Capital Structure of Select Pharma Companies Operating in India – An Analysis
Dr.C.D.Balaji1, Dr. S. Praveen Kumar2, Dr. R.Arasu3
1Professor, Department of Management Studies, Panimalar Engineering College, Chennai
2Associate Professor, Department of Management Studies, Panimalar Engineering College, Chennai
3Professor & Head, Department of Management Studies, Velammal Engineering College, Chennai
One of the important decisions that a finance manager has to take is the capital structure decision. The decision relating to the financing of capital needs to be taken considering a wide variety of factors and the interplay between these factors. Among the sectors in the Indian economy, the Indian pharmaceutical sector has been witnessing steady growth with many of the Indian pharma companies becoming preferred partners for contract manufacturing and also for research and development. Many of the Indian pharma firms have been active in the international space in terms of licensing arrangements and mergers and acquisitions. Among the pharma firms operating in India, Sun Pharma, Biocon and Glaxo Smithkline have reported consistent growth of profits. Therefore this study was undertaken to analyse the changes in the capital structure and growth in firm value. The study is analytical in nature and is based on secondary data. Data for the purpose of the study was sourced from the published annual reports of the companies for the period 2008-09 to 2012-13. On a comparative basis, GlaxoSmithkline has the lowest debt burden and therefore has a lower interest outflow. The company has been able to earn higher returns to the equity shareholders of the company. SunPharma has a higher proportion of debt in its capital structure when compared to the other two companies, however, because of the higher profit earning capacity it is in a comfortable position with regard to debt repayment capacity. Considering the high profitability and very low proportion of debt in its capital structure, GlaxoSmithKline can consider opting for borrowing in its future fund raising plans in order to benefit from leverage.
The scope and importance of the finance function has undergone a great change in the recent years with the globalization of the economies. Mobility of capital, introduction of variety of financial instruments and greater integration of capital markets have greatly increased both the challenges and opportunities for finance. Increased mobility of capital has meant greater challenges to the finance manager who has to provide better returns in order to retain capital within the enterprise and also ensure that investors are willing to invest in the firm whenever the firm requires additional funds for expansion or diversification. One of the important decisions that a finance manager has to take is the capital structure decision.
The decision relating to the financing of capital needs to be taken considering a wide variety of factor and the interplay between these factors. Among the sectors in the Indian economy, the Indian pharmaceutical sector has been witnessing steady growth with many of the Indian pharma companies becoming preferred partners for contract manufacturing and also for research and development. Many of the Indian pharma firms have been active in the international space in terms of licensing arrangements and mergers and acquisitions. Among the pharma firms operating in India, Sun Pharma, Biocon and Glaxo Smithkline have reported consistent growth of profits. Therefore this study was undertaken to analyse the changes in the capital structure and growth in firm value.
The study is analytical in nature and is based on secondary data. Data for the purpose of the study was sourced from the published annual reports of the companies for the period 2008-09 to 2012-13. The companies considered for the study are Sun Pharma, Biocon and Glaxo Smithkline.
Objectives of the Study:
The objectives of the study are:
(i) To analyse the changes in the capital structure of the companies
(ii) To assess the returns to the shareholders in terms of Earnings Per Share
(iii) To measure the value of the firms.
(iv) To assess the reasons for the increase or decrease in firm value
Dai Wen and Hou Mengjia (2010), empirically tested the relation between capital structure and firm performance in China by selecting samples of knowledge-intensive business services (KIBS) firms from Shanghai and Shenzhen stock markets in 2008. Empirical study shows that the proportions of intangible asset and capital structure have a weak positive correlation. It was also found that asset-liability ratio is negative to firm performance. Contrary to bank loan debt ratio, business credit debt ratio is positive to firm performance. This study is significant to optimize capital structure of China listed companies in the KIBS industry.
