Corporate Indebtedness

Ever since Stewart Myers’s (1977) article on ‘The Determinants of Corporate Borrowing’, the corporate finance literature on studies examining the nature and determinants of corporate financial structure has grown steadily. Empirical research on the said issue however has been largely confined to the developed economies and received scant attention in developing nations primarily because of the typical third world market imperfections, viz; the problem of financial repression induced by administered interest rates pegged at unrealistically low levels; large scale pre-emption of resources from the banking system by the government to finance its fiscal deficit; excessive structural and micro regulation that inhibited financial innovation and increased transaction costs; relatively inadequate level of prudential regulation in the financial sector; poorly developed debt and money markets; and outdated (often primitive) technological and institutional structures that made the capital markets and the rest of the financial system highly inefficient. However since the mid 1980s and early 1990s, the institutional setup under which firms in these countries operated underwent substantial transformation. To quote ‘Bhaduri (2002: p 656) The move towards the free market, coupled with the widening and deepening of various financial markets, including the capital market, has provided the scope for the corporate sectors to optimally determine their capital structure. Such an environment has also encouraged more meaningful research on the capital structure issue.’ Consequent to this, several empirical studies on the determinants of capital structure choice in the context of developing countries in general (Booth, et. al., 2001), and India in particular (Bhaduri, 2002, 2002a; Mahakud and Bhole, 2003; Bhole and Mahakud, 2004; Datta and Majumdar, 2006, Mahakud, 2006) has emerged.

This article presents the findings on the determinants of corporate borrowing for Indian firms based on a sample of 473 companies’ financial information from the period 2001-2002 to 2005-2006, using a panel data model. In doing so the article highlights the differences in  borrowing behavior of service firms; an issue completely ignored so far. Inclusion of this sector in any analysis of borrowing behaviour is important in the Indian context, given that the share of services in GDP over 2000-01 to 2005-06 stood at 52% and the services sector contributed to over 65% of GDP growth over the said period. The variables included in the study are firm size, profitability, tangibility, firm growth prospects, firm uniqueness, depreciation tax shield, firm liquidity, stock liquidity and degree of international activity.

Using financial information from the CMIE database on the indian economy, it is observed that long term borrowing increases with firm size and tangibility of firms assets, it varies inversely with profitability and growth prospects. Findings also reveal that long term borrowing in the context of manufactuting firms varies inversely with firm uniqueness and stock liquidity; the relationship is direct in the case of firm liquidity and degree of international activity.

In the context of services firms only four variables are found to be statistically significant; firm size and tangibility exhibited a positive relation with long term borrowing, while profitability and growth prospects showed an inverse relation. 

Apart from providing objective evidence on the differences in borrowing behavior of these two sets of firms,  this study have oeened up newer dimentions of corporate borrowing, especially in the context of manufacturing firms. For instance, the positive relation between indebtedness and international activity points to the possibility of revenue diversification as an enhancer of debt capacity, (it also depicts that there are apparent benefits of revenue diversification)  while the inverse relation between stock liquidity and indebtedness depict that with reduction in information asymmetry, debt financing becomes a relatively less preferred source of financing corporate activity.


Bhaduri, S. N. (2002). Determinants of capital structure choice: a study of Indian corporate sector, Applied Financial Economics, 12/9, 655-665.

Bhaduri, S. N. (2002). Determinants of Corporate Borrowing: Some Evidence from the Indian Corporate Structure, Journal of Economics and Finance, 26/2, 200-215.

Bhole, L. M. and Mahakud, J. (2004) Trends and Determinants of Capital Structure in India: A Panel Data Analysis, Finance India, XVIII/1, 37-55.

Booth, L., Aivazian, V., Demirguc-Kunt, A. and Maksimovic, V. (2001) Capital Structure in Developing Countries, Journal of Finance, LVI/1, 87-130.

Datta, M. and Majumdar, R. (2006). Factors Affecting the Borrowing Decisions of Indian Corporates: How Far They Differ from the Global Trend? – An Empirical Study, Indian Accounting Review, 10/1, 39-48.

Mahakud, J. (2006). Testing the Pecking Order Theory of Capital Structure: Evidence from Indian Corporate Sector, The ICFAI Journal of Applied Finance, 12/11, 16-26

Myers. S. (1977). Determinants of Corporate Borrowing, Journal of Financial Economics, 5/2, 147-175.