Capital Structure and Corporate Governance

Capital structure determination is considered as one of the key corporate financing decisions and managers often face difficulty in finding the optimal one. There are various theories regarding this phenomenon in the finance literature and this issue has been discussed since long. No theory can be regarded as the conclusive one as varying evidences found regarding this complex issue. Presently, the need to determine an optimal capital structure has become more troublesome as well as important due to the emergence of a need of the best corporate governance practices. To mitigate agency problem, the organizations may implement code of corporate governance. This study aims to investigate about the impact of corporate governance on capital structure determination. Secondly, this study focuses on three well known capital structure theories i.e. trade-off theory, agency theory and pecking-order theory. Quantitative research design is used for this empirical study. Sample consists of panel data of the non-financial sector companies listed at Pakistan Stock Exchange for five years 2009-2013. The data of the variables of interest are collected from annual reports published by companies and the publications of State Bank of Pakistan. The companies are selected by taking a representative sample from the whole non-financial sector. Stratified Random Sampling technique is used by taking 10% of each sector and final selected firms are 40.Then, simple random sampling technique is used for the selection of a representative sample by using random number method. Panel data analysis and Hausman test reveal that fixed effects model is better than other options and Board size has a significant impact on Debt to equity ratio in positive direction in case of Pakistani firms operating in nonfinancial sector. We may infer that Pakistani firms have positive relationship between managerial ownership and capital structure. Since this relationship is insignificant in all regressions. The negative relationship of return on assets (ROA) and debt to equity ratio suggests that Pakistani firms earn higher returns on assets and such firms rely more on internal financing resulting in less use of debt, strong negative association has been found between liquidity and debt to equity whereas the relationship with firm size is observed negative as well as insignificant. The findings of this study can help to policy makers to give importance to Board size as it is an important determinant of capital structure as larger the size of board is, the better the monitoring and decision making process.