Research Methodology for Quantitative Reserach

8/13/2019 Research Methodology for Quantitative Reserach

1/11

1 | P a g e

Table of Contents

Chapter 3: Research Methodology.................................................................................................. 23.1 Sources of Data ..................................................................................................................... 23.2 Correlation Table and Regression Model ............................................................................. 23.3 Dependant and Independent Variables ................................................................................. 4

3.3.1 Dependant Variable ....................................................................................................... 43.3.2 Independent Variables ................................................................................................... 5

3.4 Hypothesis........................................................................................................................... 11


2/11

2 | P a g e

Chapter 3: Research Methodology

This chapter provides information regarding sources of data set, sample, regression models and

definitions of dependant and independent variables.

Data

Date is something or those attributes which are used to reveal draw results. Basically there are

two types of data; Primary data and Secondary data. Primary data is a type of information that is

obtained directly from first-hand sources by means of surveys, observation or experimentation

etc. this type of data has not been previously published anywhere and is derived from a new

study. Secondary data is the other type of information that is collected from published sources

rather than first hand collection of information. This study uses secondary sources of data for

analysis and collected data from the financial reports of Bao Tou Steel Limited.

3.1 Sources of Data

To determine the explanatory variables that can affect the capital structure, this study observed

the selected variables of f Bao Tou Steel Limited over the period of 2002 to 2012.

This study based on the data of Bao Tou Steel Limited over the period of ten years and all data

has been collected from its balance sheets of respective years from 2002 to 2012. The

relationship of Capital Structure has been observed with Firm Size, Growth, Profitability, Cash

Flows, Firm Assets, Firm Age and Risk.

3.2 Correlati on Table and Regression Model

Correlation table is a two way tabulated presentation which relates the different variables in rows

and columns. It measures the degree of association between the variables entered, and one of the

most authentic way used to measure the effect of each variable with other variables. If we define

Regression Model then we can say that it is a statistical measure that attempts to determine the

strength of the relationship between one dependent variable (usually denoted by Y) and a series

of other changing variables (known as independent variables). This regression model is also

known as Ordinary Least Square (OLS) model and is also authentic and most preferred technique


3/11


4/11

4 | P a g e

PR = profitability CF= cash flows FA= firm assets AG = age RK = risk = the error term

3.3 Dependant and Independent Variables

This section presents the description of dependant and independent variables, how these

variables are measured in current study and what empirical findings have found by previous

studies.

This study is focused to determine the impact of the several control variables on the capital

structure or leverage choice of Bao Tou Steel Ltd. For this purpose, one dependant variable and

seven independent variables are used. Leverage or debt ratio is used as dependant variable while

Independent variables include, size (SZ), profitability (PF), growth (GR), firm assets (FA), cash

flow (CF), risk (RK) and age (AG).

3.3.1 Dependant Variable

Leverage (LG)

Leverage refers to proportion of assets that is financed by debt. Corporate finance literature

reveals that level of leverage depends upon the size and nature of the business. Both book and

market values have used to measure the value of leverage (Rajan and Zingales, 1995). The

former measure divides book value of debt by book value of total assets and the later measure

divides book value of debt by market value of assets or by book value of debt plus market value

of equity (Davic and Krstic, 2001). Present study use book value of leverage because the use of

debt provides tax shield that creates cash benefits and these benefits are not charged on the


5/11

5 | P a g e

market value of debt once it is issued (Shah and Khan, 2007). Hence, this makes the market

value of debt irrelevant for computation of taxes.

On the other hand, when the firm goes into bankruptcy then only book value is considered a

relevant value for calculations. Another important consideration is to deciding the use of total or

long term debt as a percentage of total assets for measuring the leverage. Several studies (Devic

and Krstic, 2001; Cassar and Holmes, 2003; Mittoo and Zhang, 2008) have used both total and

long term debt for calculate the value of leverage. According to the booth et al (1999),

developing countries (including China) are preferred to use short term financing than long term

financing. Finally, following ratio is used for measuring leverage:

LG = TD / TA

Where, LG = Leverage

TD = Total debt at the end of the accounting year

TA = Total assets at the end of the accounting year

3.3.2 Independent Variables

Size (SZ)

Size is considered a key factor that can influence the financial structure of the firm. It has

extensively used by the corporate finance researchers as control variable in the empirical analysis

of determining the capital structure of the firm and found that proportion of debt and equity

formulates according to the size of the firm (Scott and Martin, 1976; Booth et al.,2001). Various

studies report a positive relationship between size and leverage (Hamaifer et al, 1994; Al-Sakran,

2001; Antoniou et al, 2002; Gaud, 2005) while several studies intended negative relationship

between debt ratio and firms size (Rajan and Zingales, 1995; Bevan and Danbolt, 2002).

