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Capital Structure of Turkish Manufacturing Firms: A
Comparative Study of Static, Dynamic, Probit and Logistic
Panel Model


Journal: Asia-Pacific Journal of Financial Studies
Manuscript ID: Draft
Wiley - Manuscript type: Original Article
Keywords:
Capital Structure < Corporate Finance: Empirical, Corporate < Behavioral
Finance: Empirical
Abstract:
This paper attempts to explain two focal theories of the capital structure
named trade-off theory and pecking order theory. This paper is an
empirical study attempting to ascertain those factors that influence the
firm's choice of capital structure. A sample size of 118 Turkish
manufacturing companies is used for the period of 2002-2012. Our
evidence suggests that firm size, profitability and tax shield are observed
positively connected to leverage whereas growth opportunities, risk, cash
flow and equity ratio are negatively related to firm leverage. The signs of
the estimates suggest that Trade-Off Theory is at work in explaining capital
structure of Turkish manufacturing companies.



Asia-Pacific Journal of Financial Studies
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Capital Structure of Turkish Manufacturing Firms: A Comparative Study of Static,
Dynamic, Probit and Logistic Panel Model
Mehmet Sinan Temurlenk
1
Department of Econometrics, Ataturk University, Turkey
Hayati Aksu Department of Economics Ataturk University, Erzurum, Turkey
Muhammad Asad Ullah Moavia Department of Economic Policy, Ataturk University
Abstract
This paper attempts to explain two focal theories of the capital structure named trade-off
theory and pecking order theory. This paper is an empirical study attempting to ascertain
those factors that influence the firm's choice of capital structure. A sample size of 118
Turkish manufacturing companies is used for the period of 2002-2012. Our evidence suggests
that firm size, profitability and tax shield are observed positively connected to leverage
whereas growth opportunities, risk, cash flow and equity ratio are negatively related to firm
leverage. The signs of the estimates suggest that Trade-Off Theory is at work in explaining
capital structure of Turkish manufacturing companies.
Keywords: Trade-Off Theory, Pecking Order Theory of capital structure, Static, Dynamic
Panel Model, Probit, Logistic Panel Model
I. Introduction
Capital structure characterized as, the method of corporations for investments its assets
through some mishmash of equity, debt or hybrid securities. Capital structure is most
important for the survival of the firms with long time cover. For this motivation, the financial
analysts are assessing the balance sheet, in order to appraise the capital structure in right way.
Capital structure planning makes the firms balance sheet stronger. Capital structure
management is an essential job for the corporate leaders because there are lots of factors that

