Electronic copy available at: http://ssrn.com/abstract=2227602 International Research Journal of Finance and Economics ISSN 1450-2887 Issue 71 (2011) © EuroJournals Publishing, Inc. 2011 http://www.eurojournals.com/finance.htm The Effect of Economic and Accounting Variables on Capital Structure: Empirical Evidence from Iranian Companies Arezoo Aghaei Chadegani Department of Accounting, Mobarakeh Branch Islamic Azad University, Mobarakeh, Isfahan, Iran E-mail: arezooaghaie2001@yahoo.com Tel: ++60173191093 Masoud Nadem Department of Accounting, Mobarakeh Branch Islamic Azad University, Mobarakeh, Isfahan, Iran Mohamad Noroozi Department of Accounting, Mobarakeh Branch Islamic Azad University, Mobarakeh, Isfahan, Iran Seyed Mohsen Madine Department of Accounting, Mobarakeh Branch Islamic Azad University, Mobarakeh, Isfahan, Iran Abstract The aim of this study is to investigate the effects of economic and accounting variables on capital structure of companies listed on Tehran Stock Exchange. To describe the effect of research variables on capital structure, the multivariate regression model (seemingly unrelated regression equations) and initial data of listed companies between 2001 until 2008 are used. The main research question is whether changes in accounting and economic variables have effect on capital structure of Iranian companies or not. The results show that in addition to accounting variables, economic variables can significantly influenced the manager’s decisions about the composition of financial resources and in this respect they are very important. Overall, the research hypotheses were accepted and confirmed the significant relationship between economic and accounting variables and capital structure. Keywords: Capital Structure, Microeconomic Variables, Accounting Variables, Multivariate Regression 1. Introduction One of the main concerns of companies’ financial managers is making decisions about the appropriate combination of financial resources and determining the composition of capital structure which is the combination of stocks and bonds. These decisions must be make in order to increase firm value. Based on theoretical basic of financial management, capital structure determination is achieving an appropriate and desirable combination of equity and debts in a way that could maximize the firm value Electronic copy available at: http://ssrn.com/abstract=2227602 International Research Journal of Finance and Economics - Issue 71 (2011) 106 and in contrast, reduced the cost of financing (Kohher, 2007). Investigating the optimal combination of capital structure of a company has a significant importance in capital market. There are several factors that may have effect on this relationship. On the other hand, several factors (economic and accounting) may influence the composition and structure of the capital. Studies that have done in this regard led to theories about the determination and composition of optimal capital structure such as; Pecking Order Theory, Free Cash Flow Theory, Agency Theory and Market Timing Theory. Most of these theories are based on the company's internal structure and the impact of internal factors of the company and they are based on assumption of stability of economic factors and variables (Bokpin, 2009). In general, all of these theories about the determination of capital structure focus on answering questions such as; which combination of capital structure have tax savings for the company? What capital structure is cheaper and affordable for the company? Or which regulation about company’s capital structure is required to observe by firm? (Myers, 1983). In fact, issues discussed in each of the presented theories are about capital structure, including internal company factors such as managerial factors, buy and sell policies or variables that are controlled by companies. But in these theories, external factors are less considered. The most important external factors are management, planning, decision making and financing of companies and some macroeconomic and accounting variables (Bokpin, 2009). Due to changes in accounting variables such as the amount of dividend, short-term debt ratio, long-term debt on the capital structure ratio and macroeconomic variables such as inflation rate, exchange rates, Gross Domestic Product (GDP), interest rates and the rate of bank credit can affect financial resources’ combination by companies. Since attracting the financial resources have the high sensitivity to economic conditions and macro policies and also, regarding to this fact that changes of these external variables have an extent effect on variables that are controlled by management. Thus, this study investigates the effect of the accounting and economic variables using Seemingly Unrelated Regression Equation (SURE) and annual data for the years 2001 till 2008 on capital structure. Regarding the substantial changes and fluctuations of macroeconomic variables in Iran during last decades and due to this fact that changes of macroeconomic variables represent the economic situations of country, we motivated to investigate the effects of changes in economic situation on financial decisions and composition of financial resources among companies listed on TSE. To examine this relationship the seemingly unrelated regression equation is used and this research is contributed to the knowledge of this issue by using the new method and using accounting variables and macroeconomic variables at the same time and the effect of these variables together on capital structure in Iran for the first time. The discussion in this paper is organized as follows. In next section (2) the relevant literature to develop research hypotheses is discussed, in section (3) the sample selection, research method and variable measurement are explained, in section (4) the research result is analyzed and in section (5) the conclusions of study and suggestions for future researches are discussed. 