Table of Contents

Abstract...................................................................................................................... 3
Chapter One................................................................................................................ 3
1.1

INTRODUCTION.........................................................................................3

1.2

PROBLEM STATEMENT.............................................................................4

1.3 RESEARCH QUESTIONS & OBJECTIVES......................................................5

1.4 JUSTIFICATION...............................................................................................6
1.5 LIMITATIONS................................................................................................6
1.6 SCOPE............................................................................................................... 6
1.7 ASSUMPTION...................................................................................................7
1.8 KEY WORDS.....................................................................................................7
Chapter Two................................................................................................................ 7
2.1 Literature Review...............................................................................................7
2.1.1 Concept of C.S..............................................................................................7
2.1.2 Importance of C.S.......................................................................................8
2.2.3 Theories related to C.S..................................................................................9
2.2.4 The relationship between TG and C.S.........................................................12
2.2.5 The relationship between LQ and C.S.........................................................12
2.2.6 The relationship between PR and C.S..........................................................12
2.2.7 The relationship between GR and C.S.........................................................13
2.2.8 The relationship between firm SZ and C.S..................................................13
2.2.9 The relationship between NDTS and C.S.....................................................13
Chapter Three...........................................................................................................14
3.1 Theoretical Framework.....................................................................................14
3.2 Research Methodology and Research Design.....................................................14
3.3 Procedural Design.............................................................................................14
3.4 Variables..........................................................................................................15
3.5 Explanation of Variables...................................................................................15

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3.5.1 LV:............................................................................................................. 15
3.5.2 TG:............................................................................................................ 15
3.5.3 PR:............................................................................................................ 16
3.5.4 SZ of Firm:................................................................................................16
3.5.5 GR:............................................................................................................ 16
3.5.6 NDTS:........................................................................................................17
3.5.7 LQ:............................................................................................................ 17
3.6 Hypothesis........................................................................................................18
Chapter Four............................................................................................................ 18
4.1 Data Analysis and Interpretation.......................................................................18
4.1.1 Descriptive Analysis....................................................................................18
4.1.2 Correlation Analysis...................................................................................19
4.1.3 Regression Analysis....................................................................................20
4.1.4 ANOVA Analysis.........................................................................................20
4.1.5 Regression Results of Constant Coefficient Model.......................................21
Chapter Five............................................................................................................. 23
5.1 CONCLUSION................................................................................................23
5.2 Limitations and Future Implications.................................................................24
References.................................................................................................................. 25

Abstract
The study was aimed at identifying the determinants that impact the C.S of a firm.
The study utilized the convenient sampling technique and collected data from the
annual reports of the selected companies of automobile sector of Pakistan. Overall,
there were 13 automotive firms listed in a Pakistan Stock Exchange. Among those, 5
automotive firms were selected i.e. Pak Suzuki, Hino Pak, Atlas Honda, Honda Cars,
Indus Motors. Moreover, descriptive analysis, coefficient of correlations, regression
and ANNOVA analysis were carried out to determine the impact of independent
variables i.e. TG, PR, LQ, GR, SZ and NDTSs on the dependent variable i.e. financial
LV of a firm. Overall, six hypothesis were developed, out which four hypothesis were
supported and accepted by the analysed data. However, two hypothesis were rejected.
According to the findings of this research, TG, PR, LQ were found to be negatively
related to the financial LV of a firm. On the contrary, GR of a firm was found to be
positively related to the financial LV of a firm. However, SZ of a firm and NDTSs do
not have a Negative relation(indirectly proportional) with financial LV of a firm.

Chapter One
1.1 INTRODUCTION
C.S has many different meanings according to individual, hence we have several
answers to it when it comes to finance. The C.S is said to be the mixture of both
equity and debt in any form of business. It is believed that it is the duty of a manager
to form a perfect mix of equity and debt by looking on the characteristic which
includes advantages and disadvantages when forming a capital of the firm. It is said
that primary focus of any firm is to maximize the shareholder equity and it can only
be done by making a perfect mix. They play a key role when any financial decision
are taken. There is many factors of country which also effects the decision making
and directly alters the results of C.S like political decision. The focus should be on
potential benefits which a firm can earn by in its own sector or multiple sectors
depending upon their own capacity. In any automobile industry, debt capital is offered
by banks and mutual funds, leasing firms and insurance company. The manger needs
to monitor all the factors in order to make a perfect mix of C.S.
Numerous studies have identified various factors which affects the decision of C.S.
Previous researchers identified the firms SZ, PR and TG as very crucial determinants
of C.S choice (Rajan & Zingales, 1995; Graham & Harvey, 2001; Ahmad et al.,
2011). Whereas there are a number other internal and external factors that influence
the choice of C.S. The research on determinants of C.S in Pakistan was initially
started with the work of Shah& Hijazi, (2004), then developed by Shah& Khan,
(2007). Thereafter, it is further extended by the Hijazi & Tariq, (2006) by conducting
research on the cement industry of Pakistan. Then further work was done by Rafiq,
Iqbal, & Atiq, (2008) by targeting the data on the chemical industry. Then by
Waliullah & Nishat, (2008) and Ahmad et al (2011).This study takes in account to
identify the potential factors affecting the financing decision of the firms in
automobile sector of Pakistan and to evaluate relative impact of these factors on
determining the C.S. Various studies have been conducted on different industries but
no any study has been conducted specifically to Automobile sector of Pakistan. So
this study will fill that gap which will give clear insights regarding factors which are
crucial for determining C.S in automobile sector.