Han Suck Song (2005), analysed the explanatory power of some of the theories that have been proposed in the literature to explain variations in capital structures across firms. The study investigated capital structure determinants of Swedish firms based on a panel data set from 1992 to 2000 comprising about 6000 companies. Swedish firms are on average very highly leveraged, and furthermore, short-term debt comprises a considerable part of Swedish firms’ total debt. An analysis of determinants of leverage based on total debt ratios may mask significant differences in the determinants of long and short-term forms of debt. The results indicate that most of the determinants of capital structure suggested by capital structure theories appear to be relevant for Swedish firms.
Hoesli, M., Gaud, P., Jani, E., Bender (2005) analyzed the determinants of the capital structure for a panel of 106 Swiss companies listed in the Swiss stock exchange. Both static and dynamic tests were performed for the period 1991-2000. It is found that the size of companies, the importance of tangible assets and business risk are positively related to leverage, while growth and profitability are negatively associated with leverage. The sign of these relations suggest that both the pecking order theory and trade off hypothesis are at work in explaining the capital structure of Swiss companies, although more evidence exists to validate the latter theory. analysis also shows that Swiss firms adjust toward a target debt ratio, but the adjustment process is much slower than in most other countries. It is argued that reasons for this can be found in the institutional context.
Jamal Zubairi and Shazia Farooq (2013), focussed on investigating the factors influencing the capital structure of seven companies listed in the pharma and biotech sector of the Karachi Stock Exchange. Leverage has been designated as a representative of capital structure. Seven variables (all financial) were assumed independent and leverage was taken as the dependent variable forming the basis for pooled regression model. Reliability tests namely Cronbach’s Alpha measure is run in order to verify that the model is stable over time. The results of this test suggest inconsistency in the case of the entire range of the data but if considered individually the consistency, 5 out of 7 variables have positive alphas.
Jean-Laurent Viviani, (2008) had the purpose of explaining the leverage of French wine companies (410 companies) in the wine industry during the period 2000-2004. Different classical capital structure theories are reviewed (trade-off theory (TOT), pecking order theory (POT) and dynamic TOT) in order to formulate testable propositions concerning the determinants of debt levels of the French wine companies. A number of regression models (classical and panel techniques) were developed to test the static theory of trade-off against the POT. The results suggest that POT seems to better explain leverage of French wine companies. Significant differences in debt ratio were found between cooperatives and other legal structures. Debt ratios are also different between sub-sectors (wholesalers, wine growers, wine makers, etc.).
Kuang Hua Hsu and Ching Hyu Hsu (2009) examined financing behaviors in Asian countries by selecting samples of Hong Kong, Japan, Korea, Singapore, and Taiwan. Findings reveal that, although several elements have the impact on capital structure temporarily, firms from all countries investigated by this study rebalance their leverage following equity issuances. The results are more in line with the dynamic trade -off theory rather than the equity market timing or pecking order hypothesis of capital structure. In other words, firms have their target capital structures, determined by the marginal benefits of debt and costs associated with debt.
Mahabooba Lima (2012) focussed on the pharmaceutical sector. Among 20 listed companies under this industry 17 have been chosen based on their consistency of performance, data availability and favorable (positive) figures. Data for the study was from financial year 2004 to 2008. The researchers tested the influence of six determinants on capital structure, through using Least Square method by running multiple regression analysis on the dataset of listed pharmaceutical companies of Bangladesh for the period FY2004 to FY2008. Multiple regression analysis suggests that the model explains around 69.1% of the variation in the dependent variable/debt ratio. The adjusted explanation of the model is about 50.5%. Thus, the unexplained proportion of the variation is satisfactorily low. The independent variables-agency cost of equity, operating leverage, growth rate, bankruptcy risk, tangibility and debt service capacity proves to be statistically significant determinants of capital structure. Beta coefficients associated with agency cost of equity, operating leverage, tangibility and debt service capacity are statistically significant at 1% level. These facts conclude that agency cost of equity, operating leverage, tangibility and debt service capacity play a major role in the determination of the capital structure of pharmaceutical companies of Bangladesh. Whereas beta coefficients associated with growth rate and bankruptcy risk are statistically significant at 10% level. This also represents their significance in deciding optimal capital structure.