2. Literature Review 2.1. Prior Studies Capital structure is a combination of debt and equity of companies. This structure includes long-term debt, preferred stock and common stock (Dastgir, 2003). The most important issue in determining capital structure is deciding about an appropriate and desirable portion of liabilities and equity because of their direct effect on value of stock market. After determining the amount of capital needed by company, management decides about which source of funding and what method should be used. Typically, companies and finance managers consider financial policies to reach the highest market value for their stocks. Maximizing shareholder value requires using financial resources and 107 International Research Journal of Finance and Economics - Issue 71 (2011) obtaining optimal maximum efficiency and selecting appropriate risk for the company (Kohher, 2007). In this regard, managers can maximize the value of the company in two ways: • Increasing company efficiency. • Reducing cost of capital and company risk. With optimal combination of resources, company could achieve its maximum stock value. There are different theories related to whether there is truly optimal capital structure or not. The main emphasis of Different theories is on whether the company can change the composition of various sources of financing to reduce capital costs and affect the value of the stock market or not? The views about the proposed capital structure include Traditional theory, Modigliani and Miller Theory, Static Trade-off Approach and free Cash flow hypothesis. According to traditional theory, achieving an optimal capital structure is depending on the cost of financing. The company can increase their market shares price through reducing financing costs and it may lead to enhance the total value of the company (Harris and Raviv, 2002). Modigliani and Miller (1958)’ theory showed that if the Company's investment policy is constant, regardless of the taxes and engagement expenses, the company's financing policy has no influence on the current market value. Their hypothesis about capital structure shows that financing policy choices could not change the value of the company. According to Static Trade-off Approach, optimal capital structure is achieved through a combination of different sources of financing that matched the debt financing costs and benefits. Cash flow hypothesis is based on this fact that Payment of dividends has reduced the free cash flows available to managers and so prevents managers from doing opportunistic activities (Jensen, 1986). Fanelli and Keifman (2002) examine the relationship between capital structure and some economic variables in Argentina. Their results show that in country's financial markets, unstable economic environment and external events have effects on investment decisions of companies. They also express that issuance of bonds by companies for financing is suitable only when the country is in good economic situation. Miguel and Peinado (2004) investigate the relationship between capital structure and liquidity, short-term debt and long-term debt ratios for the 10 years period. They conclude that there is a reverse relationship between liquidity and financial leverage and leads to this fact that using liquidity for financing is preferable compare to use leverage. Songshin and Adrian (2009) try to find the relationship between interest rates, GDP, inflation and exchange rates and capital structure in a sample of companies in Germany, France, Italy and UK. They believe that favorable and unfavorable economic conditions of country have effect on capital structure and for deciding about the optimal capital structure, companies should consider the external factors. Bokpin (2009) also find this result for 34 countries and his results confirmed that microeconomic variables extremely have effect on capital structure. Nadeem and Wang (2010) investigate the influencing factors on capital structure decisions. They find positive significant relationship between capital structure and firm’s size. But there is not any research which investigates the relationship between accounting and microeconomic variables and capital structure at the same time. Thus, this study tries to fill this gap in the literature. 2.2. Conceptual Framework and Research Hypotheses According to literature review, there are two groups of variables that may have effect on capital structure: Microeconomic variables and Accounting variables. Macroeconomic variables include GDP, interest rate, inflation, exchange rates and the rate of bank credit. Inflation rate is the increasing levels of goods and services price that will reduce the purchasing power. According to literature, a change in inflation rate is one of the factors that has influence on management decisions about financing and increases the retained earnings of firms. Due to this fact that one of the resources of companies financing is retained earnings, thus, financing through retained earning reduce the financial leverage that shows the negative relationship between inflation rate and capital structure (Drobetz et al., 2007). International Research Journal of Finance and Economics - Issue 71 (2011) 108 Exchange rate is the price of one country’s currency against another country’s currency. Generally, changes in exchange rate can be effective on the capital structure of those companies which use foreign funds. Increasing the exchange rate