1.2 PROBLEM STATEMENT

Ideally, every company wishes to have the optimal C.S to maintain the balance
between equity and the debt. However, in reality it may not be easy to determine the
optimal C.S due to the complexity of decision which most of the finance managers
found themselves confused in deciding the best possible way to finance the
companies new projects. Moreover, the firms most often uses either equity or debt to
finance its assets, therefore, the motivation behind this study is to look at the
determinants which may be incorporated in deciding about the C.S.

1.3 RESEARCH QUESTIONS & OBJECTIVES

Questions:
RQ1: What are the various factors for determining C.S in automobile sector of
Pakistan?
RQ2: What is effect of TG on LV for determining C.S?
RQ3: What is effect of SZ on LV for determining C.S?
RQ4: What is effect of PR on LV for determining C.S?
RQ5: What is effect of GR on LV for determining C.S?
RQ6: What is effect of NDTS on LV for determining C.S?
RQ7: What is effect of LQ on LV for determining C.S?

Objectives:
RO1: To determine various factors for determining C.S in automobile sector of
Pakistan?
RQ2: To determine effect of TG on LV for determining C.S?
RQ3: To determine effect of SZ on LV for determining C.S?
RQ4: To determine effect of PR on LV for determining C.S?
RQ5: To determine effect of GR on LV for determining C.S?
RQ6: To determine effect of NDTS on LV for determining C.S?
RQ7: To determine effect of LQ on LV for determining C.S?

1.4 JUSTIFICATION
Basically, this study is aimed at identifying the crucial determinants of C.S in the
automobile industry of Pakistan. After studying the determinants of C.S, the
inferences of this research may assist the finance managers in deciding the best mix of
debt and equity called best possible combination of C.S for the companies functioning
in the automobile industry of Pakistan.

1.5 LIMITATIONS
The variables which have been taken to study the effect of each variable on the LV to
decide about the optimal C.S may not be sufficient enough. There can be many other
factors which can affect the LV level of firm and play crucial part in deciding the best
mix of equity and debt. Further, the study has been conducted in the short time period
of 4 months, therefore, the results obtained from this study cannot be generalized
since the fact that this study in only limited to the automobile industry of Pakistan.
However, the results may vary from country to country.

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1.6 SCOPE

This study has been conducted in Pakistan by collecting and analysing the financial
data of automotive companies of Pakistan for last 10 years, therefore, whatever the
results are obtained can only be generalized within the Pakistan because determinants
of C.S vary greatly from economy to economy. Moreover, the findings of this study
may assist the finance managers in deciding the best mix of equity and debt.

1.7 ASSUMPTION
Prior to this study it has been assumed that economic indicators will remain same.
Moreover, since that fact that companies have been taken from automobile industry of
Pakistan, researchers have assumed the same nature of manufacturing process within
the selected companies.

1.8 KEY WORDS

C.S, Automobile industry, Pakistan, TG, F.A, Debt Ratio, PR.
Abbreviations:
Leverage= LV, Tangibility= TG, PR = Profitability, SZ= SZ, Growth= GR, Liquidity=
LQ, F.A= Fixes Assets, Total Assets= T.A, C.S= C.S, Long Term Debt= LTD, STD=
STD

Chapter Two
2.1 Literature Review
C.S is the core element of any company in the making of suitable concept of
company's C.Ss. Various definitions have been used in the literature related to C.S
.Brealey, Myers, & Marcus (2009, p. 366) describes C.S as the mixture of long-term
debt and equity financing. However, as C.S relates to the way that companies finance
their assets it is not enough only to include LTD and equity in the C.S definition, as
they can just as eagerly issue STD or convertible debt to provide financing. The
choice is fully on discretion related to company preferences, as well as the
characteristics of the asset being financed. Similarly, Welch (2011) challenges the use
of only including financial debt and equity into the C.S measure and advances instead
a measure including total liabilities to T.A.
2.1.1 Concept of Capital Structure
The word C.S can be define as the way firms finance their overall assets that are being
used and/or will be used in current as well future operations by using various sources
of funds. (Yamini Agarwal 2013). The C.S is comprises of debt and equity where debt
is obtained by issuing the bonds or the long term notes payable, while equity is
categorized common stocks, retained earnings and the preferred stocks. However, the
STD, for example, working capital requirements can be considered as the part of the
firms C.S (Harold bieman Jr 2012). According to the Sundaresan, Wang and Yang
(2015), the C.S of any firm is the mixture of common stocks, preferred stocks, LTD
and short debt. A firms ratio of long term and STD is considered widely by the
investors at the time of analyzing the C.S. Wicaksono (2016) asserts that when
analysts discuss the C.S, most of the times they refer to the companys debt-to-equity
ratio, which provides the best insight into the extent up to what the company is risky.
Most often, a firm that has finance its assets more by debt is considered as a firm
having aggressive C.S. Therefore, the firms like this poses the higher risk to its
investors. However, the risk can be considered as the main source of the firms GR
(Eugene F. Brigham, Joel Houston, 2016).

