The Impact of Profitability, Asset Tangibility and Corporate Tax on the Capital Structure

of Cement Companies listed at Pakistan Stock Exchange

Student’s Name: Muhammad Imran Mughal

Class: MBA- 28
Roll No: MB-F15-280019
Specialization: Finance

ARMY PUBLIC COLLEGE OF MANAGEMENT

SCIENCES (APCOMS)
RAWALPINDI
NUML
2019
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INTRODUCTION

1,1 “Capital structure is very important for firms because it has an impact on long-term
corporate profits, firm’s valuation and capital budgeting decisions, The first method is to fulfill
the need for capital with capital from an external source, known as “spending with debt” The
second method is to fulfill the company’s capital needs with its own internal resources, known as
“spending its own capital The capital structure of a firm is actually a mix of different securities,
In general, a firm can choose among many alternative capital structures It can issue a large
amount of debt or very little debt”,“It can arrange lease financing, use warrants, issue convertible
bonds, sign forward contracts or trade bond swaps it can issue dozens of distinct securities in
countless combinations; however, it attempts to find the particular combination that maximizes
its overall market value,”

Theoretical foundation on the relationship between capital structure and firm

performance was first laid by Modigliani and Miller in 1950’s, They first proposed that the
firm’s value is independent of its capital structure, Later on, Modigliani and Miller’s capital
structure theory was revised in 1963 and it was argued that due to tax advantage of debt
financing, firm value can be increased by changing the capital structure, A number of theories
have been advanced in explaining the capital structure of firms, The trade-off theory, the pecking
order theory and the agency cost theory show that the classical theory of Modigliani and Miller
(1958) is unrealistic, These theories show that debt and equity are no perfect substitutes of each
other, as Modigliani and Miller (1958) stated and that the decisions of the capital structure are
important for organizations (Hillier, et al, 2010), The pecking-order theory of capital structure
developed by Myers and Majluf (1984) is of the essence that firm will adhere to the hierarchy of
financing by preferring to finance itself from internally generated funds, because the use of such
funds does not send any negative signal that may lower the stock price of the firm, When internal
finances are depleted, it will opt for equity (Anarfor, 2015),

The capital structure decision is crucial for any business organization, The decision is
important because of the need to maximize returns to various organizational constituencies, and
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also because of the impact such a decision has on a firm’s ability to deal with its competitive
environment, In corporate finance, decision of optimal structure of capital, is a controversial
issue, The capital structure is a way the company finances its operations by using different
sources of funds, Mainly, these are two sources, the one is debt and the other is equity, Debt is
obtained through issuance of bonds or long-term notes, while equity is divided into three main
sources such as retained earnings, common stock and preferred stock,
Equity financing refers to the resources generated through the sale of shares, The key
advantage of equity financing is that it does not require the repayment of funds, However, it does
not mean that there is no problem to use equity solely for business, The shareholders buy shares
with the consideration that they would own a small portion in the business, The company at that
moment is bound to investors and must produce stable earnings in order to sustain the stock
value and pay dividends, The company has to pay the cost of obtaining these sources, which is
called the cost of capital, In simple words, the cost of acquiring funds is weighted average of
both types of financing cost either it is taken in the form of debt or in equity, The cost of equity
refers to the risk that equity investors perceive in their investment and the cost of debt includes
the risk of default that creditors see from the same investment (Damodaran 2016),
Corporate financing decision, one of the four major corporate finance decisions (others
include investment, dividend and liquidity decisions), are quite complex processes, Theories in
corporate finance may only have explained certain facets of the diversity and complexity of
financing choices (Ogbulu, Okanta&Turakpe, 2018), Funding decisions greatly determine the
company’s ability to perform its operations and would affect the company’s own risk profile,
The analysis of capital structure seeks to determine the effect of liabilities upon a company’s
stock price, which would inform the company’s decision on whether it should incorporate a debt
component into its capital structure (Nasution&Siregar, 2017), In such a scenario decision
making has emerged as one of the toughest tasks as it decides the fate of every firm, Therefore,
managers have to take into consideration the cause effect relationship while making a particular
decision, The managers of present corporate world have to follow systems approach in their
decision making because a decision taken in isolation can bring a firm to the verge of a disaster,
Of all the aspects of capital investment decision, capital structure decision is the vital one, since
the profitability of an enterprise is directly affected by such decision, Hence, proper care and
attention need to be given while making the capital structure decision, There could be hundreds

2
of options but to decide which option is best in firm's interest in a particular scenario needs to
have deep insight in the field of finance as use of more proportion of Debt in capital structure can
be effective as it is less costly than equity but it also has some limitations because after a certain
limit it affects company's leverage, Therefore, a balance needs to be maintained,

The study on capital structure in a global perspective has at least two

streams, In one of these streams, several studies comparefinancing policies of
multinational and domestic firms, However,results are mixed,Lee and Kwok (1988),
Burgman (1996) and Chen et al, (1997), for instance, find evidence that multinational
companies have lower financial leverage compared to domestic ones , The explanation
for this phenomenon is based on the higher cost of capital due to agency problems,
exchange rate risk and politicalrisk, On the other hand,Mansi and Reeb (2002) find
the opposite, i,e,, that international activity increased firm leverage ,

Several studies (e,g,,Rajan and Zingales, 1995;Booth et al,, 2001; Antoniou et

al,, 2008; Beck et al,, 2008; de Jong et al,, 2008) analyze the role of country
characteristics as determinants of firm leverage, A first important observation is that
financing policy seems to have similar patterns of behavior around the world, despite
the evident institutional differences(Rajan and Zingales, 1995; Booth et al,, 2001),
Accordingly,Booth et al, (2001) find evidence that variables that explain capital
structure in developed markets (e,g,, United States and Europe) also explain
capitalstructure in emerging markets, Profitability, for instance, is one of the firm-
level variables that shows high convergence in the comparison between countries ,

In addition, these studies emphasize that country macroeco -

nomic/institutional factors and even culture differences (Sekelyand Collins, 1988;
Chui et al,, 2002) may have a marked influenceon capital structure,De Jong et al,
(2008) provide evidence thatthese factors have direct or indirect influences on
leverage, They show that, for instance, the more developed the country ’ s bond
market, the larger the leverage of firms
Pakistan is an emerging economy where most of the companies depend on bank loans to
fund their venture requirements (Shahzad et al,, 2015), Many financial institutions have been
denationalized and therefore, the companies with more volatile income can gain access to funds
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on high interest rates, The State Bank of Pakistan (SBP) is putting efforts to develop the
Marketable Government securities with special attention on increasing the investor base to
improve the liquidity in debt and capital markets, Initiatives have been taken by the Government
of Pakistan to remove the anomalies in interest rate structures to develop the corporate bond
market,
An optimum capital structure, which gives maximum returns to shareholders, plays an
important role in the growth and progress of any company, As in Singh and Singh (2016),
Solomon and Weston (1973) posit that the proper and right combination of debt and equity will
always lead to a market value enhancement,

Research Gap

“Capital structure of a firm refers to the proportion of debt and equity used to finance its assets,
Over a past several decades the theories on leverage and profitability are full of controversies,
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“Professor Franco Modigliani and Merton Miller” were the pioneer of capital structure theories
(MM-1, 1958),” “They found that profitability of a firm is irrelevant of its capital structure, if
there is no tax, no brokerage cost, no bankruptcy cost, rate of borrowing and lending is same,
investor and management of firm have same information about firm’s investment plan for future,
and operating income remains unaffected by different financing options This theory is also
known as irrelevant theory They further argue that both levered and unlevered firms have same
value, which is determined through its profitability, regardless of its capital structure,”

