Financial Liberalisation, Capital structure and investment: a study of Indian private corporate manufacturing sector

Abstract

In the new milieu of financial reforms in India, market forces increasingly govern the newlineallocation of funds and this has implications for the availability, cost and quantum of newlinefunds, which ceteris paribus will enable the corporate sector to make an optimum newlinecombination of sources of funds for industrial investment. However, in recent times, the newlinefinancial liberalization argument is criticized by certain micro economic arguments newlinebased on market failures and information asymmetries in financial markets. It is argued newlinethat in reality, information failures in loan markets and the consequent credit rationing newlinemay occur between the buyers and suppliers of productive capital. newlineThis new literature on corporate finance has emphaSized the cost disadvantages of newlineexternal finance due to asymmetric information. Because, in imperfect financial markets newlinewith asymmetric information, external funds are more expensive than internal funds newlineand firms have to follow a hierarchy in which cheaper funds are preferable to more newlineexpensive ones, and internal funds are the most preferred ones. This literature raises newlinecertain issues to be to be discussed in the context of financialliberalisation: (1) Have the newlineexpected benefits of the liberalisation and promotion of stock market and banking newlinesector translated in to better financing choices at firm level? (2) What is the influence of newlineexogenous financial sector liberalisation on firm level capital structure? (3) How does newlinethe financing pattern relate to investment of firms? The present study empirically newlineexamines these aspects using firm level data for a sample of 2269 manufacturing firms newlinein the Indian private corporate sector. newlineAgainst the background of policy changes in the financial sector, we have analysed the newlinetrends and patterns of corporate finance at the aggregate level in the pre and post newlineliberalisation period. One of the most striking aspects of trends in sources of funds for newlineprivate corporate sector is the increasing dependence of firms on internal funds rather newlinethan external funds.