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Have you any examples from your own experience that you could share with others in the class? Read more Read less. Product description Product Description Assume that you are the CFO of a company contemplating a stock repurchase next quarter. Not Enabled. No customer reviews. Share your thoughts with other customers.

Write a product review. Back to top. Get to Know Us. Length: 6 pages. Word Wise: Enabled. Enhanced Typesetting: Enabled. In this case, the change in short-term debt a decrease occurs simply because the short-term debt matures, while the simultaneous change in the long-term debt i. It is worth noting that a great part of the debt financing pattern in Egypt is a good example of the above mentioned scenario.

Second, the use of short-term debt may create another potential problem.

Capital Structure - Meaning and Factors Determining Capital Structure

Myers and Graham argue that firms may limit total debt, or use short-term debt, to minimize underinvestment costs. Summary statistics of variables used for modeling the capital structure decision.

Capital Structure & It's Importance

Size Ln Assets t. The other variables are the independents. The data covers the years from to The sample consists of 99 non-financial firms. The data are obtained from many sources. The data cover seven years — The total number of firms included in the study is 99 firms. The sample firms were selected according to two criteria. First, the non-financial firms amongst the actively trading firms in Egypt stock market. Second, those non-financial firms amongst the firms with the highest market value.

The authors employ ten model selection criteria to choose the best subset predictors of the capital structure decisions. Then, the subset which is selected by the maximum number of criteria is chosen to be the identified subset, e. It is worth noting that the ten criteria are monotone functions of the residual sum of squares RSS for subsets with the same number of predictors. Nevertheless, the direct search for the subsets with minimum RSS by visiting all possible subsets is impractical since the number of candidate subsets increases exponentially with the number of predictors.

Other authors such as Furnival and Wilson and Hocking have developed elegant procedures which reduce the amount of computations required for examining a subset and avoid examining all possible subsets.

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The Minitab package reports the subsets with the maximum R 2 or equivalently with minimum RSS for each number of predictors. Then, a Matlab macro is written by the authors to compute the other criteria which are not reported by Minitab where RSS is used as an input in the Matlab macro. In search for the candidate group subset of determinants of long-term debt financing, two approaches are developed.

The first approach is to search for the criteria that include the same number of variables. Each of the two subsets is selected by three criteria. The second approach for determining the candidate subset is to select the variables which are selected by the maximum number of criteria. This is the approach preferred and adopted by the authors. This can be done when the number of variables corresponding to the elements in the last column n i : is greater than or equal a certain number.

When we choose the variables which are selected by 9 criteria or more we obtain the same determinants of the first subset and the second subset is obtained when we select the variables chosen by 6 or more criteria. Indeed, for this reason the second approach outperforms the first one, considering that the major objective is to select the group of predictors that conform to the maximum number of criteria.

Accordingly, the first chosen subset represents the group of determinants that affect the long-term debt financing decision. Common determinants of debt financing Agreed upon by 3 or 4 dependents. The robustness of this result is considered when the same predictors are examined with regard to another alternative dependent variable, which is the change in total debt ratio.


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This result indicates a considerable resemblance between long-term and short-term debts when making capital structure decisions. That is, short-term debt is renewable and used on long-term basis as a source of long-term debt financing. In this case, firms use both long-term debt and retained earnings to finance the available investment opportunities.

That is, the availability of good investment opportunities being proxied by high MB ratio supports Myers and Graham theory that firms may use short-term debt financing to minimize underinvestment costs. They all found significant industry effects on debt ratios. Titman raised the magnitude of this relationship through studying the liquidation decision where the results indicate that firms that make special products will find liquidation costly. Titman and Wessels report a negative relationship between debt ratios and the dummy variables that control for and refer to the firms that produce specialized products such as machines and equipments.

This does not render profitability a robust determinant of short-term debt financing. As Myers points out, the practice of corporate financing decisions could be dominated by the combined effects of the three theories. The contribution of the subset selection approach is to examine the dominant determinants variables influencing the practice of debt financing decisions. The results show that in both cases of long-term debt financing and short-term debt financing, the trade-off theory dominates relatively.