2.1.2 Importance of Capital Structure

The recent study of Groen (2016) illustrates that the decisions related to financing the
firms assets are always very essential in any type of business. The Finance Managers
are always found in the biggest dilemma of deciding right proportion of debt and
equity to form the optimal C.S of the firm. Generally, there must be an accurate mix
of equity capital and debt to finance the assets of the firm. However, the C.S, most
often, is designed to benefit the equity shareholders (Groen, 2016). Thus, a firm can
generate an appropriate portion of long term funds as a loan in the form of long term
bonds or debentures by paying the fixed annual charges instead of generating the
entire funds through shareholders equity. Though, these annual fixed charges are
considered as expenses to the firm, however, this manner of financing the assets really
help firms to serve the interest of the ordinary shareholders in a much better way
(Wicaksono, 2016).
In relation to the above statement, C.S not only provides the benefits to firms
shareholders, there are many other advantages that a firm can achieve if it
successfully determines the optimal C.S. The Nigerian researcher Babalola (2012)
demonstrates some of the advantages which are discussed below:
An optimal C.S maximizes the firms market value because of the fact
that the ownership interests of the stockholders and the total value of the
claims are maximized.
A best C.S enables firm to increase its share price in the market due to
increase in the EPS (Earning per Share) of the ordinary stockholders.
Moreover, it also upsurges the dividend receipt of the ordinary
shareholders.
An optimum C.S enables the firm to search out the new wealth creating
opportunities of investment. Further, it also enhances the confidence of
debt suppliers with the help of proper capital gearing.
An appropriate C.S engages a firm to find out continuously the new
wealth creating investment opportunities in the future. Consequently, the
countys rate of GR as well as rate of investment increases extensively.

2.2.3 Theories related to Captial Structure

The C.S decision affects financial risk as well as the value of company, which is why
the decision of C.S has very importance in the field of Strategic Financial Decisions.
Looking back at C.S theories, Miller & Modigliani (1958) states that in perfect
markets with assumptions of no taxes, no transaction costs, no bankruptcy costs and
equivalency in borrowing costs for both the companies and the investors, it is of no
matter that what C.S a company uses to finance its operations. Whereas, the value of
firm is determined by the earning power and its underlying assets. On the other hand,
Jensen & Meckling (1976), suggests that to obtain optimal C.S the concept of tradeoff
is involved among corporate/personal taxes and bankruptcy costs. Therefore, static
trade off theory says that firms should consider an appropriate debt ratio through
which firm can get benefit in a shape of tax saving. Such theories help us understand
the factors that can lead in determining C.S.
Myers and Majluf (1984) presented the Pecking order theory and according to which,
corporate finance at a larger picture says that most often, companies finance their
assets/projects from three sources i.e. internal funds, debt and the equity. Moreover, it
has been observed that companies do not utilize all of these financing sources
simultaneously. Rather, they have ranked such sources in an order. Firstly, they prefer
internal financing, secondly debt and then in last they go for equity. Which clearly
depicts that companies have prioritize these sources of financing. Further, majority of
the companys opt internal financing over debt, and if external financing is required
then they prefer debt financing over equity due to the fact that debt financing is
relatively cheaper than equity financing. According to the Anton Miglo (2016), unlike
issuing equity, financing through internal funds and financing through debt do not
depict a negative signal in the market. Instead, internal financing shows that company
is financially strong that it can finance its future operations through internal funds and
need not to raise funds externally. And on the other hand, debt financing shows that
company believes in its ability to pay back the borrowed amount in a given time
period. In contrast, if company choses to issue new stock it will provide negative
signal to its shareholders.
Many of the researchers have carried out empirical studies regarding determinants of
C.S. Talat Afza & Amer Hussain (2011) carried out the study specifically of the
manufacturing industry regarding determinants of C.S of several sectors of Pakistan.

