An Empirical Analysis of the Association between Capital Structure and Financial Performance of Indian Firms in the context of the Equity Market Timing Theory

Abstract

Capital structure refers to different types of financing I e debt equity employed by a firm to acquire the resources necessary for its operations and growth. Debt financing leads to more financial risks and equity financing dilutes the control of ownership therefore the firm must look for an optimal capital structure i.e. a combination which minimizes the average cost of capital thereby maximizing the value of the firm. newline newlineThe firms choice of capital generated great interest among the financial researchers after the seminal work of Modigliani and Miller in 1958 and 1963. Their research encouraged the other researchers to investigate in the direction of realism. So the three important theories of capital structure were proposed the trade off pecking order and the equity market timing theories. The trade off theory and pecking order theory although provided a theoretical framework for studying the capital structure choice of a firm but they relied more on internal factors of the firm and did not consider the external environmental factors while raising the funds from the market. The market timing theory however overcomes this limitation and emphasizes the importance of timing of raising fund. So here the firms capital structure decisions are studied in context to the equity market timing theory. newline newlineThe literature on capital structure shows that as compared to developed economies there were few studies done for developing economies especially for India. In addition to this it was seen that there was no empirical support for the equity market timing theory of capital structure for the Indian market. Therefore here the intention is to explore whether the firms in India time the market or not. As per authors knowledge so far the present study is the first one which explores the validity of equity market timing for Indian firms with empirical support. The literature also shows that no study has been done so far which explains the firms choice of capital when the firms are classified into the three sectors of the economy.