Capital Structure's Influence on Firm Profitability in Pakistan

This research project investigates the influence of capital structure on the profitability of companies in Pakistan. The study employs secondary research methods, analyzing financial statements from 300 companies. The research explores the relationship between long-term debt, total debt, and capital structure with profitability, formulating specific research questions to guide the analysis. A comprehensive literature review, including the Modigliani and Miller propositions, trade-off theory, and pecking order theory, provides the theoretical foundation. The research utilizes a deductive approach and statistical tools to analyze the collected data. The project's structure includes an introduction, literature review, methodology, data analysis, and conclusions with recommendations. The study aims to provide insights into how capital structure decisions impact firm performance, offering valuable information for companies operating or planning to operate in Pakistan. The analysis considers factors such as firm size, asset structure, profitability, growth opportunities, and liquidity. The project also addresses the significance of the study for economic development and the allocation of capital within Pakistani industries.

Running head: CAPITAL STRUCTURE FOR FIRM’S PROFITABILITY
CAPITAL STRUCTURE FOR FIRM’S PROFITABILITY
Name of Student
Name of University
Author’s Note

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ABSTRATCT
This research paper discusses about the impact of the capital structure’s on the
profitability of the company which are mainly hailing from Pakistan. In this research paper the
secondary research methods are being adopted for the development of the research. The research
questions are being formulated for trhe development of the research and to reach the resach
objectives/. The literature review has been made for the valuation of the research and creating the
plinth for the research. The deductive approach has been adopted for the development of the
research. To analyses the data which are collected from the financial statement of the 300
companies for which statistical tools are being used for the development of the research.

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Table of Contents
1. Introduction......................................................................................................................7
1.1Introduction.................................................................................................................7
1.2 Background of the Study...........................................................................................8
1.3 Background of Profitability.......................................................................................9
1.4 Rationale of the Study...............................................................................................9
1.5 Research Objective..................................................................................................10
1.6 Research Question...................................................................................................10
1.7 Justification for Research Question.........................................................................10
1.9 Significance of the Study.........................................................................................11
1.10 Research Structure.................................................................................................11
2. Literature Review..........................................................................................................12
2.1 Introduction..............................................................................................................12
2.2.1 MM Proposition..............................................................................................12
2.2.2 Trade off Theory and Pecking Order Theory..............................................14
2.2.3 Determinants of the Capital Structure and Leverage.................................18
2.2.4 Capital Structure Performance.....................................................................22
2.2.5 The Determinants of the Cost of Equity: Evidence from Pakistan............25
2.3 Gap in Literature......................................................................................................26

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3. Research Methodology..................................................................................................28
3.1 Introduction..............................................................................................................28
3.2 Background to Methodology...............................................................................28
3.3 Research Philosophy and Approach....................................................................29
3.4 Justification of Research Philosophy...................................................................29
3.5 Research Design...................................................................................................30
3.6 Data Collection....................................................................................................30
3.7 Secondary Research.............................................................................................31
3.8 Data Analysis.......................................................................................................31
3.9 Research Method Outline.....................................................................................31
3.10 Research Onion................................................................................................32
3.11 Research Ethical Consideration........................................................................33
3.12 Time Horizon...................................................................................................33
4. Data Analysis...........................................................................................................35
5. Conclusion and Recommendation...........................................................................48
Reference...........................................................................................................................52
Appendix............................................................................................................................63

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1. Introduction
1.1Introduction
Capital structure is one of the important aspects which helps the company in the
investment decision. This capital investment is one of the important factors which also determine
the company’s performance and in return how the company’s growth is being affected. A certain
amount of concentration required for the development of the company’s growth and also about
the capital structure of the company. It is also stated by many finance person that the capital
structure is the long-term finance which is used for the long term debt and also for the preferred
stock and the part of the equity. Capital structure holds one of the important places in the balance
sheet of the company. The capital structure of the company of any company includes the debt,
equity and also the preference shares (Muhammad Shah & ul Islam 2014). On the other hand,
profitability of the company is the ability of the company to earn profit after selling the goods
and also the services rendered by the company. The profit can also be earned from the return on
assets and also the return on equity. It is necessary for the company to maintain the sum of
capital and also the capital structure of the company and also the cost of capital and also its
impact of the company’s profitability. In most of the cases the managers of the company mainly
concentrates on the amount of debt and also the amount of equity for the purpose of the funding
and also their resources (Muhammad Shah & ul Islam 2014). This is the only reason it is suggest
many finance manager of the world that the company need to selects the right amount of equity
and also the right amount of debt. This is mainly done by the finance manager of the company.
These things increase the importance of the capital structure and also the matters related with
profitability of the company. The study on the capital structure said to be complex. In the case of