10

That study suggests that there are two main theories i.e. static trade off theory and
pecking order theory, which affect the attributes of C.S in two ways, either positively
or negatively. The Financing decision of firms like automobiles, cable firms,
electrical goods and engineering related sectors depends heavily on the tax provision ,
LQ, NDTS, SZ and PR of the firm. Another study by Mohammad A. Qureshi &
Toseef Azid (2006) on the comparison between the financing decision of public sector
and private sector of Pakistan. They proposed that there is large difference of
Governance Structure in both sectors of Pakistan. The public sector has more
privileged access to financing sources, having got favorable tax treatment with less
accountability what so ever as compare to the private sector. Therefore, public sector
is preferring debt more than equity due to its different governance structure.
Furthermore, another study related to cement industry of Pakistan was carried out by
Hina Agha (2015), in which she declares that due to capital intensive nature of the
industry, this industry shows some different features. The study determined the
relationship of the 7 variables i.e. taxability, LQ cost of debt, GR, TG, dividend and
PR with the debt ratio and came up with the conclusion that 3 variables i.e. LQ, PR
and cost of debt have Negative relation(indirectly proportional)ship with debt ratio.
Which means that if LQ, PR and cost of debt increase the debt ratio will decrease. On
the contrary, tax and GR have positive relationship with debt ratio. However, TG and
dividend had no any significant impact on the debt ratio.
Moreover, Ahmed Arif & Bilal Aslam (2014) conducted study in Pakistan by taking
214 non-financial firms of Pakistan. In this study, they used debt ratio as dependent
variable and seven other variables out of which five variables i.e. TG, Dividend
Payout Ratio, Tax, LQ, and NDTSs were analyzed as independent variables. In
addition to above variables, one variable i.e. SZ was taken as control variable and Age
was taken as categorical variable to find out the relationship between the determinants
of C.S. The study came up with a conclusion that six variables i.e. TG, Dividend
Payout Ratio, Tax, LQ, NDTSs and SZ are positively related to debt ratio whereas
remaining four variables are insignificantly related to debt ratio. Consequently, it can
be asserted that determinants of C.S vary from country to country and industry to
industry.

11

Another study being done in UAE based companies i.e. financial institutions and
insurance companies excluding banks (Manuel Fernandez, 2012) with a sample of 51
firms came with results that financial LV and PR has Negative relation(indirectly
proportional)ship whereas SZ and financial LV has positive relationship with each
other. Addition to that study also concluded that lower profitable firms in UAE
generally use more debt in C.S and as firms grow bigger they tend to use more debt in
their C.S.
Another study conducted on Australian multinational and domestic corporations
(Shumi Akhtar, 2005) suggests that level of LV doesnt differ significantly between
multinational and domestic corporations. For both type of corporations GR, PR and
SZ are important determinants of LV. For domestic corporations bankruptcy cost are
not significant whereas for multinationals it is. Study conducted on Turkish nonfinancial firms which includes manufacturing, non-manufacturing, small, large listed
and unlisted firms for having accurate picture of C.S choices came to the results that
trade-off theory is better framework than the pecking order. Turkish non-financial
firms appear to trade-off tax benefits of debt against bankruptcy cost in order to attain
optimal C.S. Trade-off theory seems to be successfully in financing decisions of large
private firms not related to manufacturing, when the economic environment is stable
whereas for small public firms in manufacturing sector pecking order theory appears
to be good when the economic environment is relatively unstable.
2.2.4 The relationship between Tangibility and Capital Structure
It has been observed that the companies having higher PR experience the lower debt
ratio, irrespective of how the debt ratio was explained. Moreover, it has also been
observed that the company having more tangible assets is more likely to have the
higher long-term debt ratio but lower total debt ratio. According to the Olakunle &
Oni (2014), the TG of the assets is described by the effect of security (guarantee)
values of the company assets on the level of LV of the firm. The fundamental
argument about the use of the F.A as security (guarantee) for LV (debt) is the greater
insolvency value of tangible assets at the time of bankruptcy . Therefore, while
studying the C.S, the research of Olakunle & Oni (2014) have revealed that TG of the
firm has positive relationship with the C.S of the firm.