will lead to decrease in cash and increases interest expense and finally increases the debts ratio. Thus, there is a positive relationship between exchange rate and capital structure (Fanelli and Keifman, 2002). Gross Domestic Product (GDP) is the total monetary value of goods and services produced in a given year using the factors of production owned by citizens of a country. Based on literature review, the increase in GDP improves cash flows and earnings and it leads to reduction in the debt to equity ratio which indicates a negative relationship between GDP and capital structure (Bokpin, 2009). Interest is amount of money that borrower is paid to the lender for using his funds in a specific time period. Increase in interest rate will cause increase in investor and creditors expected rates. Since financial managers are seeking to achieve the lowest cost sources of financing, thus, with increasing in interest rates and as a consequence increasing in cost of financing through bonds, they eliminate this way of financing. This fact indicates the negative relationship between interest rate and capital structure (Bokpin, 2009). The bank credit is acquired and reported by the central bank and it is based on one million riyals in Iran. Based on literature, choosing the specific policies for giving facilities by banks provide better conditions for using these facilities which lead to the increase in debt to equity ratio. Accordingly, the relationship between bank credit and capital structure is positive (Bokpin, 2009). Accounting variables include short-term and long-term debt ratios and payable divided. Short- term debt ratio is the current liabilities to equity and represents the relationship between current debts and equity. Long-term debt ratio is another investment ratio that is the long-term liabilities to equity. Since the amount of debts ratios depend on interest rate and credit policies of governments, therefore, increasing in the amount of short-term and long-term debt ratios will lead to increase in debt to equity ratio. Thus, it would be related to a positive relationship between debts ratios and capital structure (Miguel and Peinado, 2004). To explain the relationship between payable dividend and capital structure, we refer to this fact that if company’s profits did not pay to shareholders, it will be accumulated and can be used in investment decisions. So, more paying dividends will lead to increase in debt to equity ratio. Thus, a positive relationship between payable dividend and equity will be expected (Bokpin, 2009). Based on above discussions, two main research hypotheses are as follows: H1: Macroeconomic variables including GDP, interest rate, inflation, exchange rates and the rate of bank credit have significant effect on capital structure of companies listed on TSE. H2: Accounting variables including short-term and long-term debt ratios and dividend have significant effect on capital structure of companies listed on TSE. 3. Research Method In this study, to examine the relationship between macroeconomic variables and accounting variables and capital structure panel data is used. In this method, Time Series and cross-sectional data are integrated. In general, in cross-sectional data, one or more variable for single or multiple samples are collected at the same time. In this research for choosing samples, Purposeful Sampling is used. This means that companies considering the following features were selected: • Investment companies are not financial intermediation and leasing. • They listed on Tehran Stock Exchange until the end of 2008. • During the research period their stock trading has not stopped. • In terms of increase comparability, their fiscal year ends to march. • Debt to equity ratio that represents the capital structure of these companies should be positive. 109 International Research Journal of Finance and Economics - Issue 71 (2011) Considering the mentioned conditions total number of 143 companies was selected. Thus, secondary data of these companies were gathered and Eviews software was used for analyzing data. For investigating the relationship between two groups of independent variables (Microeconomic variables and Accounting variables) with capital structure, two regression models are used. titititit titititititit LTDSHTDDividentCapital ERBDCPIIRGDPCapital εβββα ε β β β β β α ++++= + + + + + + = 8761 543211 Where: GDP: Gross Domestic Product Capital: Debt to Equity Ratio IR: Interest Rate CPI: Inflation ER: Exchange Rate BD: Bank Credit Dividend: Amount of Payable Dividend SHTD: Short-term Debt Ratio LTD: Long-term Debt Ratio Seemingly unrelated regression equations are used in this study. One of the advantages of this method is that in cases such as heteroscedasticity or other problems that may happen in ordinal linear regression are eliminated in seemingly unrelated regression models. 