“Later on in 1963 Modigliani and Miller (MM-2) relax the assumption of ‘No Corporate Taxes’,
and incorporate the Corporate tax effect and suggest that in the presence of tax shield over
interest paid on debt, firm should use maximum possible debts financing option (100% debt
financing option) to maximize its value, They argue that value of a levered firm is tax time debt
greater than value of unlevered firm, The only way to maximize the value of firm is to use 100%
debt financing option,”
“Pecking order theory propose that firm’s first choice of capital financing should be internal
(Retained earnings); if additional fund required they can use the debt financing option; and if still
more funds are required, firm can issue equity (Myers and Majluf, 1984), Whereas, trade-off
theorist suggest that firm should choose best combination of debt and equity, firm should try to
minimize its WACC (Weighted average cost of capital), According to trade-off theorist, the
determination of capital structure is the strategic decision of firm, and it is different for every
industry and for every firm,”
“Most of capital structure theories and their determinants are developed, tested and recertified in
developed countries in the context of their national dynamics (Jaros & Bartosova, 2015), These
country specific factors act as the main hurdle for its universal applicability, Although, the
country specific factors do have a significant effect on firms financing decisions, as corporate
leverage is directly related to conduciveness of financial market, Therefore, to develop a basic
understanding and to find the impact of these indigenous firms’ specific factors (managerial
policies, actions and their relationships regarding the determinants of capital structure in the
context of local economic and financial condition) on firms financing mix is the core essence of
this study,”

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1.2 Problem Statement

“Since there are relatively few papers analyzing the influenc e of industry
characteristics on capital structure and with the emergence of the China-Pakistan
Economic Corridor (CPEC), the growth of cement industry with its full production
capacity has not been analyzed thoroughly, The issue of a given capital structure that
may increase the shareholder value has not been addressed, Moreover the importance
of determinants of capital structure with regard to cement industry and its effect on
formulation of corporate policy remained unclear to the managers of cement industry
when making financial decision”

1.3 Research Question

What is the impact of profitability on the capital structure?
What is the impact of asset tangibility on the capital structure?
What is the impact of corporate tax on the capital structure?
1.4 Objectives of the Study
Following are the objectives of this study:

 To investigate the impact of profitability on the capital structure

 To investigate the impact of asset tangibility on the capital structure
 To investigate the impact of corporate tax on the capital structure

1.5 Scope of the Study

“Present study will seek to analyze this aforementioned relationship in the normal course of
cement sector of Pakistan, The main objective of this study to examine impact of profitability,
asset tangibility and corporate tax on capital structure of cement companies listed at Pakistan
Stock Exchange,”

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1.6 Rationale / Significance of Study

“A significant rise is predicted in the cement industry after the China-Pakistan Economic
Corridor (CPEC), with major projects such as the Gwadar Port, KKH-II and the Karachi-Lahore
motorway,This is a huge opportunity for local and foreign investors to take advantage of this
mega-demand, which will receive further boost from the government's 5 million houses program,
The Cement sector is one of the most vibrant segments of manufacturing sector, which plays a
crucial role in economy of Pakistan, Currently, the cement sector is adding more than Rs 40
billion to national exchequer in the shape of taxes, employed more than 150 thousand employees
and holding 1,2% of global production (PACRA, 2018), During the past decade and so, the
cement industries have achieved unprecedented heights, to meet towering local demand, as well
as international demands from Africa, Middle East and Afghanistan (Business Recorder, 2018),
Present study will be helpful for finance managers who are studying financial performance of
cement sector in Pakistan, as the managerial policies, actions and their relationships regarding
the determinants of capital structure plays a vital role in economic uplift, Present study will be
useful for researchers / students who are studying or want to explore the impact of CPEC on
growth impetus of cement industries,”

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 2

LITERATURE REVIEW
2.1 General
“As indicated by Akeem et al, (2014) there are different options of debt to equity ratio, These
incorporates; 100% equity: 0% debt, 0% equity: 100% debt and X% equity: Y% debt, From
these three options, option one is that of the unlevered firm, that is, the firm that disregards the
upside of influence (assuming any), Option two is that of a firm that has no equity capital, This
option may not really be sensible or conceivable in the genuine monetary circumstance, in light
of the fact that no supplier of assets will put his cash in a firm without equity capital, This is
what is alluded to as 'exchanging on equity', That is, it is the equity component that is available
in capital structure that spurs the debt suppliers to give their rare assets to the business (Chechet
and Olayiwola, 2014), Option three is the most practical one in that, it joins both a specific level
of debt and equity in the capital structure and along these lines, the benefits of influence
(assuming any) are misused, In developed and as well as the developing countries, there has been
a relationshiop on the impact of capital structure of a firm on firm performance (Nwankwo,
2014)”

“Chen, Harford and Kamara (2016) showed that overflows of operating leverage and financial
leverage in the meantime builds the productivity, Subsequently, operating levarage creates the
converse connection among productivity and financial leverage that seems, by all accounts, to be
conflicting with the exchange off hypothesis, yet is generally seen in the information, A large
amount of studies recognized the effect of capital structure on firms performance any country, In
the Tailab (2014) researched on American vitality, Tifow and Sayilir (2015) researched Turkey
manufacturing firm and Abeywardhana (2016) researched on United Kingdom producing
segment little and medium endeavor (SME), From 2013 forward, the majority of the examination
done in capital structure was carried on developing countries”

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2.2 Capital structure
“Most of the companies do not include short-term credit, but also a long-term means the
composition of company funds obtained from various sources in their capital structure, Hence it
is described that the capital structure of the company with a combination of debt and equity
capital in financing its assets, A combination of debt and equity is called as the capital structure
of a company, It can can also refer to the way a good corporation own money through a
combination of equity, hybrid or debt train;, However, not all companies use a standardized
structure of the financial decisions to differ in their various terms and conditions (Akeem et al,
2014), Capital structure is the important decision of any organization, In the corporate form of
business is often the duty of the company management to create a favorable capital structure of
their company that maximized the value of the firm because any wrong decision can be a
definition of the offense and financial difficulties and company bankruptcy.”

“Another significant restrictive theory of capital structure is the theory of cash flow, which
expresses that higher leverage prompts an ascent in the estimation of a firm in spite of the risk of
financial distress, when organizational operating cash flows exceed its favorable investment
opportunities (Myers, 2001), Clashes among investors and managers over policy of dividend
payout are particularly extreme when a firm’s are generating free cash flows, The issue is how to
inspire the managers to circulate the free cash among the share holder of the company as
opposed to investing it at lower cost of capital, As indicated by Jensen (1986), debt is controlling
devices that offer the managers to pay out free cash flows among investors that can't be gainfully
reinvested inside the firm, Grossman and Hart (1982) saw that debt can make a motivator for
managers to work in a productive way, devour fewer perquisites, taking better investment
decisions, and so on when liquidation is costly for them, maybe they may lose the advantages of
control and goodwill, These finding recommend that a high debt proportion might be risks for a
firm.”