The trade-off theory assumes that the firm will borrow to a level that balances the tax advantages and possible financial distress. DeAngelo and Masulis argue that there is a positive relationship in which firms subject to lower corporation tax rates will employ less debt in their capital structure. Lasfer reports the same positive relationship in the long-run, but no significant effect in the short-run. Walsh and Ryan found that tax considerations are significant in determining debt and equity decisions of the UK firms. The other survey conducted by Graham and Harvey reports that tax advantage is of moderate importance for medium-size firms, and of high importance for large, regulated dividend-paying firms e.

The literature on the theories of capital structure assumes that tangible assets are easy to collateralize and thus they reduce the agency costs of debt Myers and Majluf ; Stulz and Johnson ; Harris and Raviv ; Rajan and Zingales The literature provides some different results on the relationship between debt and fixed assets. Schmidt and Ferri and Jones found a negative correlation between total debt and the proportion of fixed assets.

The existence of uncollaterable assets leads a firm to change its capital structure favoring equity financing rather than debt financing. Myers and Majluf and Myers indicate that when managers have better information than outside investors, the former find it advantageous to issue secured debt. As the agency theory states, equity-controlled firms have a tendency to invest suboptimally to expropriate wealth from bondholders and the cost associated with this agency relationship is likely to be higher for growing firms.

This does not render interest rate a robust determinant of debt financing. The results show that the long-term debt financing is also affected by the existence of much investment growth opportunities being proxied by the MB ratio. The latter are affected by the presence of long-term debt, which can cause an agency conflict between bondholders and shareholders Myers That is, shareholders may underinvest if they perceive that the income will be used to pay off existing debt holders.

Barclay et al. Myers and Graham argue that firms may limit total debt, or use short-term debt to minimize underinvestment costs. This result comes in contrast to the results of other studies that debt usage is inversely related to growth options. Myers , Williamson and Harris and Raviv argue on the relationship between growth opportunities, bankruptcy costs and financial leverage.

They argue that the expected bankruptcy costs are higher for firms with greater growth opportunities. This leads to the conclusion that larger expected bankruptcy costs would in turn imply lower financial leverage. Titman and Wessels present additional evidence in which they argue that firms in growing industries incur higher agency costs since they have more flexibility in taking future investments. Lasfer provides evidence on the inverse relationship that firms with fewer growth opportunities have more debt in their capital structure. Rajan and Zingales found a negative correlation between market-to-book ratio and leverage driven by firms with high market-to-book ratios rather than by firms with low market-to-book ratios.

This indicates that it is unlikely that financial distress high leverage , which is associated with firms with low market-to-book ratios, is responsible for the negative correlation as suggested by Fama and French Ozkan presented further evidence on the negative and statistically significant relationship between growth opportunities and leverage. According to his explanation, this negative relationship may give support to the prediction that firms, which have a relatively large proportion of intangible assets can not support a high leverage ratio.

Nevertheless, Ozkan found a positive and statistically significant relationship between the lagged growth and leverage. He argues that the positive effect may happen because growth has a transitory effect on leverage ratios. In the case of Egypt, Eldomiaty and Ismail , and Eldomiaty have reached similar results about sample of Egyptian firms using the Bayesian methodology which stands on very different assumptions from the assumptions of the subset selection procedure employed in the present study.

The converging and matchable results of those studies, therefore, add to the contribution of this paper since the methodology used in this study is quite different from the ones used in the other related studies mentioned earlier. This also shows a significant element of external validity of the results reported in this study as well as the other related studies.

The literature on the theories of capital structure has provided wide range of factors that can be used to describe the practice of corporate financing strategies. This paper is the first attempt to employ the methodology of model selection for determining the relevant determinants of debt financing decisions in transition markets in general and in Egypt in particular.

The methodology used in this paper presents evidence that two models of corporate debt financing long-term and short-term debt financing show a robust influence of the trade-off theory. The contribution of the paper is that the reported results converge relatively and considerably to the results of other related studies in developing markets, which is considered an element of external validity. This is true since the methodologies employed in the other related studies differ from the one used in the present study.

