Funding corporate growth in the Indian context

Abstract

This study aims to investigate financing and funding choices of firms in the Indian corporate sector. For the purposes of analysis, five sectors have been chosen as representatives of the economy as a whole namely: Automotive & Auto‐Ancillaries; Infrastructure service providers and Capital goods manufacturers; Financial Services; Information Technology vendors and Resourcebased firms (oil, gas, petrochemicals, metals & minerals). At the first stage, the study aims to reconcile parameters of firms’ financial performance such as Return on Assets (RoA) with competitive strategies adopted by the firms. At the next stage, there is an attempt to explain capital structure decisions characterized mainly by Leverage of the firms based on asset side parameters such as Operating Margins (OM) and RoA. A fair amount of literature is already available on this issue starting with Myers & Majluf (1984) arguing in favor of the pecking order theory of firms in determining capital structure. Barclay et.al (1995) try to explain capital structure in terms of the nature of the industry characterized as growth‐based or mature, asset‐in‐place. Though these studies have been done in the context of developed markets, a similar study has been done in the context of Indian companies by Bhaduri (2002) which explains leverage based on growth, size and industry characteristics. However the study in this paper is done at two levels. First, a visual study of leverage decisions based on a evidence through pictorial representation of two conflicting theories explaining leverage. Second, is a mathematical regression across sectors with OM as the dependant variable. The third stage of the study is an attempt to understand valuation and valuation multiples of firms in different sectors based on asset side parameters. In this context, a framework has been developed to identify fair, under and over‐valued firms based on an asset‐side ‘Benefit Ratio’. Next, a mathematical regression based analysis has been carried out to explain market capitalization (controlled for leverage) based on asset‐side parameters. Specific attention has been paid to two issues: a) The effect of asset side volatility on market values of firms in addition to expected returns and b) The possibility of regime shifts, i.e. different behavior of markets with respect to asset side parameters in case of different categories of market capitalization namely – small, mid and largecap stocks.