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Letter of Transmittal
November 25, 2015

Dr. Samiul Parvez Ahmed

Assistant Professor
School of business,
Independent University Bangladesh.

Subject: Submission of Research Report.

Dear Sir
We are glad to state that we have been successful to submit the business research report titled
The Determinants of Capital Structure: Based on Selected Companies under Textile Industry of
Bangladesh. We have tried our level best to fulfill all the requirements of the report.
Therefore, we would like to thank you for giving us the opportunity to apply whatever
knowledge we have gained from this course and also for your continuous guidance and
encouragement.

Sincerely yours
Md. Minhaz Uddin
Ashad Chowdhury
Syed Kaisar Azam
Sadia Samdani
Tasnim Al Amin

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Acknowledgement

At first we would like to thank Dr. Samiul Parvez Ahmed for giving us the support, courage,
stimulating suggestions, encouragement, and opportunity to work on this report. Throughout our
course we have learned a lot and have gathered a lot of knowledge and experiences.

We are grateful to those people without who it would be impossible to prepare the report. During
preparation of the report we faced some difficulties but enjoyed a lot while making this report.

Besides, we would like to express our sincere gratitude and indebtedness to Dhaka Stock
Exchange for their kind co-operation.

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Executive Summary
This Report provided an analysis of various determining factors of capital structure and their
significance on debt maturity. Eight textile companies had been chosen for observations which
are publicly listed and traded in DSE. For analysis, 6 years of data (2008-2013) had been
collected from their financial statements.
In this study, leverage indicated to total liabilities divided by total assets. The ratio of operating
income to total assets was used for profitability. Tangibility was measured as a ratio of net fixed
assets divided by total assets. The natural logarithm of net sales was used for size. The
percentage change in book value of total assets is used as a firm growth.
There were four independent variables- profitability, tangibility, size, growth and one dependent
variable was leverage. Four hypotheses had to be examined in this study.
Panel data methodology was used to analyze different information. This study found that size
had a significant relationship with leverage. There was a significant relationship between
profitability and leverage. In case of tangibility, the finding was similar too. But there was no
significant relationship between growth and leverage.
Finally, some limitations had been found in this study which enabled an opportunity for further
research and these can be improved by including new explanatory variables.

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Introduction:
The theories of capital structure are the most attractive and complicated issue in the field of
finance. Decision making in capital structure is very much susceptible issue to all firms due to its
internal and external effects on firms. One of the many objectives of financial managers is to
maximize the wealth of the firm, more specifically shareholders wealth maximization. To
maximize firms value as well as minimize the cost of fund, a manager should set up an optimal
capital structure. The fundamental components in capital structure are debt and equity. A firm
should attempt to determine the optimal capital structure that causes the maximization of firms
value.

Capital structure policy is also important in a sense that level of risk and return of a firm is
mostly affected by it. Using more debt in capital structure to finance firms assets results in
increasing the variability of firm's cash flows stream more specifically it leads to generate higher
risk consequently, to compensate the higher risk stockholders expect a higher rate of return to
firm. But no strict theory has been developed yet to determine the exact optimal capital structure.

As a developing country Bangladesh has become an emerging market with a lot of potential of
investment that gets an attention for investors and managers to rethink about the influencing
factors of using debt and their extent of influence over firms. Although there have been small
numbers of research in Bangladesh focusing on the primary determinants of capital structure
such as Chowdhury MU. (2004), Lima M.(2009) , and Sayeed M.A. (2011), there is still
disagreement regarding which factors have significant impact in determining a firm's capital
structure. Nevertheless, an important factors affecting capital structure determination of a firm in
developed country may not be equally important to a firm in developing country like
Bangladesh. Furthermore, all possible factors affecting capital structure decision have not been
considered in a research at a time and that is why some factors are still important to further use in
measuring their impact on capital structure determination and there is a need to bridge between
current study and capital structure theory.