Tax rate advantage on the utilization of debt account may either be diminished or even disposed
of when a firm is consistently reporting low or negative income, Thusly, the amount of loan
installments would be felt by the firm, DeAngelo and Masulis (1980) recommended that non-
debt tax shields are the substitute of the tax shields on debt financing, So firms with bigger non-
debt tax shields are relied upon to utilize less debt in their capital structure, Researchers are

9
blended on this issue, Bradley et al, (1984) have appeared solid direct relationamong influence
and the overall measure of non-debt charge shields, Titman and Wessels (1988) have found no
assist for an impact on debt proportions emerging from non-debt tax shields, Wald (1999) and
Deesomsak et al, (2004) stated a negative relation among non debt corporate tax and leverage,
The pecking order theory, in view of works by Myers and Majluf (1984) proposes that
organizations have a pecking-order in the decision of financing their activities, Generally, this
theory expresses that organizations incline toward their own funds as opposed to dept financing,
On the off chance that outside account is required, the principal decision is to issue debt, at that
point conceivably with half and half securities, for example, convertible bonds, at that point in
the long run value if all else fails (Brealey and Myers, 1991), This conduct might be because of
the expenses of issuing new value, because of hilter kilter data or exchange costs, There are
clashing hypothetical expectations on the impacts of productivity on influence (Rajan and
Zingales, 1995); while Myers and Majluf (1984) foresee a negative relationship as per the
pecking order theory, Jensen (1986) predicts a positive relationship if the market for corporate
control is viable.”

“The relation between firm size and leverage is likewise indistinct, On the off chance that the
relationship is an intermediary for likelihood of liquidation, at that point size might be a converse
intermediary for the likelihood of insolvency, since lager firms are bound to be increasingly
enhanced and flop less regularly, As needs be, these firms may issue debt at lower costs than
littler firms, For this situation along these lines, we can anticipate that size should be
emphatically identified with influence, There exist a significant enormous vulnerability as
respects the development factor, both with respect to the impact on influence and how it will be
estimated, To begin with, we may expect a positive relation among development and influence
since higher development openings suggests a higher interest for assets, and, ceteris paribus, a
more noteworthy inclination on outer financing through the favored wellspring of debt as
indicated by the pecking-order theory (Rao and Lukose, 2007), Then again, Myers (1977)
contends that because of organization issues, firms putting resources into resources that may
create high development openings later on face troubles in getting against such resources,
Consequently, we may now rather anticipate a negative relation among leverage and growth of
the firm.”

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Capital structure is defined as the combination of debt and equity finance, An optimum capital
structure can maximize the firms’ value, Past studies related to capital structure and profitability
shows different results, The research conducted by (Nawaz & Ali, 2016) results shows that there
is a negative relationship between the financial performance and leverage and also results of
research shows that when the leverage increases, the profitability decrease, Agha, (2015)
conducted a study which found that the capital structure determinants analysis and their
relationship in the listed firms of cement industry in Pakistan, The result arrived profitability is
statistically important and negatively related with debt ratio, She recommended that finance
manager should have a deep look in the financials of the cement industry, and maximizes the
shareholder’s wealth, and to lower the debt structure to increase the ultimate profit, Nguyen &
Nguyen (2015) examine the influence of capital structure on 147 listed firms in Ho Chi Minh
City Stock Exchange (HOSE) in the period from 2006 to 2014, The authors not only test the
effect of financial leverage on firm performance in general but also use short-term debt and long-
term debt ratio to test the effect of debt maturity, The study finds that the relationship between
leverage and firm performance is significantly negative; however, there is no difference between
the impact of short-term debts and long-term debts, According to Akeem et al, (2014) one of the
importance of capital structure is that it is tightly related to the ability of firms to fulfill the needs
of various stakeholders, Capital structure represents the major claims to a corporation’s assets
which includes the different types of both equities and liabilities, Implies the proportion of debt
and equity in the total capital structure of the firm, Therefore, a firm’s capital structure simply
refers to the combination of long-term debt and equity financing.”

“According to Akeem et al, (2014) financial constraints have been a major factor
affecting corporate firms’ performance in developing countries especially Nigeria, The basis for
the determination of optimal capital structure of corporate sectors in Nigeria is the widening and
deepening of various financial markets, Mainly, the corporate sector is characterized by a large
number of firms operating in a largely deregulated and increasingly competitive environment,
Le & Phan (2017) conduct a study about the impact of capital structure on performance of non-
financial listed firms in Vietnam over the period of 2007-2012, They observe that all debt ratios
significantly negatively affect firm performance, They also argue that this result is consistent
with most researches in this field in the context of developing markets, while it is not in line with

11
some researches inspected in developed countries, which indicate a positive link between
financial leverage and firm profitability, Moreover, they point out that the controlling role of
debt is not substantial due to severe asymmetric information phenomenon and inefficient
financial system in Vietnam, Chaudhuri el al,, (2016) used MIMIC model to estimate latent firm
performance (ROA & Tobin’s Q) for Indian corporate firms and found that level of debt
financing does not impact the firm performance, However, Fosu et al,, (2016) using large sample
of UK firms suggest that leverage has a negative impact on firms’ value, Furthermore, Islam and
Khandaker (2015) argue that business and operational nature of firms differ across industries and
hence capital structure decisions and its impact on financial performance depend on the
industrial classification of the companies.”
“Tifow and Sayilir (2015) evaluate the relationship between capital structure and firm
performance using a sample of 130 manufacturing firms listed on Borsa Istanbul Stock Exchange
from 2008-2013, Short-term debt to total assets and long-term debt to total assets were used as
proxies of financial leverage, ROE, ROA, Earnings Per Share and Tobin’s Q ratio were used for
performance, while sales growth and firm size were used as control variables, Findings of the
study show that short-term debt (STDA) has a significant negative relationship with ROE, EPS
and Tobin’s Q ratio, while long-term debt (LTDA) has a significant negative relationship with
ROE, EPS and Tobin’s Q ratio but positively and significantly correlated with ROA, Babalola
(2014), using 31 manufacturing firms with audited financial statements for a period of fourteen
years (1999-2012) from static trade-off point of view, He employed the triangulation analysis
and the study revealed that capital structure is a trade-off between the costs and benefits of debt,
and it has been refuted that large firms are more inclined to retain higher performance than
middle firms under the same level debt ratio, Akinyomi (2013), using three manufacturing
companies selected randomly from the food and beverage categories and a period of five years
(2007-2011) using the static trade-off and the pecking order theory point of view, He adopted the
use of correlation analysis method and revealed that each of debt to capital, debt to common
equity, short term debt to total debt and the age of the firms’ is significantly and positively
related to return on asset and return on equity but long term debt to capital is significantly and
relatively related to return on asset and return on equity, His hypothesis also tested that there is
significant relationship between capital structure and financial performance using both return on
asset and return on equity.”

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“Profitability implies the relationship among business profit from the capital assets of business,
Benefit is estimated by profit before tax to the all out assets As indicated by pecking order theory
a firm can build its profitability by utilizing its inside assets, There are two speculations about
profitability: Trade off Theory and Pecking Order Theory, Trade-off theory guarantees that by
utilizing debts a firm can expand its profitability; according to trade off theory there is sure
relationship among benefit and influence, By expanding debts benefit likewise increments and
the other way around, Pecking order theory says that chiefs have better data about their
organization future than pariah and they secure the enthusiasm of existing investors and they
should utilize held income and in the event that not accessible, at that point they ought to incline
toward debt over value.”