12

2.2.5 The relationship between Liquidity and Capital Structure

It is said that the greater the amount of money a firm has, the less it has a LV. Which
means that firm uses its working capital to meet its short term obligations. This is how
the companies preserve their LQ and create their own sourcing of financing especially
in the situation when company needs instant financing. Therefore, the study of Sarlija
& Harc (2012) reveals that there is an adverse relationship between the LQ and the
C.S.
2.2.6 The relationship between Profitability and Capital Structure
The decision of C.S is always very critical for every type of business. The decision is
vital because of a firms need to maximize the returns to several organizational
constituencies. The recent study of Shubita & Alsawalhah (2012) revealed that there is
a significantly Negative relation(indirectly proportional) between PR and the LV. The
study further implies that an increase in PR is associated with a decrease in the LV,
thus, higher the PR, lower the level of LV of the firm. Therefore, past literature is
supporting the idea that companies should keep their level of LV lower, so that default
risk may not rise and firm remain able to finance its assets internally and be able to
deal properly with its competitive environment by increasing the PR.
2.2.7 The relationship between Growth and Capital Structure
Generally, when firms generate sufficient revenues and post the higher GR than
previous year, consequently they have less need of borrowing the funds. In the result
of it, investors also invest in the firms having higher GR because of the fact that they
have lower financial LV and have lower risk of bankruptcy. Therefore, the research
conducted by Arasteh, Nourbakhsh & Pourali (2013), assert that there is a Negative
relation(indirectly proportional)ship between the firms GR and firms level of
financial LV. Moreover, the study suggests that the firms with higher profit GR are
more likely to reduce the utilization of the financial LV in their financing.
2.2.8 The relationship between firm SZ and Capital Structure
The firms SZ plays a vital role in deciding the best mix of equity and debt. From the
trade of theory, it can be asserted that firm volume (SZ) has directly proportional with
the C.S due to the fact that SZ is considered as substitute of bankruptcy cost. The
theory further states that the higher the SZ of the firm, lower will be the bankruptcy
risk. However, on the other hand, the recent study of Harc (2015), revealed that there

13

is a significant Negative relation(indirectly proportional)ship between company SZ

and its C.S. The study further illustrates that bigger the firm is in terms of sales,
smaller volume of debt it incorporates in its C.S. Thus, the past literature supports the
viewpoint that firm SZ and C.S has inverse relation to each other.
2.2.9 The relationship between Non-Debt Tax Shield and Capital Structure
Generally, one of the primary objective of any firm is to lessen the transaction cost. In
contrast, the debt financing is more likely to upturn the transaction cost due to the
high interest rate of the bank loan. At the other hand, the NDTSs protect the firms
from paying the high costs, in result, NDTSs can help firms to shrink the total amount
of funds employed. Therefore, the researcher Gao (2016), explains in his study that
firms have the strong benefit to opt the NDTS in order to defer or lessen the taxes.
The researcher further demonstrates that NDTSs have a substitution effect over the
debt tax shields, and hence, conclude that there is an inverse relationship between the
NDTSs and the financial LV / C.S.

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Chapter Three
3.1 Theoretical Framework

Figure 1 Theoretical Framework

3.2 Research Methodology and Research Design

This study utilizes the convenient sampling technique to collect the data. The data was
collected from the annual reports of selected automobile companies of Pakistan listed
in Pakistan Stock Exchange. The selected companies are; Indus Motors, Pak Suzuki
Motors, Hino Pak, Atlas Honda and Honda Cars. The population is comprised of 12
automobile companies of Pakistan listed in Pakistan Stock Exchange. However, total
sample is comprised of 5 above mentioned automobile companies. Moreover, the
study has utilized the deductive research approach as the study is purely quantitate
which implies testing the theories developed earlier based on the hypothesis
generated. Further, the study complies with the philosophy of positivism due to the
fact that findings can easily be quantified and measured. Lastly, the research type of
this study is mono-method and the data analyzed is the time-series data because the
data in collected is the sequenced data of ten years from 2006 to 2015 with an equal
time interval.

3.3 Procedural Design

The model that has been used in this study is based on the correlation as well as
regression analysis because the ultimate objective of this research is to investigate the
relationship and the effect of independent variables i.e. TG, LQ, PR, GR, Company

15

SZ and the NDTSs over the dependent variable i.e. financial LV. Therefore, the IBM
SPSS statistics software (version 20.0) has been used to analyze the data.

3.4 Variables
Overall, the study has incorporated 7 variables. Among those 6 are independent and
the remaining one is dependent variable. The independent variables include TG, LQ,
PR, GR, Company SZ and the NDTSs. However, the financial LV is the only
dependent variable. The following model has been demonstrated below.
LVG=0+1(PRF)+2(SZ)+3(TGB)+4(GR)+5(NDTS)+6(LQD)+
Where:
0=constant co-efficient
1- 6= coefficients for variables
PRF= PR
SZ= SZ
TGB= TG
GR= GR
NDTS= NDTS
LQD= LQ

3.5 Explanation of Variables

3.5.1 LV: LV is considered as the most widely used measure of companies financial
LV. In other terms financial LV is also called debt-to-equity ratio. In this study, it is
used as a dependent variable. The D/E ratio is comprised of the long-term debt ratio
and the equity ratio which includes reserves and share capital. The debt-to-equity ratio
is calculated as LV = Total Liabilities / Total equity, used by Mohan Raj (2011) in his
analysis.
3.5.2 TG: Since the fact that fixed (tangible) assets are generally used as security,
companies with relatively large volume of F.A can easily borrow the funds on
favourable terms and conditions by providing these assets as a collateral to the
lenders. Therefore, a high TG of a firm can have a positive relation with the firms
level of LV. Thus, the TG of any firms total F.A can be determined by; TGB= F.A/
T.A.

