Firm-Specific Factors as Determinants of Capital Structure: Evidence From Indonesia

Abstract

<jats:p>The cross-sectional technique of extreme bounds analysis (EBA) is used to identify the determinants of capital structure in a sample of Indonesian shareholding companies. Additional results are presented based on variable deletion and nonnested model selection tests. The results of traditional EBA show that the only robust variable is liquidity, but the results of restricted EBA add three more robust variables: profitability, tangibility, and income variability. However, variable deletion and nonnested model selection tests lend support only to size and liquidity. The conclusion is that most of the variables that appear important in studies of capital structure may not be important at all. From a policy perspective, the finding that some firm-specific factors are relevant to corporate capital structure confirms that financial reform has eliminated the distortions of corporate financial policies and financial markets caused by the previously dominant role of state banks.</jats:p>

Ownership and Debt Financing: Indonesia Evidence

“…Lenders are more willing to lend to firms with high tangible assets as these assets are easier to repossess in bankruptcy; thus, a positive relationship is anticipated between tangible assets and debt financing as explained by the trade-off theory. Moosa and Li [24], Bunkanwanicha et al [30], and De Jong et al [43] all share similar significant positive relationship between tangibility and debt financing in their studies on Indonesian firms. Tangible asset is represented by net fixed asset over total asset [25,43].…”

“…This is explained well by pecking order theory that firms with high liquidity need less debt financing and opt to internal funding given the huge retained earnings of the firm. This reflects a negative relationship between liquidity and debt financing, and this notion is well supported by [24,25]. Firm liquidity is represented by current asset to Financial Management from an Emerging Market Perspectivecurrent liabilities [24,25].…”

“…Moosa and Li [24] when studying the financial structure of firms in Indonesia reveal that some firm-level determinants may not have similar impacts on the firms' capital structure like what have been documented in the body of knowledge. They also discover that the financial reformation experienced by the firms has indeed eliminated the inefficient corporate financial policies and financial market during the dominance of state banks.…”

“…Indonesia underwent several reformations in its financial system as its financial market activities decades ago were dull and there were a lot of flaws in the firms' financing choices with state-owned banks dominating the debt market and overshadowed the capital market [24]. It was apparent that Indonesian financial systems then needed robust deregulations and reformations.…”

“…Along the way, the government has developed standards and has strengthened enforcement for all listed firms in Indonesian Stock Exchange (IDX) as outlined in the good corporate governance guidelines. All listed firms in IDX should comply with corporate governance regulations [24]. After several financial reformations, trading activities in Indonesia were then started to improve and market capitalization grew alongside the development of Indonesia's financial markets and private sector highlighted by a major bull run in 1990 [25].…”