“Capital structure decision is a standout amongst the most significant choices looked by firm
administration (Degryse et al,, 2010), Capital structure alludes to the manner in which a firm is
financing its benefits through a blend of value and debt (Titman and Wessels, 1988),”“The way
toward financing assumes a significant position in firm administration since it must guarantee
monetary progression important for development and keeping up aggressiveness in their
condition, ”“This is particularly obvious on the move economies, where because of immature
capital markets debt remains the primary wellspring of financing, ”“Capital structure can be
characterized as a blend of a company's capital with debt and value”“The type of financing and
sorts of subsidizing sources will characterize a company's capital structure,Capital structure
speculations offers various determinants that are in charge of different effects on capital
structure, while the observational writing will in general discover proof that firm carry on as per
the hypothetical forecasts (Shamshur, 2010), For the most part they center around those
determinants which are bound to have a noteworthy job on influence choices, In spite of the fact
that there have been different examinations dissecting capital structure, it is still discussed what
the determinants of capital structure are and how they sway capital structure choices, Since
Modigliani and Miller distributed their original paper in 1958, the issue of capital structure has
produced extraordinary enthusiasm among analysts, From the hypothetical perspective, existing
exact examinations generally utilized two models of capital structure: the trade-off theory and
the pecking order theory, ”

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“The trade-off theory suggests that an organization's capital structure choices include an
exchange of between the tax cuts of debt financing and the expenses of money related pain The
pecking order theory brings up that there is a sure request in financing, beginning from held
profit as an essential wellspring of inward financing, at that point moving to debt and utilizing
value just if all else fails Every one of these hypotheses proposes how certain determinants
influence capital structure As indicated by speculations, scientists found different effects of
determinants on capital structure contingent upon the nation they are breaking down, Small and
medium-sized organizations in Croatia may utilize tangible assets as insurance, either giving
more access to the loan boss or as a certification,”

“Olakunle and Oni (2014) pointed that tangible quality of benefits is described by the impact of
the security estimations of advantages on a company's influence level Besides, the sort of
advantages that a firm has can be considered as an equivocal factor in the assurance of the debt
value proportion The expense of monetary trouble depends of the kinds of advantages that a firm
has On the off chance that a firm holds enormous interests in land, hardware and other tangible
assets, it will have littler expenses of money related trouble than firms that depend on immaterial
assets (Daskalakis and Psillaki, 2008), Thirdly, unmistakable assets are generally simple to
distinguish as opposed to impalpable assets, which are increasingly hard to recognize, discrete,
use, account or mimic,” It is imperative to see whether unmistakable assets are in capacity of
debt or not, and whether the speculations bolster the pecking order theory or the trade-of theory,

Theory

Pecking Order Theory

“The Pecking Order Theory, also known as the Pecking Order Model, relates to a
company’s capital structure Suggested by Donaldson in 1991 and later modified and made
popular by Stewart Myers and Nicolas Majluf in 1984, the theory states that managers follow a
hierarchy when considering sources of financing The pecking order theory states that managers
are given a preference to fund investment opportunities using three sources: first through the
company’s retained earnings, followed by debt, and choosing equity financing as a last resort
Pecking order theory predicts that due to the information asymmetry between the
firm (mangers/insiders) and outside investors regarding the real value of both
current operations and future income stream and prospects, external capital (debt
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and equity) will always be relatively costly compared to internal capital (retained
earnings) Pecking order theory therefore suggests that firms should finance their
investment in the order of internal funds, debt and equity (Myers, 1984; Myers &
Majluf, 1984),”

“Two main literature approaches have been advanced that examined the impact of
information asymmetry on firm’s capital structure, The contribution of Myers and
Majluf (1984) and Myers (1984) posits that capital structure is designed to mitigate
inefficiencies in the firm’s investment decisions that are caused by information
asymmetry, by following a pecking order in their investment decisions In the
second approach, Ross (1977), and Leland & Pyle (1977) assert that firm’s capital
structure choice is used as a means to signal to outside investors the information
held by insiders.”

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2.3 Profitability
“Profitability is the ability of a business to earn a profit, A profit is what is left of the revenue
a business generates after it pays all expenses directly related to the generation of the revenue,
such as producing a product, and other expenses related to the conduct of the business activities,
There are many different ways for you to analyze profitability, This lesson will focus on
profitability ratios, which are a measure of the business's ability to generate revenue compared to
the amount of expenses it incurs, Let's look at a few of the primary analytical approaches,
Chaudhuri el al,, (2016) used MIMIC model to estimate latent firm performance (ROA &
Tobin’s Q) for Indian corporate firms and found that level of debt financing does not impact the
firm performance, However, Fosu et al,, (2016) using large sample of UK firms suggest that
leverage has a negative impact on firms’ value, Furthermore, Islam and Khandaker (2015) argue
that business and operational nature of firms differ across industries and hence impact of
financial performance on capital structure decisions depend on the industrial classification of the
companies, Gill, et al,, (2011) presented positive impact of profitability on short-term debt to
total assets in both the service and manufacturing industries and further this study indicated that
short term debt to total assets; long-term debt to total assets; and total debt to total assets had
positive impact on profitability, In contrast, Omondi and Muturi (2013), Bouraoui and Louri
(2014) found that financial performance of the firm has negative impact on leverage.”
“Azhagaiah&Govoury (2011) analyzed the effect of profitability on capital structure of IT firms,
The study was conducted based on two attributes- Business revenue and Asset size, Their study
proves that profitability decreases significantly with decrease in spending of business revenue or
decrease in debt content in the capital structure, In other words as per their study increase in use
of debt tends to reduce the profitability, A study by Mohammad and Jaafer (2012) on effect of
profitability on capital structure of the industrial companies listed on Amman Stock Exchange
found that the capital structure decision is crucial for any business organization because of the
need to maximize returns to various organizational constituencies, and also because of the impact
such a decision has on an organization’s ability to deal with its competitive environment, An
appropriate mix of capital structure should be adopted in order to increase profitability, Negasa
(2016) provided empirical evidence to supporting tradeoff theory, a positive relationship between

16
debt level and profitability, However, trade-off theory was criticizing that it is correct under the
assumption of no cost of adjustment (Myers, 1984), Saputra et al (2015), Foo et al (2015) and
Mohammadzadeh et al (2013) research used pecking order theory to test the firm performance
with regard to capital structure and found that firm performance has inverse relationship with
capital structure, Saputra, Achsani and Anggreani (2015), Foo et al (2015), Mohammadzadeh et
al (2013) research found that firm performance has a negative impact oncapital structure,
consistent with the pecking order theory.”
“Debt to equity formulate is total debt divided by total equity, increase debt will raise
debt to equity (Hitchner, 2003), Based on trade off theory, debt provides tax advantage to
company (Obim, et al,, 2014), Hence, increase company debt level able to reduce tax expense
and raise firm performance, Therefore, debt to equity has a positive significant impact on
ROA,Goh et al (2016), Nawaz et al (2011) and Nirajini and Priya (2013) finding show support to
this view, Numerous studies were found a different results and indicate debt to equity has
negatively significant impact on ROA (Mwangi, et al,, 2014; Saputra, et al,, 2015; Sabin
&Miras, 2015; Abeywardhana, 2016; Leonard &Mwasa, 2014; Akeem, et al,, 2014; Muhammad,
et al,, 2014), Equity is another important element of capital structure; equity finance does not
require fixed repayment and interest (Saad, et al,, 2014), So, raising equity finance will bring a
positive impact on firm performance (Githire and Muturi (2015) and Idode et al (2014) research
result show support to this hypothesis and indicated total equity ratio has a positive significant
impact on ROA.”
“According to Modigliani & Miller (1963) relevant theory, debt provides huge tax shield effect
and it able to reduce cost of capital, Hence, raising debt to equity ratio able to reduce cost of
capital and led the manager able to produce more efficiency ROA, Saputra et al (2015) and
Nirajini&Priya (2013) research finding show support to this view, However, numerous empirical
studies has found debt to equity has significant negative impact on ROE (Mohamad & Abdullah,
2012; Sabin &Miras, 2015; Mwangi, et al,, 2014; Leonard &Mwasa, 2014; Akeem, et al,, 2014;
Chadha & Sharma, 2015; Muhammad, et al,, 2014), Based on the study of Le & Phan (2017),
high profitable firms are more efficient and thus expected to have higher performance,
Moreover, firms with high level of cash are able to alleviate financial distress problems, more
capable of supporting their new projects and paying dividends, Hence, liquidity is assumed to
positively correlate with firm performance, Another study of Soumadi&Hayajneh (2015) claim a