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Problem Statement:
Though different researchers provided their comment on the theories of capital structure from
different viewpoint, the theories of capital structure still remain one of the most controversial
issues in modern corporate finance. Not only there is any universal theory of capital structure,
but also the assumptions of the several conditional theories contradict with one another. This is
not the end of the story. Empirical results show no strong consensus despite decades of intensive
researches. Such disagreement over basic empirical results in turn proves disagreement about
desirable features for theories. Moreover, the contemporary theories and the empirical researches
are primarily based on aspects of and data from developed western economics. Few researches
are carried on the perspective of developing economies. Hence, it is hard to say whether
conclusions from theoretical and empirical research carried out in developed economies are also
applicable for developing economies too; or a different set of factors work in deciding capital
structure in developing economics.
Like other developing economies, the area of research for capital structure is still unexplored in
Bangladesh. Researches made on the ground of capital structure theories and determinants of
capital structure in the context of Bangladesh are small in number. Only few researchers such as
Chowdhury (2004), Lima M. (2009) shed light on this issue. As a result, the study of capital
structure determinants bears significant importance.
The problem statement of the study is to test the influence of various capital structure
determining factors on leverage drawn by capital structure theories.

Purpose of the Study:

The purpose of the study is to

Examine the relationship between various determination of capital structure and Leverage
of some DSC listed companies under Textile Industry of Bangladesh.

Demonstrate how various determinants of capital structure can affect Leverage.

Reflect various analyses based on 6 years data (2008-2013) from financial statements for
each company.

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Literature Review:
The following factors are considered as determining factors of Capital Structure for this study-

Size
The effect of firm size on leverage is ambiguous. Rajan and Zingales (1995) find that financial
leverage increases with size. They justify this finding by the fact that size is an inverse proxy for
the probability of bankruptcy. Bigger firms can diversify more easily and so the probability of
being in financial difficulty is lower. Under the trade-off theory, such companies can increase the
percentage of debt. In this case, a positive relationship between size and leverage is to be
expected. On the other hand, size may proxy for the information available to outsiders.

Under the pecking order theory, less information asymmetry implies preference for equity
relative to debt, thus applying a negative correlation between size and leverage. For example,
Fama and Jensen (1983) argue that there may be less asymmetric information about large firms,
since these firms tend to provide more information to outside investors than smaller firms.
Therefore, they increase their preference for equity relative to debt. Results of some studies such
as Icke and Ivgen (2011), Elli and Farouk (2011), and Kila and Mahmood (2008) revealed
negative association between size and leverage.

Among the used researches as references, according to Khairul Alom, proxy for firm size (SIZE)
is the natural logarithm of total assets. But on the other research article by Md. Faruk Hossain
and Prof. Dr. Md. Ayub Ali, following Rajan and Zingales (1995) the natural logarithm of net
sales is used as a proxy for size.

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Profitability
According to the pecking order theory, a profitable firm is more likely to finance from internal
sources rather than external sources. More profitable firms are expected to hold less debt because
they are able to generate adequate funds easily and cost effectively from internal sources for
satisfying projects cost that shows an inverse relation between profitability and leverage. A
negative relation between profitability and leverage is found in Rajan and Zingales (1995),
Supanvanij (2006), Sayilgan et al. (2006) and Sheikh & Wang (2010). Sayeed M.A. (2011)
found profitability is irrelevant in determining capital structure.
On the other hand, the high ability of paying debts obligations which is, in general, mostly
considering factor to all lenders is often subject to firms profitability that ultimately measures
the firms tolerable level of debt. It is argued that the more profitable companies can easily add
more debt in their capital structure.

Jensen (1986) shows that firms with more likelihood of agency problem use more debt to reduce
availability of free cash flows at managers hand so that managers can be restrained from bad
investment decision. However, the trade-off theory, signaling theory, and agency cost theory
support a positive relation between profitability and leverage. Following Rajan and Zingales
(1995), and Supanvanij (2006), the ratio of operating income to total assets is used as a proxy for
profitability.

Tangibility
Tangibility is measured as a ratio of net fixed assets divided by total assets. Since tangible assets
are used as collateral, firms with large amount of fixed assets can borrow on favourable terms by
providing the security of these assets to the lenders. Therefore, a high ratio of fixed assets-tototal assets should have a positive impact on firm leverage. Firms with more tangible assets tend
to have more debt (e.g., Harris and Raviv, 1991; Frank and Goyal, 2008; Parsons and Titman,
2009). This relation is not surprising because many tangible assets constitute suitable collateral.
They can be redeployed at relatively low transaction costs when the borrower becomes distressed
or defaults. Empirical as well as theoretical studies generally predict a positive relation between
leverage and asset tangibility. The positive relation between tangibility and leverage is found in
Titman & Wessels (1988), Rajan & Zingales (1995), Wald (1999), Chen (2003), Supanvanij
(2006), and Akhtar & Oliver (2009). Therefore, borrowing costs should be relatively low when