Mayan Masnoon (2012), studied the capital structure of KSE listed pharmaceutical companies by taking leverage as the dependant variable. Regression is run by considering six explanatory variables that include firm's size, tangibility, growth, earnings volatility, profitability and tax rate. Further, the model was reduced to only four explanatory variables by removing tax rate and earning volatility to deal with the problem of multi collinearity. The proxies used in the study are total debt ratio for leverage, gross fixed assets for tangibility, effective tax rate for tax, natural log of sales for size, percentage in net profit margin for earnings volatility, sustainable growth rate for growth and operating profit margin for profitability. The time horizon selected for the study is from 2008-2011. It is found that growth and tangibility have positive relation while profitability and size have a negative relation with leverage. All 4 variables are found statistically significant at a significance level of 10%.
Md. Faruk Hossain & Prof. Dr. Md. Ayub Ali (2012), attempted to investigate how firm specific factors are impacting the capital structure decision of a sample of 39 Bangladeshi firms listed in DSE utilizing OLS regression method. Data were collected from the financial statements of each firm during the five-year period from 2003 to 2007. Under OLS regression, fixed effect model was run but the results were affected by autocorrelation. As a remedial measure of autocorrelation, autoregressive model was used to examine the impact of ten explanatory variables such as profitability, tangibility, non-debt tax shield, size, earnings volatility, liquidity, managerial ownership, dividend payment, growth, and industry classification on total debt to total assets ratio. The findings of the study show that profitability, tangibility, liquidity, and managerial ownership have significant negative relations with leverage. The study also found that growth and non- debt tax shield are positively and significantly related with leverage, whereas size, earnings volatility, and dividend payment were not found to be significant explanatory variables of leverage. Results also reveal that leverage ratios are significantly different across Bangladeshi industries. Overall all the results are almost consistent with previous studies.
Mittali Sen and Pattanayak JK (2005), examined the issue of corporate financial structure and its determinants by studying the association between observed leverage and a set of explanatory variables. The present study attempts to go beyond previous studies that are mainly confined to manufacturing firms by studying the capital structure choice of Indian banking sector. It makes an attempt to determine the critical factors of capital structure by using an exploratory factor analysis on a sample of 82 Indian Banks comprising of public sector banks, private and foreign banks for a period of seven years from 1996 to 2002. The results of the study suggest that liquidity, size, efficiency and growth, quality of assets, profitability and service diversification are the most critical factors influencing the capital structure of the Indian banking firms.
Nadeem Ahmed Sheikh, Zongjun Wang, (2011) explored the factors that affect the capital structure of manufacturing firms and to investigate whether the capital structure models derived from Western settings provide convincing explanations for capital structure decisions of the Pakistani firms. The results suggest that profitability, liquidity, earnings volatility, and tangibility (asset structure) are related negatively to the debt ratio, whereas firm size is positively linked to the debt ratio. Non-debt tax shields and growth opportunities do not appear to be significantly related to the debt ratio. The findings of this study are consistent with the predictions of the trade-off theory, pecking order theory, and agency theory which shows that capital structure models derived from Western settings does provide some help in understanding the financing behavior of firms in Pakistan.
Nikolas Eriotis (2007), aimed to isolate the firm characteristics that affect capital structure. The investigation has been performed using panel data procedure for a sample of 129 Greek companies listed on the Athens Stock Exchange during 1997- 2001. The number of the companies in the sample corresponds to the 63 per cent of the listed firms in 1996. The firm characteristics are analyzed as determinants of capital structure according to different explanatory theories. The hypothesis that is tested in this paper is that the debt ratio at time depends on the size of the firm at time t, the growth of the firm at time t, its quick ratio at time t and its interest coverage ratio at time t. The firms that maintain a debt ratio above 50 per cent using a dummy variable are also distinguished. The findings of this study justify the hypothesis that there is a negative relation between the debt ratio of the firms and their growth, their quick ratio and their interest coverage ratio. Size appears to maintain a positive relation and according to the dummy variable there is a differentiation in the capital structure among the firms with a debt ratio greater than 50 per cent and those with a debt ratio lower than 50 per cent.
