Working Paper: 306

Determinants of Capital Structure of Indian Corporate Sector: Evidence of Regulatory Impact

Kaushik Basu
Meenakshi Rajeev

 

Abstract

In this study we have made an attempt to answer two crucial questions - first, whether capital market regulations exert any influence on capital structure decisions of Indian corporate firms, and second, how to measure the capabilities of firm-specific factors to explain two theories of capital structure namely, static trade-off theory and pecking order hypothesis. In order to answer these two questions, we have employed static panel data model as proposed by Driscoll and Kraay (1998), considering 1154 firms for a period of 21 years (1989-2009) which resulted in 6946 observations. In this study we have looked at the impact of firm-specific and institutional factors on debt and equity separately in order to understand the explanatory power of the same set of factors in favour of trade-off theory and pecking order hypothesis. We find evidence in favour of the argument that institutional factors matter in financing decisions of corporations. Our results suggest that capital market regulations in India have adverse impact on the use of public debt and favorable impact on the use of equity capital. It is also found that firm-specific factors are more capable of explaining trade-off theory rather than explaining the information asymmetry in the public domain. This explains the fact that private lenders have superior firm specific information which helps firms in mobilizing resources from private sources rather than from the market. This study may be of some use for academicians and policy makers to understand the impact of regulation on the use of public debt and equity capital from the capital market by the firms.

Working Papers