Investigate Debt to Equity Ratio to Determine Firm Performance of Pakistani Companies Listed in Chemical, Food and Care Products, Cement, Pharmaceutical, Auto Assembler and Textile Sector

Abstract

The purpose of this study is to investigate Debt to Equity ratio to determine firm performance of Pakistani companies listed in Chemical, Food and Care products, Cement, Pharmaceutical, Auto assembler and Textile sector. The research done on 50 companies listed under Karachi Stock exchange covered the period of 2010-2014, total observations of 250 firms-years. The independent variable is Debt to Equity and dependent variables are Size, Earnings per Share, Return on Assets, Return on Equity and Marketing. The research employed Descriptive Statistics, Pearson correlation coefficient and multiple linear regressions and the findings shows Earnings per share, Return on Equity and Return on Assets are significantly correlated to Debt to Equity ratio. While Debt to equity ratio founds a significant impact on Size and Return on Assets. Furthermore, it is recommended that other firm specific factors can also be used with a more wider time span like Dividends, Taxes etc to gauge the impact and end with a more accurate outcome. This Study will eventually benefit the finance mangers to define an optimal capital structure and also the research community by providing new knowledge regarding the impacts of capital structure. Though, other major economies can also be examined with different other industries to check the deviation of capital structure formation.

Key words: Capital Structure, Firm Performance, ROA, ROE, EPS, Firm Size, Marketing, KSE,

Chapter 1: INTRODUCTION

1. Research Background:

This study is conducted to identify and explore the firm-specific factors of capital structure which impacts on Firm’s performance in Pakistan and the research is carried out on five major contributing sectors registered in Karachi stock exchange (KSE). Pharmaceutical, Cement, Textile, Consumer goods, Automobile Industry and Chemicals are considered to be most prominent contributors to the Pakistan economy (Finance division, 2015).The pharmaceutical industry reported $718.00 million sales turnover in 2012 which was been considered a prominent turnover for the industry. Though, followed by cement sector which pools Rs 15.584 billion with net worth at Rs 24.947 billion while total sales of these companies stood Rs 14.589 billion (Finance division, 2015). Further Textile is also seemed to be vibrant in the national economy with a growth rate of 38.38% for the fiscal year of 2010-11 (Ahmed, 2012). Lastly, Consumer goods, Chemicals and automobile sectors perform drastically in the economy with the uplift of sales to 86 billion from 34 billion from 2008 to 2013 for consumer goods industry (Hussain, 2014). While Chemical and automobile sector also performed same with 5.94 percent growth and 53.9 growth rates (Finance division, 2015).

Capital Structure has been always a difficult topic to examine after the research conducted by Modigliani and Miller (Tailab, 2013). A significant number of studies have been conducted to address the impact of Capital Structure on Firm’s performance in developed as well as developing countries. Ahmad, Abdullah and Roslan (2012) conducted study on Malaysian Food and industrial sector; Nirajini and Priya (2013) did on Sri Lankan Trading Companies; Ebrati, Emadi, Balasang and Safari (2013) did research on Iranian cement, electronic, pharmaceuticals, machinery and equipment sector; Chieh (2013) conducted study of Taiwan Photovoltaic companies; Tailab (2014) did on USA energy sector; David and Olorunfemi (2010) conducted study on Nigeria’s petroleum Industry; Abbadi and Rub (2012)  on Palestinian Financial institution; Ananiadis and Varsakelis (2008) studies on Greece Manufacturing Companies; Goyal (2013) addresses India’s Banking Industry and Shubita; Alsawalhah (2012) conducted research on Jordanian Industrial sector; Chowdhury and Chowdhury (2010) conducted a study addressing the engineering, food, power and pharmaceutical sector of Bangladesh; Pouraghajan and Malekian (2012) makes a study on Iran mining, material and chemical products, food and beverages, metal, rubber and plastic, textiles sectors and Salim and Yadav (2012) did on construction, plantation, consumer product, property and transportation. As seeing the past studies the mainly focused sectors by researchers are Power, Pharmaceutical, food and industrial sectors (Chowdhury and Chowdhury, 2010); Alsawalhah, 2012; Pouraghajan and Malekian, 2012; Tailab, 2014; Ebrati, Emadi, Balasang and Safari, 2013 and Ahmad, Abdullah and Roslan, (2012).

Through the studies conducted in Pakistan, the wide set of sectors cannot be addressed. Thus, it means that this cannot mirror the entire situation. Though Mujahid and Akhtar (2014) did research on Pakistan Textile sector; Amara and Aziz (2014) Food producing sector; Bokhari and Khan (2013) on Non financial firms; Hasan and Din (2012) conducted study on textile, Mumtaz, Rauf, Ahmed and Noreen (2013) addressed the firms registered in Karachi Stock exchange and Javed, Younas and Imran (2014) targets registered non financial firms in Karachi Stock Exchange. The main components that are examined by researchers to investigate the impact of Capital structure on firm’s value are Return on Asset, Return on equity, earning per share, return on sales, Size, Dividend Payout, Share Price Performance, Debt Ratio, Long term Debt, Total Assets Ratio, Short term Debt, Sales Growth, Assets Growth, Assets Turnover, Tangibility, Risk Associated with Business Entity, Net Profit Margin, Equity, Profit before Tax, Profit after tax, TLA and TLD (Mujahid and Akhtar, 2014; Amara and Aziz, 2014; Bokhari and Khan, 2013; Hasan and Din, 2012; Javed, Younas and Imran, 2014; Memon, Bhutto and Abbas, 2013; Mumtaz, Rauf, Ahmed and Noreen, 2013). The researches carried out in Pakistan only enlighten some sectors which are not sufficient to make financial decision because of insufficient research proves to support the variables used in Pakistan and those findings cannot represents the entire sectors of the country because of distinctiveness of industry.

1. Research Rationale:

Decisions regarding capital structure are always vital in Business corporations as they hold definite impacts on firm’s value (Tongkong, 2012). Inefficient financial decisions to finance its operations may lead to liquidation, financial distress and bankruptcy, although companies with high leverage should decide an optimal capital structure to cut off its cost (Suhaila and Mahmood, 2008). Further, heavily relying on equity finance may lead in the loss of growth opportunities and liquidity issues within the company (Javed, Younus and Imran, 2014).