1
I am thankful to Department of Economics, Weber State University, U.S.A for the appreciation of this work in
their department.
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can affect the capital structure such as the fluctuations in the business cycles, fluctuations in
stock prices, business risk, volatility in the interest rate returns, the underlying risk of the
firms assets, the maturity of the debt, the ability of debt-holders to force non-payment for a
given level of the firm's value, and the incremental bankruptcy costs.These factors correlates
with provisional default have unfavourable effects on the capital structures(See Ju, Parrrino,
Poteshmanand Weisbach 2005; Boyacioglu, Karaand Baykan 2009).
For this reason, two prominent theories of capital structure that have been contributed
in literature review. Pecking order theory (POT) and trade of theory (TOT)are mostly used
with the significant policy implications. TOT claims that a firms optimum debt ratio is
determined by trade-off between the bankruptcy cost and tax advantage of borrowing. A
higher profitability decreases the distress of the firms that led the firms to increase their tax
benefits by raising leverage (Bernoth and Pick 2011). Firms prefer debt over equity until the
point where the probability of financial distress starts.POT explains that capital structure is
driven by firm's desire to finance with three resources. The first one is novel investments with
domestic resources, and second is the getting debt from monetary institutions such as banks;
while the third one is the issuance of new equity (see., Shyam-Sunder and Myers 1999).
Issuing the bonds by getting the debt from the bondholders creates the improbability in the
market values of the bonds. The bondholders have the power to make insolvent the firms
when the value of bonds declines too much. Firms prefer internal financing to external
financing (see also Lemmon and Zender 2010). Small firms do not have strong financial
positions leads to unfavourable assortment tribulations.
Our first objective of this study is to find out that either POT or TOT holds in case of
Turkey under different econometric modelling. Our second objective is to locate different
variables their impact on these two theories. For this reason we make a relative comparison
that will give the researchers a way of conducting the right decision about the capital
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structure. In the past literature, researcher used only static and dynamic panel model, however
we will include the panel probit and logistic model. For finding the firm risk and firm
distress, probit and logistic models are suitable. Although, there are no any evidence that used
the probit and logistic models for the capital structure, but some studies that approaching the
capital structure for the risk factor such as financial distress of banking sector, financial
distress of insurance sector have been categorized in the literature. We will conduct the
econometric models that whether TOT or POT hold in case of Turkey, also we will calculate
the risk factor through the probit and logistic model.
In the next section, we discuss the literature review and afterwards we present the data
and methodology and after that, we give and evaluate the estimation results. In the final
section, we present the conclusion.
II. Literature Review
In this section, we categorize the literature into two parts. In first part we show the studies
that find either TOT or POT holds. In the other part we briefly discuss the different variables
impact and their significance on capital structure performance.
Jong, Verbeek, and Verwijmeren 2011 come across that pecking order theory is the better
descriptor for the U.S.A, in contrast static trade-off theory is better descriptor of firms' capital
structure decision. Frank and Goyal 2003 find that pecking order theory does not hold for
small firms using cross section of publicly traded American firms, because debt financing
does not dominate equity financing. Helwege and Liangb 1996 make their research for the
IPO firms' by using multinomial logit model and find that probability of obtaining external
funds are unrelated to internal funds and pecking order theory does not hold when choosing
the type of security to offer. Kjellman and Hansen 1995 find that smaller firms are more
likely to follow the pecking order theory by raising the new funds.
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Kurshev and Strebulaev (2006) found that there is positive association between firms size
and their leverage with capital structure. Hovakimian (2006) establishes that there is positive
and significant impact on the firm's financial performance by using average market to book
ratio; while growth opportunities have no link with market to book ratio and the firm's
leverage. Cole (2008) establish that firms leverage is negatively interrelated to firm size, age,
profitability, liquidity and credit quality; while leverage is positively associated to firm
tangibility and firm's liability. Ovtchinnikov 2010 find that capital structure is deregulated
when there is significant decline in profitability, asset tangibility, and a significant increase in
growth opportunities occur. Also, he find that leverage is negatively related with profitability
and book-to-market ratio, and positively correlated with firm size.
Before we come to an end literature review, here are some observed evidences based
on the econometric modelling that comprise the capital structure theory. Panel data is used in
generally to investigate the capital structure configuration. The rationale behind it for using
the panel data is to inspect the time and individual discrepancy in performance with
unobservable discrepancy in cross section or aggregate time series disparity. Panel data
segregates the observable and unobservable individual heterogeneity. Some studies that used
the static and dynamic panel model as follows (Gilson 1997; Lyandres 2006; Hovakimian
2006; Exley and Smith 2006; Eriotis, Vasiliouand Neokosmidi 2007; Scellato 2007; Bartram,
Brownand Hund 2007; Huang and Ritter 2009; Agarwal, Ambrose, Huang and Yildirim
2011; Sheikh and Wang 2013; Blouin, Huizinga, Laevenand Nicodme2014).
Some studies used the probit and logistic models for finding the risk factor about the
firms, banking sector and insurance companies. The dependent variables used by the studies
are normally systematic risk measures, assets volatility, portfolios dominates contagion, and
debt adjustments. Some researchers used the probit and logistic models for the risk factors
that are as follow (Laitinen and Laitinen 2000; Westgaard and Wijst 2001; Fadlalla 2005;
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Kim and Gu 2009; Premachandra, Bhabra, and Sueyoshi 2009; Tseng and Hu 2010; Lin
2009; Gutirrez, et al 2010; Youn and Gu 2010; Tsai, Lai, and Lloyd 2012).

III. Data and Methodology
We have used 118 Turkish manufacturing firms for the period of 2002-2012 from Borsa
Istanbul. This section defines the dependent and independent variables elaborate in the
present study. The profitability is EBIT divided by total assets. GOPP is the growth
opportunity that shows the percentage change in total sales. Tax shield is the depreciation
divided by the size of the firm. Risk is the square root of profit over the loss. Cash flow is
defined as firms equity plus net profit over loss divided by the depreciation of the firm.
Equity ratio is tangible non-current asset divided by firm size. The dependent variable is the
leverage which is defined as the current liabilities
2
plus long term liabilities divided by the
firm equity For the panel probit and logistic model we have taken leverage as a proxy
variable for measuring the firm risk. In the binary models, we have defined the leverage as
current liabilities plus long term liabilities divided by firm size. We have categorized that if
the leverage value is greater than .5 that is equal to one which means that the firms got more
debt from the banking institutions leads to more risk and unstable otherwise the zero value
that constitutes the firms are stable and have more financial soundness. In Table 1 gives the
predicted signs according to the theories.
A. Static Model
The static model is the model that tests the Modigliani and Miller (1963) premise that claims
that firms' leverage is taken as a unsystematic variable. Generally, the leverage is regressed
on the set of explanatory variables. If Modigliani theory holds, then these variables- have no