Padmini and Sivarami Reddy (2012), attempted to study the Capital Structure (Debt-Equity) of Indian Pharmaceutical Industry. To this end, 12 pharmaceutical companies have been chosen and categorized into three distinct groups (A) Better Performing Companies (BPCs), (B) Moderately Performing Companies (MPCs)and (C) Low Performing Companies (LPCs). An analysis of long-term solvency, impact of financial leverage on the shareholders’ earnings and justification for the use of debt by the Indian pharma industry through the application of ratio analysis, trend analysis and statistical test has been undertaken. From the study, it is found that BPCs and MPCs of IPI depended on equity financing, whereas, LPCs were on debt financing. The debt-equity mix of IPI tended to be pro-equity. The degree of financial leverage did not alter the earnings of the shareholders favourably in IPI. The interest coverage has been sufficient in BPCs and MPCs and therefore, justification for the use of debt is valid. But a reverse situation is observed in LPCs.
Philippe Gaud et. al. (2003), analyzed the determinants of the capital structure for a panel of 106 Swiss companies listed in the Swiss stock exchange. Both static and dynamic tests are performed for the period 1991-2000. It is found that the size of companies, the importance of tangible assets and business risk are positively related to leverage, while growth and profitability are negatively associated with leverage. The sign of these relations suggest that both the pecking order theory and trade off hypothesis are at work in explaining the capital structure of Swiss companies, although more evidence exists to validate the latter theory.
Raj S.Dhankar and Ajit Boora (1996), undertook a multi-period study covering the period from 1981-82 to 1990-91. The study used both primary and secondary data. The main source of secondary data was the Bombay Stock Exchange Directory. Primary data were collected through a mailed questionnaire. In all, 100 questionnaires were mailed but the response rate was about 26 per cent. Hence, a sample of 26 companies was taken. Companies were found to differ significantly in capital structure irrespective of whether they belong to the same industry group or different groups. This is because of the fact that the magnitude of the effect of determinants of capital structure vary from company to company. In general, change in capital structure and cost of capital was found to be negatively related, but the results were not statistically significant. The results suggest that though cost of capital decreases when leverage increases, this decrease is very moderate and not proportional to debt level. Probably, it is for this very reason that most of the companies are not high leveraged. The relationship between change in capital structure and dividend policy was not found definite and statistically significant.
Rajan and Zingles (1995) in their study used four determinants (independent variables); tangibility, sales, market to book ratio, and profitability. They found all variables significant.
It was found that tangibility and sales to be positively related and market to book ratio and profitability to be negatively correlated with debt.
Salawu Rafiu Oyesola (2007) made an empirical analysis of the capital structure of selected quoted companies in Nigeria between 1990 and 2004. The analyses are performed using panel data. The major conclusion from the results is that listed firms rely heavily on equity and short-term bank financing. In addition, access to long-term debt is severely limited among all firms. Based on the data availability, six potential determinants of capital structure were analysed in this study- profitability, tangibility, growth opportunity, size, non-debt tax shields and dividend. Considering the results for all the firms, leverage is negatively correlated with profitability, but leverage is positively correlated with profitability of the large firms. Tangibility is positively correlated with total debts and long-term debts, but negatively related to short-term debts. Growth opportunity is positively related to both total debts and short-term debts. However, the level of long-term debts components is negatively related to the level of growth opportunities. Overall, the level of growth opportunities appears to have little influence on the level of leverage i.e., capital structure. The size of the companies is positively correlated with total debts and short-term debts, suggesting that large firms can better support higher debt ratios than small firms. The level of long-term debt is negatively related to company size. The non-debt tax shields and dividend are positively correlated with leverage. The overall result for all the firms is consistent with pecking order theory (semi-strong pecking order theory).
