Effect of Product Diversification on Capital structure: Evidence from Large Manufacturing Firms in Pakistan

Abstract

Abstract:

Capital structure decisions have always been contentious for finance professionals and researchers ever since Miller and Modigliani (1958). A remarkable amount of work is available on determinants of capital structures for manufacturing as well financial sector not only in developed economies but in developing economies like Pakistan as well. Despite of the fact that strategic decisions, like product diversification, influence financial decisions significantly in different ways depending on the type of investment strategy, studies on linking strategic management (like product diversification) with financial management (like capital structure) in developing economies are scarce. Theoretical arguments provided by transaction cost theory and co-insurance effect theory stated that products can diversify in related and unrelated manner on the basis of available type of resources and can influence existing capital structures of that firm to fulfill financing needs. For this purpose, a sample of 137 listed large manufacturing firms are selected which then segregated by stratified sampling technique into focused, diversified, related and unrelated segments. Each sample is stratified via PSIC (Pakistan Industrial classification code) and diversification is measured by Caves index. Different statistical techniques are used to examine the differences among determinants of capital structures of various data sets like descriptive statistics, univariate parametric t-test and non parametric wilcoxon signed rank test. By using OLS (Ordinary Least Square) regression and cross-sectional analysis the study concludes that diversified firms are more leveraged than focused firms and determinants of capital structures of diversified and focused firms significantly vary in Pakistan. Consequently, diversified firms are more financially stable, high leveraged, large in size and better in performance than focused firms in Pakistan. In depth analysis of related and unrelated diversified firms concludes that the debt ratio of related diversified firms is higher than unrelated one because of better performance of unrelated diversified firms which have more ability to generate their own resources to meet their financial needs. Product diversification particularly unrelated product diversification is a value added strategy in Pakistan and more mature firms should diversify their products as age of the firm plays an important role to get credit in Pakistan.