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the capital structure there are no such percentage differentiation present between the amount to
be transferred for the debt and the amount to be transferred for the equity. This totally depends
on the market conditions and also the economic condition of the company and the country in
which the company do their business. Finance mangers and higher mangers of the company use
different ways to improve the performance of the company by utilizing the capital structure and
also the split of the capital structure (Muhammad Shah & ul Islam 2014). The capital structure of
the company depends on the mangers on how well the mangers are consuming the debt and also
the equity. This division of the capital structure depends on the size of the organization and also
the industry the company is working for generating business. If the company uses versatile
structure for doing business then it can be seen that the company needs to separate the capital
structure for every section in respect to which industry the company is working in. these help the
mangers and the finance mangers of the company leads to allocate the capital and able to split
the capital in terms of the structure of the company mainly in debt and equity of the company.
This helps the company to reduce the structure and also able to reduce the weighted average
capital cost and maximizes the time performance of the company. The improvement of the
county’s economy has some serious effect on the industries which are present in the country.
This defines the gross domestic product of the country as it is one of the important tool which
determines the country’s economic growth. This same goes for Pakistan and also the country’s
maximum workforce is involved with the industries and working along with the company.
Moreover the maximum taxes which are provided to the country comes from the industries and
the development of the country are also related with it.

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1.2 Background of the Study
The capital structure of the company determines the company’s performance irrespective
of the company’s foundation. If the company is a private company and also if the company is
public companies the importance of the capital structure remains. It is also said that the capital
structure of the company has a different cost to the company (Muhammad Shah & ul Islam
2014). In case of the companies if any part of the capital structure decreases then the company
manages the capital structure that are wholly contributed for its owners. In this case of the total
capital refers to the total of funds which are supplied both. This is to be done by the owners and
long-terms creditors.
1.3 Background of Profitability
The profitability of the company determines the profits which need to be measure in
respect to the company’s expenses and the revenues of the company. The production and selling
structure of the company also determines the company’s profitability structure (Muhammad
Shah & ul Islam 2014). The profitability of the company does not only increase the company’s
growth but it also increases the shareholders interest. The acquiring for investment also increases
when such situations occurred and hence the company opens many other forms of industries
which made the company to go for new projects and it also helps the company to forge new
bonds.
1.4 Rationale of the Study
This study is very important for the company’s growth and also the company can see the
success rate of the company. The company’s natural growth depends both of the factors on
which this research paper is based on. They are capital structure of the company and also the
profitability of the company. This also determines the company’s going concern in future. In the

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case of the public company it can be calculated that the company gets extreme benefit from the
company.
1.5 Research Objective
The objective of the research paper states about the research movement towards
the answers of the research questions which are needed for the development of the
research (Myrodia, Kristjansdottir & Hvam 2017). The research objectives for this
research are the impact of the capital structure on the companies which are mainly from
Pakistan, the impact of the profitability of the companies which are hailing from Pakistan
and also current capital structure for the companies hailing from Pakistan.
1.6 Research Question
The research question determines the research paper and also determines the road fro the
research paper. In this research questions are being selected taking the profitability and also the
capital structure of the industry in the country. The research question which are provided below:
1. To analyze the impact of long-term debt to the profitability of the companies in
Pakistan?
2. To analyze the impact of total debt to the profitability of the companies in Pakistan?
3. Is there any impact of capital structure to the profitability of the companies in
Pakistan?
1.7 Justification for Research Question
The above mentioned research question are taken into consideration because the long-
term debt to the profitability is one of the vital ratio which required for the development of

