fixed Assets/Total Assets Operating profit/Total Assets Operating profit/Net Sales Growth rate of Total assets Log (Total Assets) Standard deviation of growth rate of gross profits

Correlation Matrix for Indian Pharmaceutical Companies during Process Patent Period
Debt Ratio 1.00 0.02 -0.22 -0.18 0.08 -0.13 0.31* GFA/TA 1.00 -0.22 -0.41*** -0.57*** -0.16 -0.04 Profit/TA 1.00 0.84*** 0.26 -0.26 0.16 Profit/Sales Growth Size Risk

1.00 0.64*** -0.08 0.11

1.00 0.15 0.17

1.00 -0.69***

1.00

***p < 0.01; **p < 0.05 and *p < 0.10

Table 3:
Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk

Correlation Matrix for Indian Pharmaceutical Companies during Transition Period


Debt Ratio 1.00 0.72*** -0.11 -0.22* -0.12 -0.34*** -0.08 GFA/TA 1.00 0.10 -0.11 -0.39*** -0.50*** 0.01 Profit/TA 1.00 0.94*** -0.03 0.22* 0.70 Profit/Sales Growth Size Risk

1.00 0.10 0.39 0.76

1.00 -0.07 -0.03

1.00 0.28**

1.00

***p < 0.01; **p < 0.05 and *p < 0.10

Except the debt equity ratio and growth rate of total assets, all other variables have increased on comparing the two periods. The debt equity ratio has decreased heavily from 85.19% to 38.2% (Table 1). The correlation coefficient for Indian companies between debt equity and explanatory variables for process and transition period are presented in the table 2 and 3 respectively. The debt equity ratio

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does not have any significant impact on any of the explanatory variables, except risk which shows marginal positive impact in the process patent period. However during the transition period (Table-3), it has significant correlation coefficient of 0.72 (P<0.01), -0.22 (P< 0.10) and -0.34 (P< 0.01) with fixed assets to total assets, profits to total sales and size of the company respectively. But the sign is positive in the first case whereas it is negative in the rest. The profit to total assets and average growth of the assets showed negative relation with debt equity ratio but at an insignificant level. It is very interesting to note that except fixed assets all other explanatory variables are negatively correlated with debt equity ratio.
Table 4: Results of Regression Analysis for Indian Pharmaceutical Companies for Process and Transition periods and Chow Test comparing regressions between two periods
Regression Model 1 Process Transition 0.5530 -1.4049*** (0.51) (-3.51) 0.2050 2.7043*** (0.20) (8.09) -1.8706 -0.5308** (-1.60) (-2.23) Regression Model 2 Process Transition 0.5795 -1.4499*** (0.54) (-3.57) 0.2408 2.6144*** (0.24) (7.91)

Independent Variables Constant GFA/TA Profit/TA Profit/Sales Growth Size Risk R2 Adjusted R2 F DF Chow Test F Chow Test DF
***p < 0.01; **p < 0.05; *p < 0.10

0.0054 (0.51) 0.0209 (0.13) 0.0234 (1.48) 0.1871 0.0517 1.38 5,30 3.71*** 6,84

0.0119*** (2.61) 0.0819* (1.84) 0.0016 (0.36) 0.6103 0.5742 16.92*** 5.54

-3.9601* (-1.68) 0.0142 (1.10) 0.0136 (0.09) 0.0206 (1.28) 0.1933 0.0588 1.44 5,30 3.26*** 6,84

-0.6552** (-2.09) 0.0132*** (2.84) 0.0955*** (2.06) 0.0025 (0.52) 0.6061 0.5696 16.62*** 5.54

The results of multiple regressions both for process and transition periods are given in the Table 4. Because of the significantly high correlation between the two measures of profitability, two separate regressions were run one for each measure of profitability for both process and transition periods. The two regressions for the process patent period, one using the profitability measure adjusted for total assets and the other using the profitability measure adjusted for sales are fitted insignificantly for the Indian companies. Only the profit adjusted with sales is to a certain extent explainable as the beta coefficient of the above profitability variable beta -3.9601 (P< 0.10) is negative significant. Except this, none of the explanatory variable has shown unique contribution to debt equity ratio. But, coming to the transition period, both the regressions are fitted significantly at 1% level. In regression model I, all the explanatory variables explain about 61.03% of the variability in the debt equity ratio and in the case of regression II, the variance explained by all the explanatory variable in the debt equity ratio is 60.6% which is comparable to the first. The proportion of fixed assets to total assets has a positive significant relation at 1 percent level relationship with debt equity ratio in both the regression models in the transition period consistent with static trade off theory. This explains that the larger the proportion of fixed assets, the higher should be the debt equity ratio since the collateral value of assets is likely to be higher for these firms resulting in lower costs of financial distress. The coefficient of profitability measures adjusted with total assets and net sales in both the models showed negative sign at 5% significance. This is at par with the pecking order theory (Myers, 1984) of capital structure implying a greater reliance on internal funds and a