16

3.5.3 PR: PR of a firm is described as earnings of a firm before interest payments,

taxes and the dividends. This measure of PR has been utilized by many researchers in
past and is considered as a most reliable variable used to determine the best mix of
equity and debt. Moreover, the pecking-order theory suggests that companies with
higher profits most of the times prefer the internal financing i.e. retained earnings
because of its cost effectiveness. These firms are found reserved to borrow the funds
from external sources. Therefore, according to this this theory, there should be an
inverse relation between PR of a firm and its level of LV. In contrast to the pecking
order theory, trade-off theory postulates that relation between PR of firm and its level
of LV would be positive. The reason behind this argument is that profitable companies
are most likely to be safe from bankruptcy, and therefore, these firms have options to
borrow to funds at a relatively cheaper interest rates. The PR ratio is calculated as; PR
= Net Income / T.A.
3.5.4 SZ of Firm: The SZ of a firm is determined by taking the Ln (natural logarithm)
of T.A. This measurement has been used by many researchers in the past. According
to the trade-off theory, there should be a positive relation between the SZ of a firm
and LV. The main reason behind this statement is that bigger companies are found to
be more diversified. They have steady cash flows and less level risk of bankruptcy
along with an easy access to the markets that provide credit. Hence, it can be said that
firm SZ is a positively related to the firms financial LV. In contrast to the trade-off
theory, pecking order theory disagrees to the above argument. Pecking order theory
demonstrates that bigger companies have relatively less information asymmetries
which makes issuance of equity more attractive. Therefore, there should be a Negative
relation(indirectly proportional) between the financial LV of firm and a firm SZ. The
firm SZ is calculated in two ways; either by taking natural log of T.A or by taking
natural log of total sales of a firm. In this study, the SZ of firm is calculated by taking
the natural log of assets.
3.5.5 GR: GR of a firm is determined as the difference in the sales of a firm between
two successive years by the previous year total sales. This dimension is used widely
by many of the researchers in the past. Generally, companies with a substantial GR
opportunities in future are most probably to face the challenges in generating finance
from LV because of the fact that GR opportunities are considered as an intangible
assists of a firm and intangible assets cannot be used as collateral for the debt.

17

Therefore, it can be asserted that companies with substantially high intangible GR

opportunities are more likely to finance their assets thorough equity instead of going
for debt. However, in contradiction, pecking order theory asserts that companies with
substantial GR(expansion) opportunities are expected to have greater information
irregularities, and thus, are anticipated to have less of equity and more of debt in their
C.S. The GR of a firm is calculated as; GR = Sales of current year minus Sales of
previous year (S1-S0) / Sales of previous year (S0).
3.5.6 NDTS: NDTS can be explained as a ratio of firms total depreciation of the year
to the firms T.A. NDTSs, for example, tax deduction for investment tax credits and
tax deduction for depreciation are considered as a replacements for the tax benefits of
debt financing. Consequently, it can be asserted that NDTSs have a Negative
relation(indirectly proportional) with firms financial LV. Thus, it can be calculated as;
NDTSs = Annual Depreciation of a firm / T.A of a firm.
3.5.7 LQ: LQ of a firm can be explained as the current assets divided by current
liabilities. LQ provides an idea of how much a company is able to meet its short term
obligations / needs. There are two different school of thoughts regarding the
relationship between LQ and the C.S. According to the trade-off theory, LQ has
positive impact on financial LV because of the fact that companies with relatively
higher LQ are more likely to opt external borrowing, due to their ability of paying
back their liabilities. However, the second school of thought pertains to the pecking
order theory, which disagrees the above idea and postulates that there is a negative
significant relation between the LQ and the financial LV. The main reason behind this
argument is that firms with higher LQ are more likely to use internal funds to finance
their assets, and thus, reduce their need to get external financing. Consequently, it can
be declared that LQ ratios of a firm may have mixed impact on the firms C.S. Thus,
LQ can be determined as; LQ = total current assets / total current liabilities.

18

3.6 Hypothesis
H1: TG has a negative impact on financial LV.
H2: PR has a negative impact on financial LV.
H3: SZ of the firm has a negative impact on financial LV.
H4: GR of the firm has a negative impact on financial LV.
H5: NDTS has a negative impact on financial LV.
H6: LQ has a negative impact on financial LV.