The results have also empirical considerations since they show the relevant determinants of capital structure to the Egyptian capital market. These determinants are recommended to the practitioners when making debt financing decisions. This article is distributed under the terms of the Creative Commons Attribution Noncommercial License which permits any noncommercial use, distribution, and reproduction in any medium, provided the original author s and source are credited. Skip to main content Skip to sections. Advertisement Hide. Download PDF. Modeling capital structure decisions in a transition market: empirical analysis of firms in Egypt.

Open Access. First Online: 02 May JEL Classification G The search for the most reliable and relevant determinants of capital structure in a transition market is particularly significant for certain reasons. First, compared with developed markets, the stock markets in transitional countries are relatively less efficient which raises the importance of searching for the most reliable factors that determine the practice of capital structure decisions.

Second, information asymmetry in transitional markets is relatively higher than that of developed markets. This means that the capital structure decisions may not be foreseen. This requires an examination of the financial factors that help lessen the degree of asymmetry.

Capital Structure - Meaning and Factors Determining Capital Structure

This raises the question of the extent to which the determinants of capital structure that have evolved in developed markets have an influence generally in a transition market and particularly in Egypt. According to the three reasons mentioned above, the paper tests the hypothesis that: Due to transitional markets less efficiency, information asymmetry and global convergence, capital structure decisions in transition markets are relatively influenced by the three theories of capital structure.

The relevant literature on the determinants of capital structure provides number of factors that have been examined or even pointed out. It has been realized that the number of factors differs from one study to another.

Therefore, this study examines as a comprehensive number of determinants of capital structure as possible. These determinants cover relatively the tradeoff theory, pecking order theory and free cash flow theory. Some determinants could not be included due to the lack of relevant data. Bankruptcy risk BR t [A direct measure of bankruptcy risk White and Turnbull ; Marsh ] d Bankruptcy risk as a proxy for the bankruptcy costs Warner ; Myers ; Castanias The authors have covered a wide range of factors of capital structure that were examined in the literature empirically.

The sample consists of 99 non-financial firms a ICs are dummies for the industry type. Over the last three decades, several subset selection criteria have been proposed and studied in the linear regression models. These criteria have two basic elements. The first element is a function of error variance estimator which measures the goodness of fit.

The second is a function of the number of unknown parameters which penalizes overfitting. The AIC is one of the most popular criteria for model selection. Schwarz proposed the Bayes information criterion BIC as a Bayesian solution to the model selection problem. The BIC was derived as a large sample approximation of Bayes factor using the posterior-probability criterion and evaluating the leading terms of its asymptotic expansion.

Schwarz assumed a fixed penalty for guessing the wrong model and considered an infinite sequence of nested models each of which has a non-zero prior probability. Akaike proposed the FPE to select the best subset by choosing the model that minimizes a form of prediction mean squared error. Following a similar approach to Akaike , , Hannan and Quinn suggested a penalty term as loglog n. Smith and Spiegelhalter employed Bayesian approach for model selection. Shibata investigated the asymptotic efficiency of AIC and showed that, when the true model has infinite dimension, AIC is efficient as the sample size approaches infinity.

This section shows the empirical results of the statistical modeling of the determinants of long-term debt and short-term debt. This section is organized as follows. First, according to the statistical modeling process, it describes how the subset selection is done. The same identified subsets of predictors are obtained if we choose the predictors that appear in the selected models of 8 criteria or more. Therefore, this subset is chosen to represent the group of determinants that affect the short-term debt financing decision. Similarly, the same procedures are employed to examine the potential overlaps between long-term and short-term debt financing.

The latter shows the most common determinants of long-term debt and short-term debt chosen by the most criteria employed by the modeling process. When one determinant is chosen by many criteria, it means that the determinant is highly associated with the measure of capital structure, thus the determinant is quite relevant to explain debt financing decisions in Egypt. Open Access This article is distributed under the terms of the Creative Commons Attribution Noncommercial License which permits any noncommercial use, distribution, and reproduction in any medium, provided the original author s and source are credited.

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