According to the Rajan and Zingales (1995), the relationship between size and leverage could be

negative because larger firms have less asymmetric information that reduces the chances of

undervaluation of issuing new stock, preferred to issue more equity than debt.


6/11

6 | P a g e

On the other hand, Static Trade-off hypothesis explores a positive relationship between size and

firm because larger firms are diversified in nature and considered less risky, hence, prefer to

utilize more debt. In addition, larger firms are preferred to issue more debt because it reduces

direct bankruptcy costs due to market confidence (Warner, 1977). Moreover, smaller firms prefer

to acquire lower debt because, these firms might face the risk of liquidation at the time of

financial distress (Ozkan, 1996). Consistent with the results of Static Trade-Off theory, current

study predicts a positive relationship between size and debt ratio.

The natural log of sales or the natural log of assets is generally used as a proxy to determine the

size of the firm. Current study use natural log of sale (premiums) to measure the size Bao Tou

Steel Limited. It is given by

SZ = Firm Sales

Therefore, first hypothesis is that there is positive relationship between leverage and size of the

firm.

Profitabili ty (PF)

Theoretical predictions yield no consistent relationship between debt ratio and profitability.

Jensen (1986) intended that profitable firms use debt as a tool that enforce managers to invest in

more disciplined way and as a result reduce free cash flows, which implied a positive

relationship. Static Trade-off model also predicts a positive relationship between profitability and

debt ratio due to the tax shield benefits. But according to the Pecking Order Theory (Myers and

Majluf, 1984), firms prefer to use internal source of financing (retained earnings), then debt and

finally issue external equity if more funds are required.

Therefore, the more profitable the firms are the more retained earnings they will have, which

exhibit a lower debt is utilized in formation of capital structure. This shows a negative

relationship between profitability and leverage of the firm. In addition, profitable firms are avoid

to get loan in inefficient markets due to disciplinary role of debt (Agency Theory).Various

studies (Gonedes et al, 1988; Friend and Hasbrouck,1989; Shah and Khan, 2007)also reported a

negative relationship between profitability and debt ratio. Present study also predicts a negative


7/11

7 | P a g e

relationship between profitability and leverage. Following proxy is used for measuring the

profitability:

PT = NIBT

Where, PT = Profitability of the firm at the end of fiscal year

NIBT = Net income before tax

Thus, second hypothesis is that there is negative relationship between leverage and profitability

of the firm.

Growth (GT)

According to the Pecking Order Theory, a firm firstly uses retained earnings or internally

generated funds for running the operations of business, but these funds are insufficient for future

growth of the firm. For this purpose, firm uses debt financing which helps for enhancing the

business activities. This implies that growing firms expected to have high leverage (Drobetz and

Fix, 2003). However, agency cost of debt is expected to be higher of growing firms because

these firms have more flexibility with respect to the future investments. The rationale is that the

lenders may feel fear that such firms would invest in more risky projects in future as they have

diversified in nature and have more flexibility related to selection of investments (Titman and

Wessels, 1988).

Therefore, lenders impose higher costs at lending to reduce their risk. This forces the firm to

utilize less amount of debt and more equity for investments to reduce the higher cost of debt.

Myers (1977), Barclay et al. (1995) and Rajan and Zingales (1995) are proposed a negative

relationship between leverage and growth. Consistent with the capital structure literature, current

study also be expecting a negative relationship between growth and ratio of debt.

Different studies have used different proxies for measuring the growth; market to book value of

equity, market value of assets to the book value of assets, research expenditure to total sales and


8/11

8 | P a g e

annual percentage change in assets or sales. Present study use percentage change in sales

(premiums) as a proxy to measure the growth. It is given by,

GR = % change in (P)

Where, GR = Growth of the firm

P = Premiums (sales) of the firm

Therefore, third hypothesis is that there is negative relationship between leverage and growth

of the firm.