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analyzing the companies. The second question is considered because the company’s debt over
profitability states the company has more debt in respect to the assets. This is very important for
the sustainability of the company. The last question which is taken for this research paper states
about the requirement of the capital structure in the company. The efficient capital structure of
the company determines the company’s ability to earn the profit as it is directly related with the
company’s profitability.
1.9 Significance of the Study
This study is very important for the companies which are doing their business in Pakistan
or the companies who wants to start business in Pakistan as it gives brief idea about the
economic structure of the company and also the company’s involvement of the country.
1.10 Research Structure
As per the rules of the research paper this research paper includes the introduction where
the topic are being introduced. Then comes the literature review where the review of the research
paper, articles, journals and also the documents which was uploaded previously. This review will
be made on the topic which is related with the topic and also states the lacks which exits in that
research paper. Then comes the research methodology part which states how the research will be
done and on which direction research will go (Myrodia, Kristjansdottir & Hvam 2017). The next
part will contain the research analysis which will provide the analysis of the data after being
collected. The last part will be the conclusion and also the recommendation which will conclude
the paper and also recommend the paper in future work.

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2. Literature Review
2.1 Introduction
The company has option to invest their capital in both debt and equity. The
company sometimes also avails the option for investing in both debt and equity. The company
usually divides the capital between the debt and equity in a proportionate way in accordance with
the need for the requirements. The finance is of no essence until and unless the value of the firm
is the profitability and risk which is not the part of the capital structure (Myrodia, Kristjansdottir
& Hvam 2017). In this part of the research paper the review has been made on the different part
which states the yoke between the profitability and also the capital structure of the company.
This part of the research paper will also influence the topic and establish the influence which will
show the importance of the capital structure and the ideal division which are to be made in the
case of debt and equity. This part of the research paper creates the base for the research paper as
it supports the research objectives and the research questions with the help of the studies which
are mentioned in other review and hence the study became important for the existing theories.
The articles, journals and also some of the research paper which are chosen for the purpose of the
review to support the research objective and the research question which are need for the
development of this research paper (Myrodia, Kristjansdottir & Hvam 2017). The lack which is
present in the articles, journals and also the research paper are also being presented in this part of
the research paper. This will help the research paper as same gap will not be present in this case.
2.2.1 MM Proposition
The proposition made by Modigliani-Miller about the value of the firm which tends to
relies on debt and also on the equity of the finance that will raise the finance of the firm. This is

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to be done by raising the equity from the equity market which ultimately adds up to the capital
structure of the firm. The researcher in this case created the model on the basis of the perfect
market which are not added to the transactions cost or taxes which are related with it. They also
stated that information symmetry is non-existent. The other researcher named Stretcher and
Johnson created the model on the basis of the impractical notions which concedes and also
condenses credit as the model lays the plinth for the differences between the levered and
unlevered company. In spite of the model which was created to incorporate taxes mentioned in
the equation and also holds the increasing debt which affects the increasing rate of return for
equity shareholders (Myrodia, Kristjansdottir & Hvam 2017). This happens because they are
being added to the risk which are accompanying with the bankruptcy. This model denies the
existence the relationship between the leverage and also weighted average cost of capital
(WACC) on the basis of the firm value. In another study the researcher reached the inconsistent
end about the tax deductible benefit of the leverage. This also means that the researcher has also
suggested that maximum level of debt has some serious impact on the maximum firm value.
There are other studies which are made on the capital structure for the purpose of the private and
also the public firms which are being operated which are being criticized. It is seen that the
criticized for the capital which are being varied with the cost associated with them. Authors
which are present in the present for the equity markets and also depended on acquiring funds
which are related with the debt for financing. This was suggested as the cheaper alternative. The
researcher found out that this information to be not ibn chronological manner and also dilution of
the costs needs to be control for the purpose of the differences in cost (Myrodia, Kristjansdottir
& Hvam 2017). The lack of the voluntary disclosures which makes the cost of equity which are
issuance in terms of the private firm is concerned. This is also seen that it is more expensive. As