Shun U. Chen and Li U. Chen (2011), presented empirical evidence on the determinants of capital structure and firm value in a newly industrialised country. The firm characteristics were analysed as determinants of capital structure according to different explanatory theories. The sample considered was 647 companies listed on the Taiwan Stock Exchange (TSE) from 2005 to 2009. The findings of the study suggested that firm size, profitability and asset structure can be considered explanatory variables of capital structure. The firm size, profitability and capital structure affect book value. The determinants of market value are profitability and firm size. In addition, there are some differences in the capital structure among industry types. When the dependent variable is book value, firm size and growth opportunity have a greater impact on this in the electronic industry. Meanwhile, profitability and firm size have a greater impact on capital structure in non electronic industries. When the dependent variable is market value, larger companies can borrow more debt and create more market value in the electronic industry. The capital structure negatively affects market value in electronic firms, but does not affect market value in non-electronic ones.
Sobia Quayyum (2013), had the objective of analyzing the different factors in cement industry of Pakistan & their effect of on leverage of company, in order to analyze determine its capital structure. The dependent variable is Leverage and Independent variables of the study are: Profitability, Growth, Size and Tangibility of assets. It was found that leverage is positively correlated with tangibility & negatively correlated with other three variables i.e. size, profitability & growth. However the relationship between size & leverage was not found as significant. The relationship of leverage with profitability, tangibility & growth were significant. As this study was conducted by taking 20 companies as sample out of 22 operating cement companies in Pakistan, so significant data is said to be highly accurate as large sample size ensures the high data accuracy.
Wolfgang Drobetz and Roger Fix (2003) in their study used six variables: tangibility of assets, firm size, the market – to - book ratio, profitability, volatility, uniqueness of the product and non-debt tax shields. They found tangibility and size positively correlated with leverage and profitability and growth negatively correlated with leverage.
Yuanxin Liu & Xiangbo Ning (2009) selected 25 electric power listed companies in the electric power industry as the sample to study the influences of micro factors on the capital structure of listed companies, and the sample period was from 2002 to 2007,and these micro factors mainly included company scale, profitability, growth, non-debt tax shields, fluidity and capital structure. The research results showed that the company scale, non-debt tax shields and assets structure were not significantly correlated with the capital structure, and the profitability was significantly negatively correlated with the capital structure, and the fluidity of the assets was negatively correlated with the capital structure.
DISCUSSION AND FINDINGS:
With regard to Sun Pharmaceuticals:
The profit before tax of the company which declined in the year 2010-11 has shown a consistent increase in the succeeding years. The interest costs of the company which was increasing during the period 2009-12, declined in the year 2012-13 concomitant with the reduction in the debt burden in 2012-13. Due to further issue of shares during 2011-12, the earning per share of the company has decreased in the later years as compared to the initial year of the study. The value of the firm was highest during 2011-12 but because of the retirement of debt in 2012-13, the value of the firm also declined in 2012-13. Though the market value of equity has increased in the period 2011-13, the increase has happened because of a higher equity base.
With regard to Biocon Pharma:
The profits of the company in 2010-11 has more than doubled when compared to profits of 2009-10 and from 2010-11, profits have grown only marginally with the profits in 2012-13 being lesser than that of the previous year. The interest outflow of the company has come down in 2012-13 due to the retirement of debt. The Earnings per share of the company has been stable during the study period after an upward spike during 2010-11. The value of the firm after showing a consistent increase during the first three years of the study has declined during 2012-13.
With regard to GlaxoSmithkline:
The profits of the company have shown a fluctuating trend during the study period with profits declining in 2012-13. The debt burden of the company is very low resulting in very low interest outflow. The firm has been able to provide attractive returns to its equity shareholders, however, the earnings per share of the company has shown a sharp decrease in 2012-13. Debt constitutes a miniscule proportion of the value of the firm, with equity accounting for a very high share, The value of the firm has shown a fluctuating trend due to the declines in 2010-11 and 2012-13.
On a comparative basis, GlaxoSmithkline has the lowest debt burden and therefore has a lower interest outflow. The company has been able to earn higher returns to the equity shareholders of the company. SunPharma has a higher proportion of debt in its capital structure when compared to the other two companies, however, because of the higher profit earning capacity it is in a comfortable position with regard to debt repayment capacity. Considering the high profitability and very low proportion of debt in its capital structure, GlaxoSmithKline can consider opting for borrowing in its future fund raising plans in order to benefit from leverage.
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