F irm Assets

Assets are considered to have an impact on borrowing decisions because they have greater value

in case of bankruptcy .A firm with large portion of fixed assets can easily raise debt at relatively

lower rates by providing the collateral of these assets to the creditors. Having the incentive of

getting the loan at nominal rates, these types of firms are expected to borrow more as compared

to those firms where cost of borrowing is higher due to less proportion of fixed assets (Suto,

1990). Hence, firms with large proportion of fixed assets are preferred to employ more debt for

getting the advantage of this opportunity. In the contrary, negative relationship has also beenreported between leverage and fixed assets in small and medium firms (Daskalakis and Psillaki,

2007) and in less developed economies (Joever, 2006). Therefore, current study is expected to

have negative relationship between leverage and assets. The amount of net fixed assets indicates

the cost of fixed assets less depreciation. It is given by,

FA = Total Assets at the end of accounting period.

Therefore, forth hypothesis is that there is negative relationship between leverage and assets ofthe firm.

Cash F lows


9/11

9 | P a g e

Cash Flow specifies the ability of the firm to cover its short term liabilities but also shows the

liquidity position of the firm. Firms with higher cash flows are preferred to acquire more debt

because of great ability to meet short term obligations (Ozkan, 2001). This shows a positive

relationship between the cash flows and firms liquidity position. On the other hand, when firms

have more liquid assets then it may prefer to use these assets to finance their investments and

discourage to raise external funds (Pecking Order Theory).

Currently this study assumes positive relationship between CF and Leverage for Bao Tou Steel

Limited.

CF = Cash flow generated from the operation of the business

Therefore, fifth hypothesis is that there is a negative relationship between leverage and cash

flows of the firm.

Age (AG)

Corporate finance literature reveals that age of the firm is also considered one the key control

variable that can have an impact on the capital structure decisions of the firm. Mixed results have

found about the relationship between leverage and age of the firm. A firms age reflects the

experience in the particular business and eventually reflects its maturity. Greater business

experience negatively effects or reduces the probability of bankruptcy and as a result reflects

high debt ratio for older firms (Trade-off Theory). On the other hand, when firm survives in

business for a long time then it can accumulates more funds for running the operations of the

business and subsequently keeps away the firm to go for debt financing (Nivorozhkin, 2005).

This trend shows the negative relationship between the leverage and age of the firm. Moreover,

positive relationship between leverage and age is not likely to apply in transition economies

because experience or maturity of the firms before economic reforms is likely to be limited (Al-

Bahsh and Sentis, 2008). Present study is expected to have negative relationship between age and

capital structure of Bao Tou Steel Limited because China is considered a transition economy.

Difference between the establishment year and the observation year of the firm is used as a proxy

to measure the age. It is given by,


10/11

10 | P a g e

AG = OYEY

Where, AG = Age of the firm

OY = Observation year of the firm

EY = Establishment year of the firm

Therefore, sixth hypothesis is that there is negative relationship between leverage and age of

the firm

Risk (RK)

Risk is another key explanatory variable that may affects the capital structure of the firm. It is

considered to be either the inherent business risk or it may arise in the firm as a result of

inefficient management practices. Firms with high volatility in earnings might face higher risk

that forces the management to reduce the debt level because higher risk increases the chances of

bankruptcy (Pandy, 2001). This predicts a negative relationship between leverage and risk and

this result is also consistent with trade-off and pecking order hypothesis. Consistent with the

results of Pecking Order Theory and Static Trade-off Theory, present study is expected to have a

negative relationship between risk and leverage.

Several proxies have used in empirical studies to measure the risk of the firm such as standard

deviation of the difference in operating cash flows to total assets, standard deviation of returns on

net income, and standard deviation of percentage change in net income (Xiaoyan, 2008). So this

study assumes percentage change in net income considered as risk attached to Bao Tou Steel Ltd.

RK= %age change in net income

Therefore, seventh hypothesis is that there is negative relationship between leverage and risk of

the firm.


11/11

11 | P a g e

3.4 Hypothesis

This research study uses following seven hypotheses for the analysis:

Hypotheses 1: There is positive relationship between leverage and size of the firm.

Hypotheses 2:There is negative relationship between leverage and profitability of the firm.

Hypotheses 3:There is negative relationship between leverage and growth of the firm.

Hypotheses 4:There is negative relationship between leverage and assets of the firm.

Hypotheses 5: There is a negative relationship between leverage and cash flows of the firm.

Hypotheses 6:There is negative relationship between leverage and age of the firm.

Hypotheses 7:There is negative relationship between leverage and risk of the firm.

Research Methodology for Quantitative Reserach

Documents

Transcript of Research Methodology for Quantitative Reserach