Economic research
CHAPTER III - Research Methodology
3.Introduction
This section addresses about the research methodology adopted for the present study. The objectives of this research are to investigate the determinants of capital structure of the listed companies in Indonesia and to analyze how firms in the listed sector raise capital for investments, internally or externally. The steps involved in choosing the research approach with appropriate justification, appropriate data collection methods adopted are also explained in this chapter. “Methodologies refer to the overall approach to the research process, from the theoretical underpinning to the collection and analysis of data. Like theories, methodologies cannot be true or false, only more or less useful” was the definition provided Silverman to define pure research methodology (as cited in Hussey & Hussey, 1997, p.54).
3.1 Research Designs
In any business research, researchers have to explore their findings by providing systematic enquiry as mentioned by Cooper and Schindler (2003). There are different kinds of research usually adopted for the study which includes explanatory, descriptive, and exploratory. In the present study, researcher used exploratory research design, where it aims at assessing phenomena and new insights are obtained (Saunders et al, 2007). In the present study researcher attempted to identify the determinants of capital structure of the listed companies in Indonesia at various levels.
3.1 Development of Hypotheses
A major purpose of this paper is to estimate the relative importance of factors affecting Indonesia firm’s choice of capital structure. Financial theory and empirical results identify a number of variables that influence a firm's debt position in the context of country and firm levels (Rajan and Zingales, 1995; Booth et. al., 2001; Deesomsak et. al., 2004; De Jong et. al., 2008). In order to establish hypotheses about the determinants of capital structure in the sample, current capital structure theories and existing evidence are discussed as below:
3.1.1 Profitability
H1: Profitability has a negative effect on leverage
Myers (1984) suggests that companies may have a 'pecking order' and prefer internal financing to external financing. In other word, companies will have a hierarchy of financing from retained earnings (accumulated net profit), debts and equity. Cole (2008) measured profitability by the winsorised return on assets, and showed a consistent negative relation with the loan-to-asset ratio. The coefficients for ROA were significant at the 0.05 level for three of the four surveys, with 1998 being the exception. As a robustness test, they replaced return on asset with a simple zero-one indicator for profitable firms. They found that this variable had a negative and highly significant coefficient in each of the four surveys. These latter findings were strongly supportive of the pecking order theory, which predicted that profitable firms used less debt because they could fund projects with retained earnings, but it was inconsistent with the trade-off theory, which predicted that profitable firms used more debt to take advantage of the debt tax shield, and because they had lower probability of financial distress. Sbeiti (2010) found that firm profitability seemed to have a statistically negative and significant relationship with both the book and market leverage in the three countries.
3.1.2 Growth opportunities
H2: Growth opportunities have a significant effect on leverage.
There are two different arguments about how growth rate affects leverage. Since growth can enhance the firms' borrowing ability in the future, this would suggest that growth increases firms’ assets, and therefore higher leverage. Gupta (1969) suggests that a company with rapid growth will tend to finance the expansion with debt. Thus, this study suggests that rapidly growing firms should have higher leverage. But Myers (1977) argue that firms with higher growth rates tend to use less and or short term debt in their capital structure to reduce the agency costs. Titman and Wessels (1998) also note that firms usually attempt to invest in suboptimal projects in order to transfer wealth from bondholders. Since costs related to this type of agency problem is higher in rapidly growing firms, then firms use less debt in order to avoid this cost. Shah and Khan (2007) found that growth variable was significant at a 10% level and was negatively related to leverage. As they expected, this negative coefficient of -0.0511 showed that growing firms did not use debt financing. They concluded that their results were in conformity with the result of Titman and Wessels (1988); Barclay, et al. (1995) and Rajan and Zingales (1995). Sbeiti (2010) found a negative relation between growth opportunities and leverage and it was consistent with the predictions of the agency theory that high growth firms used less debt, since they did not wish to be exposed to possible restrictions by lenders. For this reason, growth rate should have a negative relationship with debt.
3.1.3 Non-debt Tax Shield
H3: Non-debt tax shield has a negative effect on leverage.
As predicted by the Trade-off Theory, a major motivation for using debt instead of equity is to save corporate tax. However, firms can use non-debt tax shields such as depreciation to reduce corporate tax. Thus, a higher non-debt tax shield reduces the potential tax benefit of debt and hence it should be inversely related to leverage. Previous studies that support this relationship can be found in DeAngelo and Masulis (1980), Rajan and Zingales (1995) and Deesomsak et al. (2004).
3.1.4 Firm size
H4: Firm size has a positive effect on leverage.
The trade-off theory claims a positive relation between firm size and debt, since larger firms have been shown to have lower risk and relatively lower bankruptcy cost (Myers, 1984). Therefore, firm size is expected to have a positive impact on leverage consistent with the studies by Marsh (1982) and Rajan and Zingales (1995).