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Market Value and Capital Structure: A Study of Indian Manufacturing Firms – isec

Market Value and Capital Structure: A Study of Indian Manufacturing Firms

Abstract

India’s stock market witnessed significant development post 1990 due to a series of reform measures. As a result, firms are able to raise market-based capital, which helped them to reduce their dependence on institution-based finance. Consequently, the market valuation of a firm has become an important variable in corporate finance decisions. However, traditional theories of capital structure fail to offer an unambiguous explanation on the impact of market value on capital structure. To bridge this lacuna in capital structure literature, Baker and Wrugler (2002) propounded the market timing theory, which argues that firms time the market, that is, firms raise equity capital when market valuation is high and buy back when market valuation is lower, and hence the current capital structure of the firm is the cumulative result of past attempts to time the equity market. In this study, we attempted to understand the role of market value in influencing the capital structure decisions of the manufacturing firms in India. We found that market value negatively influences debt ratio both in the short term and long term, indicating the practice of market timing. Further, we found that the negative impact comes from changes in equity issues rather than changes in retained earnings or debt retirement.

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