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correspondingly lower use of debt. The variables like growth showed positive and significant relationship with debt equity ratio consistent with the pecking order theory since a higher growth implies a higher demand for funds and a greater reliance on external financing through the preferred source of debt. The other variables like size and risk showed positive relationship with debt equity ratio. The positive coefficient significant at 1 % level of size reveals that the Indian Pharmaceutical companies tend to have higher debt ratio. The positive coefficient on risk is however insignificant inconsistent with the static trade off theory. Further consideration of structural shift between the process to transition period showed a significant shift in the debt equity ratio. Chow test showed F =16.92, P < 01.01 for Regression model I and F = 16.62, P < 0.01 for Regression model II. of the selected domestic companies after change of policies, thereby favouring product patent instead of process patent. B) Foreign Companies
Table 5: Position of MNC Pharmaceutical Companies in India during the Process Patent and Transition periods Number of companies = 4
Process Patent 24 75.94 215.23 117.89 0.52 13.24 16.68 9.69 Transition period 40 16.30 507.21 392.81 0.40 9.43 35.86 24.92

Variable Number of observations Average Debt Ratio (%) Average Sales (Rs.Crore) Average Total Assets (Rs.Crore) Gross Fixed Assets/Total Assets Growth Rate of Total Assets Operating Income/Sales (%) Operating Income/Total Assets (%)

Table 6:
Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk

Correlation Matrix for MNC Pharmaceutical Companies in India during the Process Patent Period
Debt Ratio 1.00 -0.09 -0.44** 0.02 0.10 0.09 -0.28 GFA/TA 1.00 -0.11 -0.14 -0.29 0.74*** -0.07 Profit/TA 1.00 0.64*** -0.08 -0.17 0.27 Profit/Sales Growth Size Risk

1.00 0.00 -0.26 0.08

1.00 -0.58*** 0.42**

1.00 -0.42**

1.00

***p < 0.01; **p < 0.05

Table 7:
Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk

Correlation Matrix for MNC Pharmaceutical Companies in India during the Transition Period
Debt Ratio 1.00 0.37** 0.29** 0.09 -0.50*** -0.38** -0.25 GFA/TA 1.00 -0.34** -0.58*** -0.49*** -0.60*** -0.65*** Profit/TA 1.00 0.89*** -0.34** 0.12 0.63*** Profit/Sales Growth Size Risk

1.00 -0.03 0.44*** 0.81***

1.00 0.33** 0.23

1.00 0.52***

1.00

***p < 0.01; **p < 0.05

As in the case of Indian companies, the Multinational Companies debt equity ratio has also fallen from 79.94 % to 16.30 %. Growth of total assets and ratio of fixed assets to total assets had also fallen between the two periods. All other variables have increased during the same period. The correlation coefficient between debt equity ratio and independent variables for process and transition period are presented in Tables 6 and 7. The debt equity ratio has a negative correlation coefficient of 0.44 at 5 % significance with profit to total assets during the process patent. But in the transition period (Table 7), it has significant correlation coefficient of 0.37 [P < 0.05] 0.29 [P < 0.05]

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with fixed assets to total assets and profit measure adjusted to total assets respectively but growth and size showed negative significant relation of 0.5 [P<0.010] and 0.38 [P<0.05] respectively with debt equity ratio.
Table 8: Results of Regression Analysis for MNC Pharmaceutical Companies in India for Process and Transition period and Chow Test comparing regressions between the two periods
Regression Model 1 Process Transition 1.2867 -0.0210 (1.01) (-0.04) -2.2568 0.5337 (-0.96) (1.22) -3.9835 0.6493*** (-1.62) (2.89) Regression Model 2 Process Transition -0.1907 0.3694 (-0.13) (0.83) -2.4033 0.5434 (-0.96) (1.28)

Independent Variables Constant GFA/TA Profit/TA Profit/Sales Growth Size Risk R2 Adjusted R2 F DF Chow Test F Chow Test DF

0.0146 (0.90) 0.2834 (0.83) -0.0082 (-0.68) 0.2858 0.0875 1.44 5,18 6.25*** 6,52

-0.0004 (-0.07) -0.0187 (-0.28) -0.0116** (-2.01) 0.4373 0.3546 5.28*** 5,34

2.6462 (0.55) 0.0242 (1.44) 0.4157 (1.10) -0.0132 (-1.08) 0.1953 -0.0282 0.87 5,18 4.56*** 6,52