17
similar negative impact of TD/TA on ROE and Tobin’s Q when analyzing data of 76 companies
in Jordan over the period from 2001 to 2006.”
"Net income" (NI), "return on Assets" (ROA), and "return on Equity" which are the proportion
of benefit are utilized as dependent factors, though working capital administration arrangement
and Debt proportion which is an intermediary variable of money related influence are utilized as
free factors,

Amid the year 2013 Mumtaz Raheel [6] clarified in this exploration that association's capital
structures a significant job in deciding its future development, manageability and money related
execution, It is seen that speculators are exceptionally inspired by the presentation of firms
recorded in the financial exchange, Observational proof gives little sign of distinguishing the
easygoing connection between capital structure of a firm and its money related execution,
However it is for the most part trusted that exchanges and costs assume a fundamental job in the
decision of debt to value financing, “Debt/Equity proportion is normally utilized as a proportion
of capital structure, while different proportions like (Earning per Share, Price/Earnings Ratio,
Operating overall revenue, Return on Asset, Return on value) are utilized as intermediaries for
firm execution These proportions are utilized to consider the connection between capital
structure and firm execution with regards to enormous privately owned businesses in Pakistan,
An aggregate of 83 organizations are chosen from KSE 100 file for our examination,”

“Mandelker and Rhee (1984) in their examination found a connection between Degree of
Operating Leverage (DOL), Degree of Financial Leverage (DFL) and beta, They had the option
to demonstrate exactly that DOL and DFL disclosed between 38 to 48 percent changes in a
cross-area of information, Profitability is a solid purpose of dispute between the two hypotheses
displayed by Myers (1984) for example Pecking Order Theory (POT) and Static Tradeoff Theory
(STT), Myers partitioned the contemporary reasoning on capital structure into two hypothetical
flows, The first is the Static Tradeoff Theory (STT), which clarifies that a firm pursues an
objective debt value proportion and afterward carries on appropriately, The advantages and
expenses related with the debt choice sets this objective proportion, These incorporate
assessments, cost of money related misery and office costs.”

Second, the Pecking Order Theory (POT) set forward by Myers (1984) and Myers and Majluf
(1984), expressed that organizations pursue a chain of importance of money related choices
18
while setting up their capital structure, At first, firms want to back their undertakings through
inside financing for example held income, On the off chance that they need outer financing, they
initially apply for a bank advance then for open debt, If all else fails, the firm will issue value to
back its task, Along these lines as per POT the beneficial firms are less inclined to acquire debt
for new undertakings since they have the accessible inside assets for this reason,

“For the STT, the higher the profitability of the firm, the more reasons it should issue debt, in
this way additionally lessening its taxation rate, Then again, the POT surmises that bigger
income lead to increment in the primary source that organizations spread their monetary
deficiency: held profit, In this manner, the STT anticipates a positive connection among
profitability and influence, while the POT expects precisely the inverse, Additionally for the
Static Tradeoff approach, the bigger the firm, the more noteworthy the likelihood it has of
issuing debt, bringing about a positive connection among debt and size, One reason for this is the
bigger the firm, Huge firms don't consider the immediate liquidation costs as a functioning
variable in choosing the dimension of influence on the grounds that bigger firms, being
increasingly broadened, have less odds of chapter 11 (see, for subtleties Titman and Wessels
(1988)”

Larry et al, (1995) revealed that there exists a negative connection among influence and future
development, This connection is negative for firms whose development openings are either not
perceived by the capital markets or are not adequately significant to defeated the impacts of their
debt overhang, They likewise affirmed that influence does not lessen development for firms
known to have great benefit openings, To analyze the connection among influence and
development they utilized informational collection over a time of 20 years and they found a solid
negative connection between them.”

2.4 Asset Tangibility

“Recent study on asset tangibility was done by Nasution, &Siregar, (2017) to examine the impact
of asset tangibility on capital structure on manufacturing firms in Indonesia, The findings of the
study show that asset tangibility has negative impact on capital structure, A study by Olankule
and Emmanuel, (2015) was conducted to examine impact of asset tangibility On capital structure
19
of Nigerian companies, The findings of the study showed both variables have positive
relationship with each other, Ahmed et al, (2016) investigated the influence of firm level factors
on the capital structure in Pakistan’s life insurance corporations, In order to do this investigation,
they took debt as a dependent variable, whereas, the profitability, size, growth, age, risk, asset
tangibility and liquidity have been decided as independent variables, The findings of the OLS
regression indicated that size, profitability, danger, liquidity, age and asset tangibility are
significant determining factors of the capital structure of life insurance organizations,
Kabeer&Rafique, (2018) conducted study on factors of capital structure of Pakistani
manufacturing sector, They examined the impact on capital structure of manufacturing
companies, The results of the study showed that asset tangibility has positive relationship with
capital structure and also impacts positively on it as well.”

The composition of tangible assets is of importance to explain the level of debt within firms
(Giambona, Golec, &Schwienbacher, 2014), Tangible assets are divided into smaller and more
specific assets groups, which are presented in the notes of the annual reports, Consequently, this
division reveals in some extent the redeploy ability and liquidity of the assets, Tangible assets
that could be used within different industries should suggest higher debt capacity for the firm,
Secondly, the size of the costs that a company has to pay in a potential financial distress situation
is of importance and is suggested to vary by industry, For example, real estate firms are assumed
to have lower financial distress cost in comparison with technology firms, whose value comes
mostly from their human capital, Thus the real estate firms have a larger proportion of their firm
value that could easily be sold.”

“The trade-off theory claims there should be a positive relationship between leverage and
tangible assets and that the type of industry has an impact, Generally, companies whose core
business are related mainly with research and development costs and have great prospects to
grow will have lower debt financing than mature firms with low growth forecasts, The reason is
because in case of financial distress the stakeholders have a better position in a firm with a high
tangible- to total asset ratio, because of the possibility to sell to the secondary market, In
addition, non-firm specific tangible assets should lower the cost of financial distress and
therefore increase the optimal debt capacity (Berk& DeMarzo,2014), Tangibility measures the
20
ratio between fixed assets over total assets a firm have on its balance sheet, Charalambakis and
Psychoyios (2012) claims it exist a positive relationship between such a ratio and the level of
debt because tangible assets could be used as collateral for the debt holders,Olakunle and Oni
(2014) pointed that tangibility of assets is characterized by the effect of the collateral values of
assets on a firm’s leverage level, Secondly, the type of assets that a firm possesses can be
considered as an ambiguous factor in the determination of the debt-equity ratio, The cost of
financial distress depends of the types of assets that a firm has, If a firm retains large investments
in land, equipment and other tangible assets, it will have smaller costs of financial distress than
firms that rely on intangible assets (Daskalakis and Psillaki, 2008), Thirdly, tangible assets are
relatively easy to identify in contrast to intangible assets, which are more difficult to identify,
separate, utilize, account or imitate, It is important to see whether tangible assets are in function
of debt or not, and whether the hypotheses support the pecking order theory or the trade-off
theory.”

Koksal et al, (2013) investigated the factors that determine the capital structure choices in
Turkey, They used tangibility as a proxy for the type of assets, They found that tangibility
appears to be the key determinant of long-term leverage (positive relationship), but is not
important for short-term leverage (negative relationship), Their empirical findings suggested that
the trade-off theory is a better description of the capital structure of Turkish firms then the
pecking order theory.

