Determinants of Leverage of Indian Companies: An Empirical Analysis (A Study of Cement Industry in India

Abstract

Capital structure of a firm is defined by its leverage; that is a mix of debt and equity financing which is subject to different financial difficulties. Financial leverage represents the total debt reported to the equity of a firm, reflecting the capacity of the financial managers to attract external financial resources in order to improve the efficiency of the equity.

The Pecking Order theory popularized by Stewart C. Myers postulates that equity is a less preferred means of raising new capital, and is actually a last resort.  The theory argues that equity is a less preferred means to raise capital because when managers issue new equity investors believe that managers overvalue the firms and are taking advantage of this over-valuation. As a result, investors will place a lower value to the new equity issuance.

Tests of the pecking order theory have not been able to show that it is of first-order importance in determining a firm's capital structure. However, several authors have found that there are instances where it is a good approximation of reality. The present study is an attempt to examine the variable determining the leverage and risk of cement companies operating in India. five variables are selected on the basis of previous studies and literature available   to study their impact on firm leverage. These variables are firm size, growth, profitability, liquidity, and tangibility.

A linear regression model has been developed to estimate the effect of above variables on leverage and risk of companies and it is observed that there is negative and low degree of relationship between the variables under study.