2
The liabilities of the firms are the most important that can affect the firms into financial distress. The
elimination of limited liability for equity can shift the structure of corporate liabilities towards the debt
instruments that leads the financial markets stable Toporowski(2010).
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significant impact from a statistical point of view. We conjecture that leverage can be
explained by the following variables:
Leverage fSize, Profitability, GOPP, Tax Shield, Risk, Cash Flow, Equity Ratio
The natures of the business, the risk outline of shareholders and managers suggest that
the Turkish firms vary annually. Moreover, it is likely that macroeconomic shocks and
changes in the institutional context have occurred in recent years. For these purposes, we
have preferred panel data analysis, as it is possible to include time effects, which may be
random or fixed.
The static model estimate with Pooled OLS, fixed effects (the dummy variable model)
and random effects (error component model) estimators. Fixed effect is generally robust and
generally consistent. Fixed effect is useful for the large number of parameters and contains
assumptions that are more logical. Fixed effect is more coherent model because it precludes
time invariant regressor. Random effect is used for the small number of parameters with
efficient estimation but this model is objectionable with orthogonality assumption. However,
potential bias/inconsistency of OLS depends on fixed or random effect. With strict
endogeniety of explanatory variables and error term, the OLS with first difference is unbiased
and consistent but inefficient. In order to resolve this problem and to compute the first step
estimator of step estimator of

; there needs to use the fixed effect or exercise the OLS

3
in
first difference with Newey-West with one lag.
Fixed effects model is costly in degrees of freedom because it is equivalent to the use
of a dummy variable for every firm. The random effects model assumes the independence
between error terms and explanatory variables. Hausman(1978) test is then performed to
validate the endogeniety of the firm specific effect with dependent variables. A Wald test is
used for the joint significance of time dummy variables. In order to make a comparison, we

3
For the large number of observations; least squares is unbiased, consistent efficient but inconvenient.
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reported simple pooled ordinary least squares as well as pooled ordinary least squares with
dummy variable for time, sectors and Fama-McBeth type estimations (Gaud et. al2003). Our
static model to analyse firms with panel data is as follows:

(1)
Where;

:ith firms leverage in period t

: 1vector of explanatory variables

: 1vector of constants

: firm effect assumed constant for ith firm over period of t

: time effect assumed constant for given t over ith firm

: error term 1, . , 1, . ,
B. Dynamic Panel Model
Panel data analysis permits us to study the dynamic nature of the capital structure decisions at
the firm level. However, the fixed or random effects models may give biased and inconsistent
estimators because the error term correlated with the lagged variables. To deal with variables
that are interconnected with the error term, we use instrumental variables technique. Using
instrumental variables has the additional advantage for solving problems encountered in static
models mainly the simultaneity bias between the leverage measure and the explanatory
variables, and measurement error issue. It is well known that the introduction of the lagged
dependent variables which mean that standard estimators are inconsistent. Consistent
estimators find by using the GMM approach describe, for example, by Arellano and Bond
(1991) which involves transformation of the equation into first- differences and then using
lagged values of the endogenous variables as instruments with number of instruments being
different in each time. The dynamic model is written in the following form:

0 1 (2)
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Where

is the target leverage ratio with 0 1 inversely related to adjustment
costs. When 0, then

which means that there is no movement towards the target

debt ratio because the adjustment costs are too high. When 0, then

, so the
adjustment occurs without frictions. Once we have developed the mechanism of equation (2)
which becomes the following regression form:

(3)
We will use the Arellano and Bond(1991) two-step GMM estimator for our dynamic
model that allows for heteroskedasticity across the firms. The GMM estimator is consistent if
there is no second order serial correlation between error terms of the first-differenced
equation. Arellano and Bond (1991) show that when the number of firms is limited, the
asymptotic standard errors associated with the two-step estimates biased downward.
Conversely, the one-step estimators are less efficient than the two-step estimators even in
presence of homoskedasticity of the error terms. we use 1-step, 2-step and n-step that is
postulated by Arellano and Bond (1991).
C. Probit and Logistic Model
Probit and logistic models are the regression models wherever the dependent variables take
two values zero and one. These models call the ordinal or the twofold rejoinder models and
the assessment that derived using the maximum likelihood methods. We will use the probit
and logistic model in order to formulate the capital structure based on financial soundness of
the different Turkish manufacturing companies. The difference in the probit and logistic
model is only the distribution functions. The cumulative standard logistic function is used in
logistic model instead of cumulative normal distribution function that is used in probit model.
The equation of the logistic model is:
1|

, ,

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1
1 e

(4)
In probit model, the value of follows z-value of normal distribution that represents
higher the value of which means that event is more likely to be happened. The
estimated curve follows the cumulative normal distribution. Probit and logistic models
predict the choice between debt financing and equity financing.



.5 1 0

(5)
IV. Estimation Results
In Table 2, we show the results of OLS, fixed individual, fixed period, individual
random and period random effect models. Intercept, profitability, and tax shield are
positively associated with firm leverage, whereas risk, cash flow, equity ratio are negatively
related with firm leverage. GOPP have insignificant negative impact on the firm leverage.
Trade -Off theory is hold under OLS, fixed individual, fixed period, individual random and
random effect models. Wald test is used in the panel data to make the comparison between
fixed effect and the OLS. In our case, OLS shows the significant probability. Adjusted

is
better in the random effect model as compared to fixed effect and OLS model. Hausman test
cannot reject the null hypothesis of the random effect model is better for the alternative of
fixed effect model is better.
In Table 3, we demonstrate the dynamic GMM results for first differences of firm
size, profitability, risk and equity ratio are positively associated with first difference of firm
leverage; while lag of first differenced leverage value, first differences of GOPP, tax shield
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and cash flow are negatively related with first difference of firm leverage. Dynamic model
also holds the TOT. J-statistics shows the null hypothesis of over-identifying restrictions are
valid are rejected for the alternative of over-identifying restrictions are not valid in AB 2-step
and AB n-step at 5% and 10% respectively.
In Table 4, we conclude the binary probit and logistic model results that intercept,
size of the firm, GOPP, risk and cash flow are positively related to firm leverage; while
profitability, tax shield and equity ratio are negatively associated with firm leverage. Tax
shield, cash flow and GOPP are insignificant towards leverage. Probit and logistic model also
proves that TOT is hold. Probit and logistic models compared based on their distribution
function and information criteria such as Akaike Information Criteria (AIC) and Bayesian
Schwartz Criteria (BSC). Based on the AIC and BSC, probit model is more preferable as
compared to logistic model that contains larger values. McFadden

is based on the
estimated likelihood ratio. McFadden values of probit and logistic models are approximately
same.
V. Conclusion
The capital structure decision is one of the most essential issue in the field of finance. The
basic question of whether an exclusive grouping of debt and equity capital maximizes firm
values, and if it happens then, what factors verify the capital structure theory. We have
followed two theories of finance that are TOT and POT. POT that predicts external debt
financing driven by internal financial deficit that has more illustrative power than TOT.TOT
predicts that each firm adjusts gradually towards an optimal debt ratio. TOT also presumes
that firms get benefits to leverage within capital structure until the optimal structure of the
firm is accomplished. TOT that suggests how much the company should get the finance with
debt scheme and how much equity should be recognized for the firm. This study examines
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the impact of firm size, firm profitability, growth opportunities, tax shield, risk of the firm,
cash flow and equity ratio to the firm leverage. TOT is hold in all the econometric modelling,
which predicts that each firm adjust gradually towards an optimal debt ratio. TOT is the best
for the firm consideration as compared to the POT because TOT suggests that how much cost
and benefits of raising capital through debt or equity should be realized. In our case, Turkish
companies follow the TOT. Foreign capital contributes too much to the Turkish economy in
the last decades that helped the Turkish economy in economic growth and development that
gives the important information about capital structure for the major developments in Turkey.
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Table 1: Predicted Sign Suggested by Theories
Variables Trade-off Theory Pecking Order Theory
Size Positive Negative
Profitability Positive Negative
GOPP Negative Sign Ambiguity
Tax Shield Positive Negative
Risk Negative Negative
Cash Flow Negative Negative
Equity Ratio Negative Positive

