Abstract:
Capital structure is considered amongst the most important elements in developing the
financial structures of any firm. The present study focuses on testing the existence of capital
structure irrelevance, presented by Modgiliani and Miller (1958), in nonfinancial sector of
Pakistan. Agency Cost, corporate Taxes and Cost of Financial Distress are taken as control
variables. The sample of the study comprises of 100 nonfinancial companies listed at Karachi
Stock Exchange, Pakistan for the period of 2005 to 2012. Fixed Effects Model is applied for the
analysis. The study concludes that capital structure show no significant effects on EPS, Tobin’s
Q and ROCE without considering Tax effect and only Net profit shows to be positively
influenced by capital structure. Measures of capital structure show no significant effects on EPS
and Tobin’s Q after incorporating agency cost and cost of financial distress separately, whereas
Net profit and ROCE are significantly influenced by capital structure. In short, the capital
structure irrelevance theorem by Modgiliani and Miller is fully supported by the results of the
study considering Tax as a government intervention to create an imperfect market situation. For
agency cost and cost of financial distress, the capital structure irrelevance theorem is partially
supported in nonfinancial sector of Pakistan.
