The Determinants of Capital Structure : Analysis of Non-Financial Firms Listed in Karachi Stock Exchange in Pakistan

The study finds that determining the exact optimal or best capital structure is not a science, so after analyzing a number of factors, a firm establishes a target capital structure it believes is optimal, which is then used as a guide for raising funds in the future. In Pakistan as well there are different factors that affect a firm's capital structure decision. The finding of the report shows that in Pakistani firms most of the firm tends toward the equity or internal financing instead of the debt. In Pakistan debt or long term financing is not considered as prior to equity financing because the bond market in this country is not yet so developed. Main source of external financing available to the Pakistani firms is commercial bank operating all around the country. These commercial banks encourage short term and secured loans only. Larger firm can easily get loans from commercials as banks likes to advance loan to those firm which are financially sound and can absorb more shock. Where as most of Pakistani firms are of medium size. Therefore firms are less tempted toward the long term loan to finance their future investments. Another possible reason why Pakistani firms try to avoid debt financing is that these firms want to avoid the legal obligations and scrutiny procedures related to the debt financing. Often many firms listed in Karachi Stock Exchange try's to escape the discipline of capital market for example they don't pay dividend for years and do not experience significant decline in stock prices. Such shares are not traded and new issues are never announced. Other reason for non debt financing trend of Pakistani, but not yet proven, is that religious teaching regarding the interest or Reba forbids interest bearing loan transactions. This is main reason for slow development of bond market in Pakistan. This study finds that with increase in profitability of Pakistani firms, they less tend toward debt financing, thus confirming the finding of picking theory by Mayer and Mujluf (1984) 28 . One possible reason for this negative relationship between profitability and leverage of the firm is that most of the Pakistani firms try to retain its earning for future requirements as they prefer to pick internal financing over the out financing. However the study finds that with the passage of the Pakistani firms are andwill realize the importance of the debt financing in increase the value of the firm and ultimately the wealth of the share holders