“A tangible asset is a benefit that has a physical structure, Unmistakable assets incorporate both
fixed assets, for example, hardware, structures and land, and current assets, for example, stock,
In corporate account, the scholastic commitment of Modigliani and Miller (1958, 1963), gave
conceivable clarification on how financing choices (debt value blend) educates the company's
capital structure, Modigliani and Miller (1958) in their workshop paper inspected the connection
between the firm financing decision and its esteem, Modigliani and Miller in their paper
investigated the importance of tax assessment in deciding the association's financing conduct
which they expressed given a world without tax collection, the company's esteem will be free of
its debt value blend, The hypothesis holds that the association's reasonable worth is determined
by the hazard related with the fundamental assets of the firm and furthermore on the profit limit
of the firm, The commitment on capital structure unimportance and the tax shield advantage by

21
Modigliani and Miller (1958, 1963) made ready for the advancement of elective hypotheses and
arrangement of experimental research activities on capital structure, The elective hypotheses
incorporate the exchange off hypothesis, the pecking request/topsy-turvy data hypothesis and
office cost hypothesis, Every one of these speculations have been exposed to broad experimental
testing with regards to created nations, especially the United States (US), anyway very little
research has been finished as for creating nations, A portion of the reasons that represent this are
clear; many creating nations at first selected a state-supported course to advancement, with a
moderately inconsequential job appointed to the private corporate segment (Prasad, 2001)”

“Morellec (2001) contends that when a firm is dissolvable, asset deals increment the firm esteem
by distributing advantages for better employments, He additionally contends that when the firm
is in trouble, asset deals speak to the least expensive wellspring of assets for the firm, In addition,
asset deals permit the firm to life partner proceeded with task of its outstanding assets without
requiring outside capital, Sanyal and Mann (2010) inspected the financial structure of start-up
firms, Thy found that new companies with increasingly unmistakable assets as potential
insurance are bound to utilize outside debt in the financial structure, since these advantages have
a high liquidation esteem, As the creators above finished up, insurance estimation of advantages
was observed to be a significant determinant in capital structure, Ongoing papers confirmed
either a negative or positive connection among substance and capital structure , Koksal et al,
(2013) examined the components that decide the capital structure decisions in Turkey, Thy
utilized tangible quality as an intermediary for the kind of benefits, Thy observed that tangible
quality has all the earmarks of being the key determinant of long haul influence (positive
relationship), however isn't significant for transient influence (negative relationship), Thir
observational fidings proposed that the trade-of theory is a superior portrayal of the capital
structure of Turkish firms then the pecking order theory, In their examination, Daskalakis and
Thnou (2010) explored determinants of capital structure of Greek SMEs in the period
somewhere in the range of 2003 and 2007, Thy found that the firms' debt proportion is adversely
identified with asset structure.”

“They inferred that firms that create generally high inward subsidizes will in general keep away
from debt financing, This, firms that depend more on unmistakable assets will in general utilize
less debt than firms with moderately less tangible assets, Psillaki and Daskalakis (2008) explored

22
the capital structure of Greek, French, Italian and Portuguese little and medium-sized ventures,
Thy contend that the expenses of financial trouble rely upon the kinds of advantages that a firm
utilizes, In the event that a firm holds enormous interests in land, gear and other tangible assets,
it will have littler expenses of financial trouble than a firm that depends on impalpable assets,
This, firms with increasingly unmistakable assets should issue more debt, Then again, enormous
property of tangible assets may suggest that a firm has as of now a steady wellspring of return,
which gives all the more inside produced reserves and debilitates it from going to outer
financing, In this way, the negative connection among influence and asset structure shows that
firms utilize heaps of unmistakable assets and appear to depend more on inside assets created
from these benefits, which is anticipated by the pecking order theory, Thy found that benefit
structure is significant and contrarily associated with influence, A conceivable clarification is
that firms with heaps of tangible assets may have effectively discovered a steady wellspring of
return, which gives them all the more inside produced reserves and debilitates them from going
to outside financing, Campello and Giambina (2011) inspected the connection between corporate
asset structure and capital structure by abusing variety in the marketability of unmistakable
assets, Thy contended that unmistakable assets are regularly illiquid, so they demonstrate that
redeploy ability of tangible assets is the primary determinant of corporate influence for firms that
are bound to confront credit erosions, particularly amid times of tight credit, Their proof
demonstrates that unmistakable assets drive capital structure to the degree that they are redeploy
able, Just the segment of advantage substance that reacts to attractiveness has informative control
over firm influence, Thy found that the connection among redeploy ability and influence is
significant and articulated in firms for which the guarantee asset is especially significant in the
getting procedure, For huge firms, conversely, redeploy ability is an insignificant driver for
influence, La Rocca et al, (2009) analyzed the key financing decisions of private ventures
through the viewpoint of the business life cycle.”

“They presume that tangible quality has a positive association with debt, however its force
differed over a firm's life cycle, Their inquire about demonstrates that youthful firms have less-
unmistakable assets as stock, which makes them increasingly dependent on insurance advantages
for secure debt and acquire credit under better terms, In the developing and develop phases of a
firm's life cycle, this effect diminishes, however is as yet significant, Degryse et al, (2010)
anticipated that benefit substance should be emphatically associated with debt as it gives
23
insurance, Thy found solid help concerning the positive connection between complete debt and
security, The positive effect on all out debt came totally from long haul debt, as momentary debt
is contrarily affected by the guarantee, Since the insurance is an approach to decrease danger of
SMEs, these firms can completely utilize their security to draw in long haul debt, For the firm,
the expenses of long haul debt are lower since banks charge moderately higher financing costs
on momentary credits, These findings are as per the development coordinating rule that long haul
assets are financed with long haul financing and transient assets are financed with momentary
assets.”

2.5 Corporate Tax

“A corporate tax is a levy placed on the profit of a firm to raise taxes, After operating earnings
are calculated by deducting expenses, including the cost of goods sold (COGS) and depreciation
from revenues, enacted tax rates are applied to generate a legal obligation the business owes the
government, Rules surrounding corporate taxation vary greatly around the world and must be
voted upon and approved by the government to be enacted (Jing Xing2015), Doidge and Dyck
(2015) investigate the effects on corporate policies when corporate tax was imposed on Canadian
trusts in 2006, and found that these affected trusts increased leverage following the policy
change, Chen Deng (2015) conducted research on investigating impact of corporate tax on
capital stature, The results of the study showed negative relationship between both variables,
Another study conducted on same variables showed positive relationship between both (Michael,
Maffini and Jing, 2015), The research by Agha (2015) on capital structure determinants and their
relationships on listed firms of Pakistan cement industry for the period 2008-2013 using panel
least square method of regression analysis shows that the independent variables including
liquidity, profitability and cost of debt have a significant impact and negatively related with debt
ratio, implying that if the variables increase, debt ratio will decrease, The study also reveals that
tax and growth variables have significant impact and a positive relationship, implying that if
these variables increase debt ratio will decrease, Three other variables used in the study (size,
tangibility and dividend) have no significant impact on debt ratio, meaning that there would be
no impact of any change occurring in these variables on debt ratio.”