Chapter Four
4.1 Data Analysis and Interpretation
4.1.1 Descriptive Analysis

Table 1 Descriptive Analysis

From the descriptive analysis, it can be illustrated that the mean of LV is 2.1946
times, which depicts that in automobile sector of Pakistan, the average level of LV in
any company would be 2.1946x. The maximum level of LV of any company would be
28.28x and minimum level of LV would be 0.20x. However, the level of LV in an
automobile sector of Pakistan may deviate by 4.16299x from its mean. Moreover, the
mean value of TG is 0.2769, which shows that average TG of firms in an automobile
sector of Pakistan is 27.69%. The maximum TG would be 58% and minimum TG
would be 10%. Whereas, TG level can deviate by 12.498% from its meas. Similarly,
the above table of descriptive statistics shows that average PR of the firms in an
automobile industry of Pakistan is recorded as 8.37% which can go maximum up to
37% and minimum at -10%. Though, the PR can deviate by 9.04% from its mean.
Further, form the table it can be asserted that average SZ of a firm in an automobile

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sector of Pakistan is 16.33 times which can reach maximum at 17.74 times and
minimum at 15.24 times with the possible deviation of 0.60458 times from its mean.
Likewise, the average GR of automobile firms has been found as 12.22% with
maximum level of 86% and minimum level of -34% and can be deviated by 28.95%
from its mean. In addition to from the figures of above mentioned table it can be
determined that companies are having 3.65% of NDTS with the maximum level of
8.4% to the minimum value of .24% and can be deviated by 1.8% from its mean.
Lastly, the average LQ of automobile firms has been found as 1.71 times with the
maximum value of 4.44 times to minimum value of .06 and that can be deviated by .
875 from its mean (Refer Table 1).
4.1.2 Correlation Analysis

Table 2 Coefficients of Correlation

Table-2 demonstrates correlation matrix of the variables used in the study. Correlation
table depicts that PR is indirectly (negatively) correlated with the LV with the
coefficient value as -.443Which confirms the consistency with pecking order theory.
Moreover, SZ of a firm also shows negative correlation with LV with coefficient value
as -0.190 which also complies with pecking order theory. Further, the above table

20

depicts that TG has positive correlation with the financial LV of a firm with
correlation value of 0.302 and thus, disagrees with the pecking order theory. Similarly,
GR also shows positive correlation with LV and its value of coefficient of correlation
is .090. Likewise, LQ of a firm has proved to have negative correlation with LV with
the value of coefficient of correlation as -0.464. In last, NDTS also had a positive
correlation with LV with a coefficient value of correlation as 0.436 and hence, rejects
the pecking order theory.

4.1.3 Regression Analysis

Table 3 Regression Analysis

The output generated from multiple regressions has been summarized in Table-3.
Moreover, it can be illustrated from the above table that R Square value of the model
is 42.1%, which indicates that 42.1 percent variation in LV is explained by the
variables like PR, GR, LQ, NDTS, TG and SZ whereas the remaining 57.9 percent is
explained by unobserved factors such as tax, risk, dividend pay-out ratio etc.
However, the adjusted R2 value is 8 percent lower than the R2 and is indicated as 34.1
percent.
4.1.4 ANOVA Analysis

Table 4 ANOVA Analysis

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Table-4 represents the test results of ANOVA, which explains that whether the model
as a whole is significantly better at predicting the outcome than using the mean as a
best predictor. From the data it can be demonstrated that the P-value of 0.000 is less
than the alpha level of 0.05, which provides an enough evidence to conclude that this
analysis is significant.
4.1.5 Regression Results of Constant Coefficient Model

Table 5 Coefficients of Regression Analysis

From the above table, following regression equation has been developed;
LV= -3.881 -.343(PRO) +.071(SIZ) -.103(TANG) +.065(GRO) +.354(NDTS) 0.332(LIQ)
Regression analysis is used to determine the relationship between the firm-level
variables and LV. Table- 5 shows the correlation coefficients estimates, which
describes the relationship between the independent variables and dependent variables
along with the impact of independent variable over independent variable. From the
above table, it can be noted that Beta coefficient of TG is -0.103, which shows that
TG is negatively associated with the LV. The P-value of .594 which is greater than
0.05 shows that the relationship between both the variables is insignificant. Therefore,
it can be concluded that this finding is in contrast with the previous study of Olakunle
& Oni (2014). Moreover, the beta coefficient shows that one unit increase in TG of
F.A will decrease the level of LV by .103. Hence, this Negative relation(indirectly
proportional)ship between both variables provides an enough evidence to accept the