1.0367*** (3.20) -0.0042 (-0.86) -0.0835 (-1.33) -0.0138** (-2.33) 0.4613 0.3821 5.82*** 5,34

The results of multiple regressions for process and transition period are given in Table 8. In the process patent period, the two regression equations - one using profitability measures adjusted for total assets and other using profitability measures adjusted for net sales are fitted insignificantly as in the case of Indian Pharmaceutical companies and none of the coefficient are significant. However in the transition period, both the regressions are fitted significantly at 1 % level. In regression model I, profit measures adjusted to total assets are significant at 1% level and all other independent variables collectively explain about 43.7% of variability in the debt equity ratio. In regression model II profit to total sales is significant positively at 1 % level and all other independent variables collectively explain variability by 46.1% which is 3 % more than the first. The proportion of fixed assets to total assets has shown positive and insignificant relationship in the transition period in both the models. The coefficient of profitability measures adjusted to total assets and net sales are also positively significant at 1 % level in the transition period in both the regression models favouring Myers static trade off theory. This is just reverse to the Indian pharmaceutical companies, which had negative relation consistent with the static trade off theory. The coefficient of risk is negative at 5% significance with assertion that low variability in gross profit tends to cause high debt ratio consistent with the static trade off theory. The coefficient of growth and size have shifted from positive sign to negative sign in between the two periods, however an insignificant level. Further, comparing the two regression models between the process and transition periods exposed that has been significant structural shift in the debt equity ratio of the selected foreign pharmaceutical companies in India after change of policy favouring product patent instead of process patent.

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C) Pooled Pharmaceutical Companies:


Table 9: Position of Pharmaceutical Industry (Selected Indian and MNC companies Pooled) during Process Patent and Transition periods Number of companies = 10
Process Patent 60 81.49 190.89 128.54 0.50 16.17 17.56 11.01 Transition period 100 29.44 680.98 671.92 0.44 12.48 31.91 26.84

Variable Number of observations Average Debt Ratio (%) Average Sales (Rs.Crores) Average Total Assets (Rs.Crores) Gross Fixed Assets/Total Assets Growth Rate of Total Assets Operating Income/Sales (%) Operating Income/Total Assets (%)

Table 10: Correlation Matrix for Pharmaceutical Industry (Selected Indian and MNC companies Pooled) during Process Patent Period
Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk Debt Ratio 1.00 -0.03 -0.27* -0.10 0.10 -0.07 0.02 GFA/TA 1.00 -0.21 -0.38*** -0.50*** 0.11 -0.04 Profit / TA 1.00 0.81*** 0.19 -0.25** 0.18 Profit/Sales Growth Size Risk

1.00 0.51*** -0.16 0.08

1.00 -0.10 0.26**

1.00 -0.54***

1.00

***p < 0.01; **p < 0.05 and *p < 0.10

Table 11: Correlation Matrix for Pharmaceutical Industry (Selected Indian and MNC Companies Pooled) during Transition period
Debt Ratio GFA/TA Profit/TA Profit/Sales Growth Size Risk Debt Ratio 1.00 0.65*** -0.01 -0.10 -0.14 -0.26*** -0.09 GFA/TA 1.00 -0.11 -0.26*** -0.34*** -0.45*** -0.17* Profit / TA 1.00 0.89*** -0.19* 0.14 0.63*** Profit/Sales Growth Size Risk

1.00 0.07 0.40*** 0.77***

1.00 0.10 0.09

1.00 0.36***

1.00

***p < 0.01; **p < 0.05 and *p < 0.10

The correlation coefficients between debt ratio and the explanatory variables for the process and transition periods are presented in Tables 10 and 11. The debt ratio has a significant negative correlation coefficient of 0.27 (p < 0.05) with the operating income to total assets. However, with operating income to total sales, the sign of the correlation coefficient is same as that of operating income to total assets but insignificant during the process patent period (Table 10). During the transition period (Table 11), it has significant correlation coefficients of 0.65 (p < 0.01) and 0.26 (p < 0.01) with fixed assets to total assets and size respectively, but the sign is positive in the first case and negative for the second. The correlation coefficients of both profitability variables adjusted for total assets and sales with debt ratio are insignificant and negative in sign. The correlation coefficients between debt ratio and other explanatory variables are not significant at the conventional level.

