1.1 about this theory, laid the foundation of

1.1
Background of the study

Franco
Modigliani and Merton Miller both are considered the father of the theory,
“Capital Structure”. Their original vision and their persistent development and
improvements about this theory, laid the foundation of modern corporate
finance. (John & Ronald, 1997)

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The
term “Capital Structure” explains the decisions which describes the allocation
between debt and equity financing in a company. (John & Ronald, 1997). At
managerial level, decisions about capital structure are solely not based on
theories, rather the decision is often covered by practical restrictions to the
theoretical base. (Robert & Steve, 2011).

Decisions
having concern with capital structure are vital for each corporate. In the
corporate business, by and large it is the duty of the
administration/management to make decisions on capital structure in a way that
the value of the firm is maximized. However, to maximize the firm’s value, it
is not a simple and easy task since it includes the choice of debt and equity
in a balanced ratio keeping in perspective of various expenses and advantages
combined with these securities. A wrong choice in the determination procedure
of debt to equity ratio may lead the business to financial distress and in the
long run to bankruptcy. In the past few decades, there have been many research
articles conducted to describe and justify the relationship between capital
structure decisions and the value of the firm. Many alternatives theories have
been constructed in order to determine that what should be the optimal capital
structure of the firm. Regardless of the hypothetical interest of capital
structure, a particular approach or methodology has not been recognized yet,
which can be used by the firms to obtain optimal debt to equity ratio. This
might be because of the reality that the researches regarding capital structure
vary in their relative attention; for example, the trade-off theory focuses on
taxes, the pecking order theory tells us about the difference in information.
However, we can develop an understanding that how firms behave financially, as
well as we can identify the factors that can affect the firm’s capital
structure by following these theories. (Ahmed & Zongjun, 2011)

1.2
Gap Analysis

With
the passage of time there are many researches are conducting in order to study
capital structure. But very few ones work on these independent variables e.g.
Liquidity, Probability, non-debt tax shield and tangibility. Some companies are
taking from textile spinning sector of Pakistan which are registered in stock
exchange commission of Pakistan. Let look back, some research papers have
founded in Pakistan about capital structure Mahira Rafique (2011) work on
degree of financial leverage and profitability. Sajid and talat (2009) work on
working capital. Attaullah and tahir (2004) work on taxes bankruptcy costs and
agency theory using accounting ratios. Pass studies of Pakistan shows that
there are some researchers examine various sectors with respect to firm size
and working capital. As in the
case of Memon, Bhutto and Abbas (2012), the textile sector was analyzed.

Comparably these factors have been examined in other sectors
through other factors. The analysis of past studies reveals that there are many
researchers focus on size and many other factors but they didn’t explain these
four factors which are effecting on capital structure. If there have some
papers but they are very few in accountings which are explaining these factors.

The research accesses the factors in the context of Pakistan stock
exchange of Pakistan which includes companies from the non-financial sector.

1.3 Research
Question

Does
liquidity, profitability, non-debt tax shield and tangibility have any effect
on capital structure of firm?

1.4 Rationale

This
paper explains, what are the factors affecting the capital structure of the
firm? This study explains the different firms’ capital structure behavior and
the effect of different factors affecting the capital structure of these firms,
in developing countries like Pakistan as a sample case. This study concentrates
on these four factors, liquidity of a firm, profitability of a firm, non-debt
tax shield and tangibility.

1.5 Research
Objectives

1.
To study the impact of liquidity on capital structure.

2.
To study the impact of profitability on capital structure.

3.
To study the impact of non-debt tax shield on capital structure.

4.
To study the impact of tangibility on capital structure.

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