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alternate hypothesis 1 which is also consistent with the pecking order theory, and
shows that firms with more TG use less LV.
Additionally, the beta coefficient of PR is -0.343 which shows that PR is negatively
associated with the LV which is also in line with pecking order theory. Moreover, the
P-value of PR is .010 which is less than 0.05. Therefore, it can be illustrated that there
is significant relationship between both the variables. The Negative relation(indirectly
proportional)ship shows that one unit increase in PR will decrease the LV by .343.
Hence, there is strong evidence to accept the alternate hypothesis 2, which is in line
with the previous research of Shubita & Alsawalhah (2012). Consequently, findings
suggest that profitable Automobile firms in Pakistan prefer to finance new
investments using internal source of financing like retained earnings, surplus etc.
instead of debt.
Further, the beta coefficient of Firm SZ is .071 which shows that firm SZ is positively
associated with LV. However, the P-value is noticed as .671 which is greater than
0.05, therefore, it can be asserted that there is insignificant relation between both the
variables. The positive relation between these variables depicts that one unit increase
in firms SZ will increase the LV by .071. Based on this result, the alternate
hypothesis 3 cannot be accepted and which is inconsistent with pecking order theory.
In addition, this finding is contrary to the results of previous study of Harc (2015).
Thus, it can be explained that the firms with large SZ use more LV in their C.S.
Furthermore, the relationship between LV and GR is found to be positive and
insignificant with the beta coefficient value of .065 and the P-value of .623 which is
greater than 0.05, which indicates that one unit increase in firms GR will increase the
LV by .065. The positive relationship between GR and LV provides an enough
evidence to accept the alternate hypothesis 4, which is found to be in contrast to the
findings of Arasteh, Nourbakhsh & Pourali (2013). However, this result shows that
growing Automobile companies in Pakistan rely more on LV.
The NDTSs (NDTS) are positively associated with the LV having a coefficient value
of .354 significant with the P-Value as .039. The beta coefficient shows that one unit
increase in NDTS will increase the LV by .354. Thus, based on these findings the
alternate hypothesis 5 cannot be accepted and which is also inconsistent with the
pecking order theory and previous research finding of Gao (2016). The discussed

23

relationship between NDTS and LV indicates that Automobile firms with high level
tax Shield will tend to use high debt instead of internal financing.
In last, LQ has found to be negatively related to LV with coefficient value of -.332
and is significant with P-value of .036. The beta coefficient value shows that one unit
increase in LQ will decrease LV by .332. Such relationship between LQ and LV
provides a strong evidence to accept the alternate hypothesis 6 which also supports
the pecking order theory. Moreover, these findings are found to be in line with
previous research findings of Sarlija & Harc (2012). Such relationship between LQ
and LV depicts that Automobile firms of Pakistan having more LQ will tend to opt
less debt financing in their C.S.

Chapter Five
5.1 CONCLUSION
In this study the main objective was to determine the factors that leads to changes in
C.S of an Automobile sector of Pakistan. Being a primary objective of any company
to maximize shareholders wealth, top management of every company is very much
worried about capital mixture of debt and financing which can reap maximum
benefits for the company. In simple words each and every Board and top level
management wants to have optimal C.S which would be beneficial for company.

24

In order to find out such determinants which determines the C.S, we have taken five
companies from Automobile industry of Pakistan (Hino Pak, Indus Motors, PakSuzuki Motors, Atlas Honda, Honda Cars) and Ten years data of each company has
been taken i.e. from 2006 to 2015. To extract out the data for six variables i.e. TG,
PR, SZ, GR, NDTS and LQ, the annual reports of each company have been reviewed.
Furthermore descriptive analysis, correlation and ordinary least square regression
were the tools of statistics used in this study to find the results.
From the results obtained it can be concluded that out of six hypothesis two
hypothesis were rejected whereas four of them were accepted. Four hypothesis related
to TG, PR, GR and LQ were accepted whereas remaining two hypothesis related to
SZ and NDTS have been rejected. The findings of this study may vary from previous
researches. The main reason behind this variation can be socio-economic factors that
may affect the companies decision of financing. Moreover, in Pakistan perspective,
political networks of company owners also play an important role in raising the funds.
These type of networks help the company owners to have an easy access to credit
market which results in greater level of debt.
From the findings of this research it can be concluded that most often, automobile
firms of Pakistan follows pecking order theory for their financing decision. Out of six
variables only three variables (PR, NDTS and LQ) were found to be significant
whereas the remaining variables i.e. TG, SZ and GR were found to be insignificant,
which depicts that these variables do not play any significant role in the determination
of LV in Automobile industry of Pakistan.

5.2 Limitations and Future Implications

The study has considered six independent variables to study the impact of each
variable on financial LV of a firm. The selected variables were; LQ, PR, TG, GR, SZ
and the NDTS. Meanwhile, there can be many other variables other than those used in
this research, which can be studied to determine their impact on financial LV of a
firm. Therefore, it can be stated that the findings of this research cannot be
generalized to other countries. Moreover, the economic conditions and credit markets
stability varies greatly form economy to economy. Thus, the findings of this study
may not be fair enough to generalize impacts of each variable selected in this study on

25

the financial LV of a firm. Furthermore, this study has been conducted in a short time
period of just 4 months. Although, this type of study requires sufficient time to obtain
the fair and justifiable results. Therefore, future research can be conducted by taking
variables other than those used in this study and with an enough time period to
achieve insights and better understandings of the variables that impact the financial
LV of a firm and help companies decide to decide the best mix of equity and debt.
Additionally, this study was purely based on the automotive companies of Pakistan
that were listed in Pakistan stock exchange. In future, the research can be carried out
by taking other sectors like cement industry, FMCG, Oil industry etc. in order to
know how variables other than those used in this research really impacts the C.S.