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Table 12: Results of Regression Analysis for Pharmaceutical Industry (Selected Indian and MNC companies Pooled) for Process and Transition periods and Chow Test comparing regressions between the two periods
Independent Variables Constant GFA/TA Profit/TA Profit/Sales Growth Size Risk R2 Adjusted R2 F DF Chow Test F Chow Test DF
***p < 0.01; **p < 0.05 and *p < 0.10

Regression Model 1 Process Transition 1.6305*** -0.7677*** (2.27) (-2.63) -0.0027 1.9039*** (-0.0032) (7.73) -2.4721** 0.2119 (-2.43) (1.24)

Regression Model 2 Process Transition 1.3473* -0.6699** (1.82) (-2.40) 0.0846 1.8870*** (0.10) (7.68)

0.0083 (1.03) -0.1106 (-1.07) -0.0030 (-0.34) 0.1144 0.0324 1.40 5,54 6.08*** 6,148

0.0056 (1.57) 0.0225 (0.61) -0.0026 (-0.71) 0.4371 0.4072 14.60*** 5,94

-2.7801 (-1.43) 0.0122 (1.34) -0.0906 (-0.85) -0.0054 (-0.59) 0.0538 -0.0338 0.61 5,54 4.78*** 6,148

0.2624 (1.05) 0.0043 (1.27) 0.0097 (0.26) -0.0028 (-0.68) 0.4345 0.4045 14.45*** 5,94

The results of multiple regressions for the process patent period and the period are given in the Table 12. Due to high collinearity (high correlation) between the two profitability variables, namely, operating income to total assets and operating income to net sales, two separate regressions were run, one for each measure of profitability for both process and transition periods. The two regression equations for the process patent period, one using the profitability measure adjusted for total assets and other using the profitability measure adjusted for net sales are fitted insignificantly for the pooled pharmaceutical companies. At least in the case of regression with profitability adjusted for total assets the adjusted R2 is positive and to certain extent explainable as the beta coefficient of the above profitability variable (beta = -2.4721, p < 0.05) has been negative significant. But, in the case of regression with profitability adjusted for net sales, the adjusted R2 is negative, and none of the explanatory variable has shown unique contribution to debt ratio. However, both the regressions for transition period are fitted significantly at 1 per cent level. In the regression using profitability adjusted for total assets, all the independent variables explain about 43.7 per cent (R2 = 0.4371) of the variability in the debt ratio and in the case of regression using profitability adjusted for net sales, the variance explained by all the explanatory variables in the debt ratio is 43.5 per cent, which is almost same as that of the first model.

VIII. Conclusion
The intra-industry variations in the capital structure for the Indian pharmaceutical companies can be explained by the existing theories of capital structure. The higher the proportion of fixed assets to total assets and the higher the growth rate of assets, higher is the industry debt equity ratio. The lower the ratio of operating income to total assets and operating income to net sales, higher is the debt equity ratio. This shows that the Indian companies are shifting from high debt to high equity over the period clearly indicating consistency with the static trade off theory. The average growth and size of the companies are positively related to the significant 1% level and risk which are also positively related

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but not significant level. However in the case of foreign pharmaceutical companies only the profits adjusted to total assets and sales are positively related, whereas the risk measured by the standard deviation of the growth in gross profit is negatively related to leverage. These are just reverse of that in the Indian companies. By considering the pooled pharmaceutical companies, the fixed assets to total assets are positively related to leverage in the transition period. This is common to both Indian companies and MNCs. None of the variable had given unique contribution to leverage. In all the three analyses, the comparison of the two pairs of regression models between process to transition periods exposes that there has been significant structural shift in the leverage of the selected pharmaceutical companies in India after change of policy favouring product patent compared to process patent.

References
[1] [2] [3] [4] [5] [6] [7] Sidharth Sinha (1993): Inter industry Variations in Capital Structure, Economic and Political Weekly. pp. M-91-94 Bradley, M G Jarell and E H Kim (1984): On the Existence of an Optimal Capital Structure: Theory and Evidenace, The Journal of Finance, Vol.39,pp 857-78. Myers; S and N Majiluf (1984): Corporate Financing and Investment Decisions When Firms Have Information Investors Do Not Have, Journal of Financial Economics, Vol 13, pp 187221. Myers,S (1984): The Capital Structure Puzzle, Journal of Finance, Vol 39, pp 575-92. Richard Kolondy and Diane Rizzulo Sucher. Changes in capital structure, new equity issues and scale effects, The Journal of Financial Research; Vol.III; No.2; 1958; pp.127-135. Titman.S and R. Wessels (1988): The Determinates of Capital Structure Choice, Journal of Finance, Vol 43, No 1, pp 1-19. Brealey, R and S Myers (1991): Principles of Corporate Finance, McGraw Hill, New York.