THE PAKISTAN DEVELOPMENT REVIEW
Did They Do It Differently? Capital Structure Choices of Public and Private Sectors in Pakistan
Capital structure is one of the most complex areas of strategic financial decision making due to its interrelationship with other financial decision variables. For more than four decades discussion in corporate finance concerns the question of optimal capital structure: Given a level of total capital necessary for supporting firm’s activities, is there a way of dividing this capital into debt and equity which maximises firm value? And, if so, what are the critical factors in setting the leverage ratio for a given firm? Corporate finance literature is overwhelmed by this hot debate, which is still going on, about firm value triggered by the two conflicting conclusions of Modigliani and Miller (1958, 1963). For a comprehensive review of this literature, see Harris and Raviv (1991). The theoretical and empirical research about the optimal capital structure has so far been inconclusive and conflicting. However, the capital structure approach to firm value has been successful to replace heuristics with more methodical approach to define capital structure of the firm. The researchers have theoretically as well as empirically identified many endogenous and exogenous factors affecting the firm’s leverage. They have theoretically and empirically identified agency costs, information asymmetry, taxes, non-debt tax shields, growth, firm size, assets’ collateral value and tangibility, profitability and liquidity, earnings variability, expected costs of financial distress, industry classification, country factor, and firm’s international activities as the determinants of firm’s debt-equity choices.