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firms tangible assets support their debt, resulting in a positive relation between asset tangibility
and financial leverage.
La Rocca et al. (2009) examined the strategic financing choices of small businesses through the
lens of the business life cycle. They conclude that tangibility has a positive relationship with
debt, but its intensity varied across a firms life cycle. Their research shows that young firms
have less-tangible assets in the form of stock, which makes them more reliant on collateral assets
to secure debt and obtain credit under better terms. In the growing and mature stages of a firms
life cycle, this effect decreases, but is still relevant. Degryse et al. (2010) expected asset
tangibility to be positively correlated with debt as it provides collateral.
Bas et al. (2009) studied the determinants of capital structure decisions of small and private firms
in 25 developing countries from five different regions. They confirmed the importance of firm
level factors in accordance with the capital structure theory. Based on the maturity matching
principle, long-term debt is financed by long-term assets, implying that as asset tangibility
increases; firms borrow more long-term debt, while short-term debt is negatively related with
asset tangibility. Leverage is negatively related with asset tangibility because firms in their
sample had more short-term debt than long-term debt, suggesting that small firms with more
collateral borrow less short-term debt, but their results showed that medium firms with more
collateral also borrow less.

According to overall assets, Herciu and Ogrean (2012) argued that a firm is highly competitive
as long as its managers are able to mix tangible and intangible assets in the most effective and
efficient manner. Therefore, a firm can get the same score of competitiveness by using a
different combination of assets and by giving different importance coefficients to the tangible
and intangible assets.

Growth
Myers (1977) argues that firms with growth potential will tend to have less debt in capital
structure. Growth opportunities can produce moral hazard effects and push firms to take more
risk. In order to mitigate this problem, assets in growth opportunities should be financed with
equity instead of debt due to minimizing the loss/risk per stockholder. It supports inverse relation
between firm growth and leverage which is also the findings of Gued et al. (2003), Sayilgan
(2009), Buferna et al. (2005), and Akhtar and Oliver (2009). On the other hand, Titman &
Wessels (1988), and Chen (2003) found a positive association between growth opportunities and
leverage. According to pecking order theory firm prefers to finance new project with internal

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funds. Nonetheless, a growing firm may not have sufficient internal funds to finance its new
projects frequently. As a result firms require external financing that prefers debt financing to
equity financing. Following Chen (2003) and Buferna et al.(2005), the percentage change in
book value of total assets is used as a proxy for firm growth.

According to pecking order theory there is positive relationship between growth (past growth)
and leverage since a high growth implies a higher demand for funds and ceteris paribus, a greater
reliance on external financing through the preferred source of debt (Siha, 1992). Thus, the
pecking order theory suggests the higher proportion of debt in the capital structure of the
growing enterprises than that of the stagnant one. However, static trade-off theory does not make
any definite prediction. Agency cost theory contrary to pecking order theory suggests a negative
relationship between the growth rate and debt level of enterprises. According to agency cost
theory equity controlled firms have a tendency to invest sub-optimally to expropriate wealth
from the enterprises bondholders. The agency cost is likely to be higher for growing companies
having more flexibility in their choice of future investment. This conclusion is evident by
empirical studies by Jensen and Meckling (1976), Kim and Sorensen (1986), Titman and
Wessels (1988), Stulz, 1990.

There is much controversy about the relationship between growth rate and the level of leverage.
Following the studies of Sinha, S 1992and Myers, SC1984 higher growth rate implies higher
leverage of the firm. Chowdhur, MU2004 also expects a positive sign between growth
opportunities and leverage. According to pecking order theory hypothesis, a firm will use
internally generated fundsat first and then debt financing which implies that a growing firm will
have a high leverage (Drobetz, W and Fix, R 2003). High growth rates are expected to be
accompanied by high debt ratios due to insufficient additions to retained earnings. So, it is
believed that firms growing at higher rates should have higher debt ratios than firms with lower
growth rates. In some cases, internally generated funds may not be sufficient to maintain the high
growth rates, thus firms require the use of external financing. As additional risk premium is
required by equity holders as residual claimants for high growth firms, the cost of equity capital
may be distorted in relation to the cost of debt capital. Therefore, the total debt ratio are
positively related to the growth rate.