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Table 2: Static Model Estimation Results [Dependent Variable: Leverage]
Variables OLS Fixed Effect Random Effect
Fixed
Individual
Fixed
Period
Individual
Random
Period
Random
Intercept 1.4504
(0.000)
1.1506
(0.000)
1.4366
(0.000)
1.3521
(0.002)
1.3522
(0.003)
Size 0.0000
(0.064)
0.0000
(0.000)
0.0000
(0.052)
0.0000
(0.000)
0.0000
(0.017)
Profitability 3.7639
(0.000)
2.9105
(0.000)
4.3445
(0.000)
5.3491
(0.006)
5.3489
(0.000)
GOPP -0.0085
(0.708)
0.0080
(0.390)
-0.0104
(0.673)
-0.0013
(0.877)
-0.0013
(0.861)
Tax Shield

6.6745
(0.000)
3.9122
(0.000)
5.5731
(0.000)
6.3947
(0.000)
6.3948
(0.000)
Risk -1.2136
(0.087)
-1.1372
(0.000)
-1.4260
(0.000)
-1.9036
(0.010)
-1.9035
(0.000)
Cash Flow -4.5277
(0.000)
-3.0074
(0.000)
-4.2421
(0.000)
-4.5913
(0.000)
-4.5913
(0.000)
Equity Ratio -1.1918
(0.056)
-0.6397
(0.000)
-1.1938
(0.004)
-1.1109
(0.091)
-1.1109
(0.142)
Adjusted

0.764 0.841 0.754 0.806 0.806

Wald Test for
Dummies
29.5226
(0.000)
19.076
(0.000)

0.9384
(0.490)
------- ---------
Hausman Test ----------- --------- --------- 7.0069
(0.428)
6.0606
(0.532)
Note: Significance levels of parameters are in the parenthesis.

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Table 3: Dynamic Panel GMM Model Estimation Results [Dependent Variable:
Leverage]
Variable AB 1-step AB 2-step AB n-step

-0.0659 -0.0660 -0.0793

(0.006) (0.000) (0.000)
Size 0.0000 0.0000 0.000
(0.946) (0.521) (0.000)

Profitability 2.0146 1.9790 12.094
(0.834) (0.000) (0.000)
GOPP -1.4633 -1.4252 -1.096
(0.126) (0.000) (0.000)
Tax shield -52.876 -171.94 -214.72
(0.603) (0.000) (0.000)
Risk 0.7069 1.6838 19.175
(0.603) (0.042) (0.000)
Cash Flow -3.639 -3.6407 -1.755
(0.0138) (0.000) (0.000)
Equity Ratio 5.1821 5.3689 7.6990
(0.439) (0.000) (0.000)
Leverage

0.0615 0.0615 0.0615

J-Statistics 28.127 55.539 50.798
(0.852) (0.025) (0.064)
Instrumental Rank [45] [45] [45]
Note: Significance levels of parameters are in the parenthesis. The transformation is used in order to remove
the cross-section fixed effect that is the difference of each variable in the regression. The transformed innovation
such as, AB 1-step, AB 2-ste and AB n-step that followed MA (1) process. Arellano-Bond (AB) type dynamic
panel instrument leverage one lag is used. GMM white weighting matrix is used in order to remove the serial
correlation structure that varies for all cross sections. J-Statistics or sometimes called the Sargan test, based on
the assumption that model parameters are identified via prior restrictions on the coefficients and tests the over-
identifying restrictions.



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Table 4: Panel Binary Models
Variables Probit Model Logistic Model
Constant 0.5325 0.8810
(0.000) (0.000)
Size 0.0000 0.0000
(0.000) (0.000)
Profitability -4.5923 -7.599
(0.000) (0.000)
GOPP 0.0544 0.1462
(0.534) (0.551)
Tax Shield -1.3438 -2.441
(0.147) (0.123)
Risk 3.4780 5.6730
(0.000) (0.000)
Cash Flow 0.0021 0.0037
(0.933) (0.927)
Equity Ratio -1.6850 -2.7622
(0.000) (0.000)

AIC 1.1997 1.2006
BSC 1.2341 1.2350
McFadden

0.1057 0.1050
Note:

is the logit (dependent variable takes on two values 1 and zero with probabilities and 1
respectively).



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