MACRO ECONOMY AND CAPITAL STRUCTURE DECISION IN PAKISTANI INSURANCE SECTOR

Abstract

An optimal Capital Structure is the fundamental decision for any business management
for wealth maximization of the shareholders and economic development. This study is
designed to analyze important determinants of Capital Structure in insurance industry
of Pakistan. The firm related characteristics (liquidity, profitability, tangibility and
business risk,) and macroeconomic variables (Inflation rate and GDP rate ) have been
studied. The secondary data for 41 insurance companies life-insurance, non-life
insurance and takaful (Islamic) sector have used for the period 2001-2015. The
Hausman's specification and Breusch, and Pagan Lagrange Multiplier Test have select
fixed effect and pooled regression models for the study. The findings of the study has
revealed that profitability, liquidity and business risk are significant but inversely
associated to debt ratio in both estimation technique i.e. fixed effect and random effect
model. The negative relationship of debt ratio and profitability and liquidity support
pecking order predication, while the inverse association of financing policy and
earning volatility support both trade off and pecking order theory. However, tangibility
is positive and significantly associated to capital structure in both models. Inflation rate
is significant and positive in pooled model but insignificant in fixed effect model, while
GDP are insignificant factor of Leverage. The financial manager should be more
careful to make Capital structure decision in insurance sector of Pakistan by focusing
firm level factors like liquidity, profitability, tangibility, business risk and country level
factor i.e., inflation rate. The management of insurance sector might not incline the debt
ratio because the profitability will decease and volatility in earnings would also be
diminished. Moreover, the management of insurance sector can incline the debt portion
as the tangibility of the firm enhanced.. The results and relationship support the
predication of pecking order and trade off theory of Capital Structure. According to the
best knowledge of the author this is the first study in the insurance sector that has
consider both firm specific and exogenous factors that affect capital structure decision
and also used most appropriate models of panel data fixed effect and random effect.