24
“The trade-off theory of capital structure states that an organization’s capital is constituted by
both debt and equity and that their ratio (debt-equity ratio) is a trade-off between its interest tax
shields and the costs of financial distress, The theory states that there is an advantage of
financing through debts due to tax benefit of the debts, However, some costs such as debt costs,
bankrupt costs and non-bankrupt costs do arise, The tax benefit, among other factors, makes the
after-tax cost of debt lower and hence the weighted average cost of capital (WACC) will also be
lower (Anarfor, 2015),Trade-off theory was developing by multi research paper and grew up
from the M&M relevant theory (Myers, 1984), Tradeoff theory indicated each financial source
has own benefit and cost (Awan & Amin, 2014), The firm’s optimum capital structure is
identified by the tradeoff of the benefit and the cost of debt finance (Myers, 1984), Trade-off
theory indicated higher profitability firm will be able to take more tax advantage by increases
borrowing without risking financial distress and apply a higher portion of debt finance in capital
structure (Kausar, et al,, 2014).”
Among the determinants of capital structure, tax assessment is presumably the most discussed,
“As indicated by the compelling trade off theory of debt, the ideal dimension of debt in an
association's capital structure is dictated by the parity of the assessment shield given by debt and
the present estimation of money related misery costs (Myers, 2003), All the more explicitly,
there is sure connection between the corporate assessment shield and firm esteem given that each
expansion in the debt part of a company's capital structure diminishes the after-charge income,
Then again, when unreasonable measure of debt has been gathered by the firm, it hazards a
default bringing about the exchange of control to the loan bosses and the incurrence of
deadweight costs which further lessen firm esteem (Frank and Goyal, 2008), Hence, the lower
the expense preferences of debt, the lower the ideal debt value proportion, In spite of exchange
off hypotheses clear intrigue, experimental tests have created blended outcomes, All the more
explicitly, the exact proof for a tax effect on capital structure has been not exactly complete due
to (a) the trouble of figuring precisely the negligible tax cuts, which are affected by non-debt
charge shields and different assessment guidelines, and (b) the restricted accessibility of non-US
firm information on statutory corporate expense changes, With respect to tests, Givoly et al,
(1992) locate a positive connection between changes in US corporate duties and changes in
influence, just as a substitution impact among debt and non-debt charge shields because of the
Tax Reform Act of 1986, Graham and Harvey (2001) meet 392 CFOs in the U,S, furthermore,

25
find that the assessment bit of leeway of intrigue deductibility is of critical worry by CFOs in
huge, managed, and profit paying firms, Ayers et al, (2001), utilizing an example of little U,S,
firms (i,e,, <500 representatives), locate a negative connection between viable assessment rate
and debt, Specifically, they locate a negative impact of negligible taxrates on the utilization of
outside debt (credits from non-proprietors), and no impact of minor expense rates on the
utilization of inside debt (advances from proprietors), Prominently, this proof comes solely from
openly recorded U,S, firms, Similarly as with numerous parts of firm financing, chapter 11 costs
and hilter kilter data in financing choices of firms experiencing significant change and creating
nations stay vague (Prasad et al,, 2005).”

“To cite some more precedents for the presumptions made are look into by Auerbach (1985),
The creator discovers evidence that speculators coordinate their taxstatus with the profit value
proportions of firms and accordingly structure demographics, Additionally, Seida and Wempe
(2000) investigations the reaction of the speculators to the 1986 assessment changes in the US,
The financial specialists understood their increases as they anticipated an ascent in the capital
addition charge rate in such changes, Another examination on similar lines is that of Lang and
Shackelord (2000), The creator finds and reports that when data with respect to bringing down of
capital increase charge was discharged, a lift happened in the stock costs for firms which had the
most minimal profit yield, Fama and French (1998) set up a model wherein they endeavored to
control for benefit by utilizing the factors income, venture, and innovative work in order to
disconnect the tax impacts natural in intrigue and profit, They made different varieties to the
fundamental model to catch the impacts, The creators accepted negative estimating impact in
profits and positive sign for intrigue (debt) however couldn't discover the outcomes true to form
and their model couldn't demonstrate the expressed speculation, Likewise, for profits they report
that there is a probability of profits are catching the impacts of benefit left by different factors,
They found a negative connection among influence and esteem, showing that there are no net tax
cuts of influence and their outcomes appear to help the Miller's speculation, They propose two
potential reasons for the equivalent; one is the Miller's assessment impacts and the other one is
the office issue that higher influence and hazardous changes in influence are not greet by the
speculators, consequently clarifying the negative sign on the influence factors, Goldstein, Ju, and
Leland (2001) attempted to discover that whether the debt issuance choice is a static or a
dynamic decision, The creators explore its suggestions for ideal influence proportions and degree
26
of tax breaks of debt, The creators utilize just debt expanding cases, overlooking debt lessening
rates and to help their contention state that because of the nearness of exchange costs, the
administration is hesitant to diminish the debt top, The creators propose a dynamic capital
structure model where coming about ideal debt levels are discovered like those in all actuality
and they locate that dynamic models demonstrate that organizations have bigger tax reductions
than what is anticipated by static models; correspondingly they gave their contention for upward
rebuilding, Kemsley and Nissim (2002) endeavored to fathom the issues present in the
examination work of Fama and French (1998), The creators relapsed profit before premium and
expense (EBIT) on the incentive with debt and debt variable, yet the issue with this exploration
work is that it might catch the impact of debt on income as opposed with the impact of income
on debt.”

2.6 Theoretical Framework

Profitability
Capital structure
Assets tangibility

Corporate tax

2.7 Research Hypotheses

H1: Profitability has positive and significant impact on Capital structure of cement companies
listed at Pakistan stock exchange,

H10: Profitability has no impact on Capital structure of cement companies listed at Pakistan
stock exchange,

H2: Assets tangibility has positive and significant impact on Capital structure of cement
companies listed at Pakistan stock exchange,

27
H20: Assets tangibility has no impact on Capital structure of cement companies listed at Pakistan
stock exchange,

H3: Corporate tax has positive and significant impact on Capital structure of cement companies
listed at Pakistan stock exchange,

H30: Corporate tax has no impact on Capital structure of cement companies listed at Pakistan
stock exchange,

28
 3

METHODOLOGY
3.1 Research Design

“The basic objective of this research is to enquire the impact of Profitability, Asset Tangibility
and Corporate Tax on Capital Structure of Cement Companies listed at Pakistan Stock Exchange
(PSX).”
3.2 Sampling Techniques
3.2.1 Population
“The population for this study is the cement companies that are listed on the Pakistan Stock
Exchange (PSX) from 2007 to 2017, 22 of these Companies make up the research sample.”

3,2,2 Sampling method

The data was collected from the annual reports of Cement Companies listed on the PSX,The
sample for study is the financial statements of the Cement Companies that include the complete
set of data needed to detect all existing variables,

3.3 Data collection Techniques

In this study secondary data was collected from annual reports, Pakistan Stock Exchange and
SBP website, The data in this study was collected from 2007 till 2017,

3.3.1 Research Measurements

29
Variable Measurements References

Dependent Variable
Capital structure Debt to equity ratio: (Sabin and Miras, 2015)

Debt/Equity

Independent Variables
Profitability Return on equity; (Akeem, et al,, 2014)
Total Income/Total Equity
Assets tangibility Tangibility Asset: FA/TA (Nasution, &Siregar, 2017),

Corporate tax Tax=EBT-EAT/TA (Nasution, &Siregar, 2017),

https://www,khistocks,com/company-information/financial-highlights,html

3.4 Data Analysis

The data was analyzed by using SPSS 24 to make study customized and get statistically
significant results of the study,

3.4.1 Data Analysis Techniques

In this study following data analysis techniques wereused:

 Descriptive Analysis

 Correlation

 Multi regression

30
 4

RESULTS

3.5 Descriptive Statistics

Mean Std, Deviation

Capital structure 3,0400 ,53093

ROE 4,7590 ,70638

Tangibility 4,7470 ,5478

Corporate Tax 2,2197 ,3009

Above table shows descriptive statistics of the variables used in the study, Capital structure ratio
has mean value of 3,0400 and std deviation value of,53093, ROE has mean value of 4,7590 and
std deviation value of,,70638, Asset Tangibility has mean value of 4,7470and std deviation value
of, ,5478, Corporate taxhas mean value of 2,2197and std deviation value of,3009,

3.6 Correlation

DE ROE Tangibility Corporate Tax

Capital structure 1

ROE ,403 1
Tangibility ,597 ,499 1
Corporate Tax ,472 ,591 ,621 1

The above table is about correlation which shows the relationship of independent variable with

31
dependent of the study, It also shows whether variables have negative or positive relationship
with each other, This table also shows the significance of the variables,
The correlation between Profitability and Capital structure is ,403 which means both variables
have moderate positive and significant relationship with each other, This shows if Profitability
increases then Capital structure increases with too, So Profitability has positive and significant
impact on Capital structure of cement companies listed at Pakistan stock exchange,

Assets tangibility and Capital structure correlation is ,597 which means both variables have
moderate positive and significant relationship with each other, This shows if Assets tangibility
increases then Capital structure increases with too, So Assets tangibility has positive and
significant impact on Capital structure of cement companies listed at Pakistan stock exchange,

Corporate tax and Capital structure correlation ismoderate ,472 which means both variables have
positive and significant relationship with each other, This shows if corporate tax increases then
capital structure increases with too, So corporate tax has positive and significant impact on
capital structure of cement companies listed at Pakistan stock exchange,

3.7 Regression

Coefficients

32
 Model B T Sig,
1 (Constant) 1,361 5,511 ,000

ROE ,552 5,418 ,000

Tangibility ,111 4,561 ,000

Corporate Tax ,333 3,562 ,000

a, Predictors: (Constant), Corporate Tax, ROE, Tangibility

b, Dependent Variable: DE

R= ,770, R square = ,741, F = 31,621

The above table shows values of R, R square, F, Beta, and t, The r value shows the correlation
among variables of the study, The r value is ,770 or 77% which means variables level of
correlation is very strong, r square value shows how much independent variables explain
dependent variable, The r square value is ,741 or 74,1% which shows Corporate Tax, ROE and
Tangibility explain Capital structure by 74,1%,

According to above Table, the results of regression analysis shows that the return on equity, asset
tangibility and corporate tax positively affect capital structure, The nature of each variable’s
influence can be seen in whether the beta unstandardized coefficient variable is positive, while
significance can be assessed by comparing the variable’s significance value with 0,05; if the
significance value < 0,05 then the independent variable has a significant individual effect upon
the dependent variable, The significance of Return on equity is 0,000, which is smaller than 0,05,
while its beta unstandardized coefficient has a value of ,552, This result shows that return on
equity has a positive effect upon capital structure, The significance for Tangibility is 0,000 – less
than 0,05 -- while the value of its beta unstandardized coefficient is positive at 0,111, These
results indicate that Tangibility positively affects the capital structure, The significance for
corporate tax is 0,000, which is less than 0,05, while the value of its beta unstandardized
33
coefficient is positive value at ,333, This result shows that corporate tax has positive affect on
capital structure,

The above table shows the significance of the research model of the study which is significance
and perfect fit, The F is 31,621 which is more than 2,

ROE t value is 5,418 which is a bigger value than 1,96 and the significance value is ,000 which
is less than 0,05, Its beta value is ,552 which shows that one unit change inROE will change
capital structure by ,552 in units,H1 accepted,

Tangibility t value is 4,561 which is a bigger value than 1,96 and the significance value is ,000
which is less than 0,05, Its beta value is ,111 which shows that one unit change inTangibility will
change capital structure by ,111 in units, H2 accepted

Corporate Tax t value is 3,562 which is a bigger value than 1,96 and the significance value is
,000 which is less than 0,05, Its beta value is ,333 which shows that one unit change inCorporate
Tax will change capital structure by ,333 in units,H3 accepted

3.8 Summary
Table 1

34
 Accepted/
Anticipated Hypothesis Actual Hypothesis
Rejected

H1:Profitability has positive and significant H1:Profitability has positive and significant
impact on Capital structure of cement impact on Capital structure of cement Accepted
companies, companies,

H2:Assets tangibility has positive and H2:Assets tangibility has positive and
Accepted
significant impact on Capital structure significant impact on Capital structure

H3: Corporate tax has positive and significant H3: Corporate tax has positive and significant
Accepted
impact on Capital structure impact on Capital structure

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 5

DISCUSSION
The results of the examination of the research variables as a group shows that Profitability
(Return on equity), Asset Tangibility and Corporate tax together have a significant effect upon
Capital Structure as shown by their significance value P<0,05, specifically P = 0,000, This result
is in accord with a prior study by Badar and Saeed (2013), Negasa (2016), A,O Olankule and
Emmanuel O,Oni (2017) and Nasution, Siregar and Panggabean (2017) which concluded that
profitability, asset tangibility and corporate tax together has a significant effect upon capital
structure,
Meanwhile, the results of individual testing for each independent variable are:
H1: Profitability has positive and significant impact on the capital structure
Profitability (Return on equity) positively affects the dependent variable of capital structure,
This is shown by a significance value of P = 0,000, which is smaller than the threshold value
of 0,05, Meanwhile, thebeta coefficient has a value of ,552,This result differs with a previous
study by Nassar S (2016) but agrees from the results of research conducted bySaputra et al
(2015) , Negasa (2016), Fosu et al,, (2016)and Baddar and Saeed (2013) which showed that
profitability had a positive effect upon Capital Structure.
H2: Assets tangibility has positive and significant impact on the capital structure
Tangibility positively affects the dependent variable of Capital Structure, Its significance value
P = 0,000,is smaller than the threshold value of 0.05, while the beta coefficient has a positive
value of ,111, The results of this study are in accord with previous research by A,O Olankule and
Emmanuel O, Oni (2015),Kabeer and Rafique (2018) and Nasution, Siregar and
Panggabean(2017), However, Rajan and Zingales(1995) andT A Muritala (2012) found to the
contrary that Tangibility has negative effect on Capital Structure,
H3: Corporate tax has positive and significant impact on the capital structure
Corporate tax positively affects the dependent variable of capital structure, The significance
value P = 0,000 is less than the threshold value of 0. 05, while the value of the beta coefficient is
positive at ,333, The results of this study are in accordance with a previous studies by Michael P
Devereux ,GiorgiaMaffini and Jing Xing (2015) and Nasution, Siregar and Panggabean (2017)
but different from the results of research by Chen Deng (2015), Chen Deng (2015) found in his
research that Corporate Tax negatively affects Capital Structure,
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3.9 Conclusion
“This study analyzed a sample of 22 firms in cement industry of Pakistan in order to find out the
determinants of capital structure of the companies in cement industry of Pakistan, The results
showed that profitability, tangibility and corporate tax of the firms significantly affect the capital
structure decisions, The findings of the study suggested that while taking capital structure
decisions due consideration should be given to profitability, tangibility and corporate tax of the
firm.”

3.10 Limitations and Future suggestions

It is suggested for the future researchers to conduct their studies on multiple sectors, and
compare the output among the sector, It is also advised for future research to add more variables
especially country specific characteristics and their effects on firm leverage such as interest rates,
stock market capitalization, bond market development, GDP growth, credit/shareholder’s right
protection framework etc,, with longer period, Government policy toward private sector and its
impact on firm’s leverage decision can be taken into consideration, while various eras of
financial behavior from financial institution towards private sector can also an interesting area
for research,

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