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Conceptual Framework:

Size
Profit

Leverage

Tangibility
Growth

Relationship Model:
The following Model is formulated to state the hypothesized relationship:

Leveragei,t= 0 + 1SIZEi,t + 2PROFITi,t + 3TANGi,t + 4GROWTHi,t

Where:
LEVERAGE = Total liabilities divided by total assets.
SIZE = Natural logarithm of sales or total assets.
PROFIT = Profitability (ROA)
TANG = Book value of fixed assets to total assets.
GROWTH = Percentage change in total assets.

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Research Question:
Is there any significant relationship between various determinants of capital structure and
Leverage?

Hypotheses:

H1: There is a significant relationship between size and leverage.

H2: There is a significant relationship between profitability and leverage.
H3: There is a significant relationship between tangibility and leverage.
H4: There is a significant relationship between growth and leverage.

Methodology:
Data Collection
This study was based on secondary data and it investigated some DSC listed companies selected
under Textile Industry of Bangladesh. The companies were randomly chosen. Financial
Statements of Year 2008-2013 had been taken for calculation in case of each textile company.
Variables used for the analysis include size, profitability, tangibility, growth and leverage. The
panel character of the data allowed for the use of panel data methodology. Panel data involves
the pooling of observations on a cross-section of units over several times.

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Data Analysis:
Descriptive Analysis:
This study conducted descriptive analysis to describe the basic features of the data in the sample.
Through a statistical tool named E-Views, this study was able to find out total observations,
their minimum value, maximum value, their mean and standard deviation etc.
As shown under Table I, the mean value of leverage was 62.80% with variability of 16.64%.
In addition, it was found that the mean of size was 21.167 with SD of87.29%. ROA or
profitability showed 1.898% as mean, 2.75% as standard deviation and a maximum value of
.083. Tangibility and growth indicated their mean value of 50.04% and 9.77% with SD of
16.89% and 15.25% respectively.

Table I

LEVERAGE

SIZE

PROFITABILITY TANGIBILITY

GROWTH

Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis

0.628002
0.653867
0.857971
0.326445
0.166497
-0.364445
2.067720

21.16712
21.40240
22.60304
19.63482
0.872852
-0.365634
2.021341

0.018979
0.018064
0.082693
-0.044911
0.027523
-0.250303
3.015902

0.500410
0.491828
0.765192
0.218087
0.168893
-0.026548
1.881770

0.097740
0.057475
0.691995
-0.138958
0.152526
1.786495
7.285725

Jarque-Bera
Probability

2.334045
0.311292

2.487545
0.288295

0.418099
0.811355

2.088763
0.351909

51.88950
0.000000

Sum
Sum Sq. Dev.

25.12007
1.081135

846.6848
29.71293

0.759153
0.029544

20.01641
1.112469

3.909592
0.907306

Observations

40

40

40

40

40

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Correlation Analysis:
Output of correlation analysis (Table II) is represented in the table of pair-wise correlation. This
study calculated correlation of variables with each other to examine the existence of relationship
among variables. This study showed that there were both positive and negative correlations for
different pairs of variables.

Table II

LEVERAGE

SIZE

PROFITABILITY

TANGIBILITY

GROWTH

LEVERAGE

1.000000

-0.338732

-0.261389

-0.227340

-0.262498

SIZE

-0.338732

1.000000

-0.186954

-0.193790

0.331807

PROFITABILITY

-0.261389

-0.186954

1.000000

-0.080407

0.083096

TANGIBILITY

-0.227340

-0.193790

-0.080407

1.000000

-0.272058

GROWTH

-0.262498

0.331807

0.083096

-0.272058

1.000000

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Regression Analysis:
From EViews mentioned under Table III, the study reflected the following regression equation
considering leverage as dependent variable.
Leverage= 2.55 - 0.079*SIZE- 2.137*PROFIT- 0.385*TANG 0.221*GROWTH

Table III
Dependent Variable: LEVERAGE
Method: Panel Least Squares
Date: 11/13/15 Time: 23:08
Sample: 2009 2013
Periods included: 5
Cross-sections included: 8
Total panel (balanced) observations: 40
Variable

Coefficient

Std. Error

t-Statistic

Prob.