4. The Results of Hypotheses Testing The results of seemingly unrelated regression analysis are shown in Table 1. Table 1: The results of seemingly unrelated regression analysis Method: Seemingly Unrelated Regression Period: 2001 - 2008 Observations: 143 Coefficient SD t-value errors C(1) – 173/0303 84/2731 – 2/05321 0/0431 C(2) 1/8251 0/02024 6/0247 0/000 C(3) 1/6256 0/03185 5/4279 0/000 C(4) 0/6534 1/63160 2/59422 0/0387 C(5) – 16/3694 24/0196 – 0/20428 0/5128 C(6) 0/60205 0/03504 2/74256 0/0043 C(7) – 1/3576 0/01710 – 3/9442 0/0002 C(8) – 1/6125 0/02606 – 4/7028 0/000 C(9) – 0/9442 2/9605 – 4/6558 0/0037 C(10) 2/0673 0/01177 3/1447 0/0023 Equation : CAPITAL = C(1) + C(2) *SHTD + C(3) *LTD + C(4) *DIVIDENT (R 2 ) R – squared 0/870073 var dependent Mean 503/06657 R – squared Adjusted 0/850612 var dependent S.D. 309/5764 regression S.E.of 92/47225 resid squared Sum 1/146219 stat Durbin – Watson 0/755425 Equation : CAPITAL = C(5) + C(6) *ER + C(7) * CPI + C(8) * IR + C(9) * GDP + C(10) * BD (R 2 ) R – squared 0/910565 var dependent Mean 86/12350 R – squared Adjusted 0/900043 var dependent S.D. 42/72556 regression S.E.of 13/50809 resid square Sum 3101/964 stat Durbin – Watson 1/885065 Significant at 5% level According to the results of data analysis, with 1% increase in short term debt ratio, capital structure will increase 1.82 %. Also, with 1% increase in long term debt ratio and payable dividend, International Research Journal of Finance and Economics - Issue 71 (2011) 110 capital structure will increase 1.62% and 0.65% respectively. Moreover, the results show that according to seemingly unrelated regression model, the amount of bank credits have the most important effect on debt to equity ratio and with 1% increase in this variable capital structure will increase 7.2%. Also, exchange rate has positive impact on debt to equity ratio and interest rate, inflation and GDP have negative impact on debt to equity ratio. As table 1 represents, R 2 of accounting and economic variables are 0.87 and 0.91 respectively. It means that 87% of changes in capital structure could explained by accounting variables and 91% by economic variables. Overall, the results show that all economic and accounting variables have effect on capital structure. Regarding to this fact that Iran is a new developed country, government provides considerable facilities for production in different industries that increase the manager’s wishes to use these facilities and bank credits. 5. Summary and Concluding Remarks In this research the relationship between accounting and economic variables and capital structure were examined. All research hypotheses are confirmed by result analysis and results represent a positive relationship between short-term and long-term debt ratios, dividend, exchange rate, bank credit with capital structure in TSE. The results also show the negative relationship between interest rate, inflation rate and GDP with capital structure in TSE. Further analysis show that among microeconomic variables, the amount of bank credit has the most important effect on capital structure. With creating easy conditions for receiving bank credits, debt to equity ratio is increase and it leads to a positive relationship between the amount of bank credit and capital structure. Inflation rate is another microeconomic variable that has a significant effect on capital structure. Since, this variable has ongoing changes and fluctuations in Iran, economic policy makers should consider the effect of this variable on financing activity of industrial companies because it may influence the going concern of companies. Moreover, exchange rate and GDP are two microeconomic variables that have effect on composition of company’s financial resources. Change in exchange rate may influence the capital structure of those firms which have external and foreign financing. Thus, exchange rate has a positive relationship with capital structure. Company’s cash flows are improved by increasing in GDP and there is a negative relationship between GDP and capital structure. All accounting variables include short-term and long-term debt ratios and payable dividend have also positive relationship with capital structure. Further researches are suggested to find the effect of other accounting variables on capital structure. References [1] Bokpin, G. A. 2009. "Macroeconomic Development and Capital Structure Decisions of Firms". Studies in Economics and Finance. Vol. 26, No. 2, Pp. 129-142. [2] Dastgir, M. 2003. “ Basic of financial management”. Norpardazan. First Issue. [3] Harris, M. and Raviv, A. 2002. "Theory of Capital Structure", Journal of Finance. No. 46, PP. 297-355. [4] Drobetz, A. and Baker, M and Wurgler, J. 2007. "How Persistent is the Impact of Market Timing on Capital Structures15, No. 1, PP. 1- 33.?", Review of Financial Studies, Vol.20. [5] Fanelli, J.M. and Keifman, S. 2002. "Finance and changing patterns in developing countries", in Fanelli, J.M. and Medhora, R. (Eds), Finance and Competitiveness in Developing, Routledge, London. [6] Jensen, C. M. 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers". The American Economic Review. Vol. 76, No. 2, PP. 323-329. 111 International Research Journal of Finance and Economics - Issue 71 (2011) [7] Kohher, R. 2007. “Strategic Assets, Capital Structure, and Firm Performance", Journal Of Financial And Strategic Decisions. No.3, PP. 23-36. [8] Miguel, A. and Peinado, C. 2004. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads". Journal of Finance, Vol. 51, No. 3, PP: 987-1019. [9] Myers S. C. 1983. "The Search for Optimal Capital Structure" .Midland Corporate Finance Journal. [10] Nadeem, A. and Wang, Z. 2010. “Financing Behavior of Textile Firms in Pakistan”. International Journal of Innovation, Management and Technology, Vol. 1, No. 2, June 2010130-135. [11] Song Shin, H. and Adrian, T. 2009. "Federal Reserve Bank of New York Staff Reports" .http://papers.ssrn.com/. . accounting variables and capital structure. Keywords: Capital Structure, Microeconomic Variables, Accounting Variables, Multivariate Regression 1. Introduction One of the main concerns of companies . internal structure and the impact of internal factors of the company and they are based on assumption of stability of economic factors and variables (Bokpin, 2009). In general, all of these theories. http://www.eurojournals.com/finance.htm The Effect of Economic and Accounting Variables on Capital Structure: Empirical Evidence from Iranian Companies Arezoo Aghaei Chadegani Department of Accounting, Mobarakeh