DETERMINANTS OF CAPITAL STRUCTURE OF OIL AND GAS SECTOR OF PAKISTAN

Abstract

This study investigates the determinants of capital structure of firms in oil and gas sector of Pakistan, by taking six companies of oil and gas sector, listed on Karachi Stock Exchange (KSE) over the period of five years from 2007 to 2011, using simple regression analysis. This research attempts to examine the practical implication of capital structure theories in oil and gas sector of Pakistan. The study uses debt to capital ratio as a measure of leverage and chooses six explanatory variables i.e. profitability, tangibility, size, growth, liquidity and tax to analyze their impact on capital structure choice. According to the empirical results liquidity and tax are the important determinants of capital structure where as other factors such as profitability, tangibility, size and growth are insignificant to capital structure. The negative relationship of profitability and size with leverage indicate consistency with the Pecking Order Theory, while the negative correlation of growth and positive correlation of tangibility with leverage support the Static Tradeoff Theory, however these correlations lack in their statistical significance. The results further reveal that the dependence of leverage on tax is 86% and on liquidity is 67% and both of them are statistically significant at 95% and at 90% confidence interval respectively. The positive relationship of liquidity with debt does not support the Pecking Order Theory; instead it tends to confirm the theoretical model of Static Tradeoff Theory which suggests that firms with higher liquidity ratios are in better position to pay off their liabilities, thus favoring debt capital. The negative relationship of tax with leverage does not show consistency with the Static Tradeoff Theory which predicts that the incentive of getting tax shield benefits motivates firms to go for debt financing, whereas this negative relationship depicts that in spite of high taxes, firms do not favor debt capital. Thus tax and liquidity of the firms mainly define the choice of capital structure in oil and gas sector of Pakistan. The researcher further analyzes in this study that the determinants of capital structure are industry specific, as they tend to vary from industry to industry. Therefore this study reflects that by analyzing the capital structure of a specific industry, one can determine or find out the unique attributes, which are not evident in the collective study of many industries as conducted by Attaullah Shah and Tahir Hijazi in 2004.