C
SIZE
PROFITABILITY
TANGIBILITY
GROWTH

2.552172
-0.078857
-2.137203
-0.385359
-0.220850

0.606048
0.028011
0.836930
0.138421
0.160204

4.211169
-2.815252
-2.553623
-2.783968
-1.378557

0.0002
0.0080
0.0152
0.0086
0.1768

R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)

0.374357
0.302855
0.139017
0.676405
24.83932
5.235611
0.002059

Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat

0.628002
0.166497
-0.991966
-0.780856
-0.915636
0.858508

The result displayed negative coefficient in case of each independent variable considering
leverage as dependent variable. The study showed that there would be 0.079 % inverse change in
debt to asset ratio due to 1% change on size which supports the study of Icke and Ivgen (2011),
Elli and Farouk (2011), and Kila and Mahmood (2008). A 1% change in net income to total asset
ratio would have reduced debt to asset ratio by 2.137% which supports the study conducted by
Rajan and Zingales (1995), Supanvanij (2006), Sayilgan et al. (2006) and Sheikh & Wang
(2010). Tangibility and growth also reflected negative influence on leverage by 0.385% and
0.221% respectively for every 1% change of both. The value of R-squared indicated that the
independent variables explained leverage by 37.44%.

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p-value test
Considering the significance level of 5%, if p 0.05, null hypotheses (H0) will be rejected and
alternate one will be considered. The value has been shown under Table IV below -

Table IV
H0

H1-4

There is no significant
relationship between size
and leverage.
There is no significant
relationship between
profitability and
leverage.
There is no significant
relationship between
tangibility and leverage.

1. There is a significant
relationship between size
and leverage.
2. There is a significant
relationship between
profitability and
leverage.
3. There is a significant
relationship between
tangibility and leverage.

There is no significant
relationship between
growth and leverage.

4. There is a significant
relationship between
growth and leverage.

p-value

Decision

0.0080

Rejected Null
Hypotheses

0.0152

Rejected Null
Hypotheses

0.0086

Rejected Null
Hypotheses

0.1768

Accepted Null
Hypotheses

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Findings:
Throughout the study, the objective was to investigate the significance of determining factors of
capital structure on leverage based on some selected companies under textile industry of
Bangladesh. In order to achieve the goal, this study gathered secondary data of 5 years (20082013) of these publicly listed companies traded in Dhaka Stock Exchange (DSE) and Panel data
methodology was used to analyze different information. This study indicated that size had a
significant relationship with leverage. There was a significant relationship between profitability
and leverage. In case of tangibility, the finding was similar too. But there was no significant
relationship between growth and leverage. An important finding of this study was that some
factors working on firms capital structure in other countries also worked in a similar fashion in
Bangladesh.

Limitation:
This study gathered and analyzed the information of 8 textile companies in Bangladesh.
So the results would be more reliable if number of observations was increased.
Overall results found in this study might not be satisfactory. These can be improved by
including new explanatory variables.

Significance of the Study:

This study conducted an analysis of the significance of capital structure on leverage based on 8
DSC listed Textile companies of Bangladesh. Even though the analysis has been built on known
research methods and models used in similar studies in different countries, the findings of this
study are unique.
This study will help to understand the general practices of capital structure in Bangladesh
including the sensitivity of leverage. This will also act as a guide for the financial managers to
design their capital structure and utilize debt properly to maximize the market value of the firm.
Finally, the limitations revealed through the study can open the door to conduct further research
on capital structure determinants which will surely lead to significant new insights.

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Conclusion:
One of the many objectives of financial managers is to maximize the wealth of shareholders.
Shareholders wealth maximization depends on some issues like managing lower cost of capital,
generating tax shield benefits from debt financing etc. And all these issues are determined and
managed by reaching at a point of optimal capital structure. As a result, financial managers strive
to ensure the optimal mix of debt and equity in the firm's capital structure. However, Capital
structure is an important factor for a firm. Proper design and utilization of capital structure and
debt can lead a firm to maximize its value. This study might be used as a guideline for
understanding different determining factors of capital structure and their relationship with
leverage. Different financial and statistical tools were used to examine the relationship among
them. However, this study had some limitations. Further research is needed to improve this
study more.

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