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Managerial FinanceVol. 34 No. 12, 2008

pp. 919-933# Emerald Group Publishing Limited

0307-4358DOI 10.1108/03074350810915851

The relationship between capitalstructure and ownership

structureNew evidence from Jordanian panel data

Basil Al-Najjar and Peter TaylorBristol Business School, University of the West of England, Bristol, UK

Abstract

Purpose – The study aims to investigate the comparatively under-researched relationship betweenownership structure and capital structure in an emerging market. It is also one of the first studies toapply both single and reduced-form equation methods using a panel data approach.Design/methodology/approach – The study applies econometrics modelling using both singleequation and reduces equation models for panel data.Findings – The results demonstrate that Jordanian firms follow the same determinants of capitalstructure as occur in developed markets, namely: profitability, firm size, growth rate, market-to-bookratio, asset structure and liquidity. In addition, institutional ownership structure is found to bedetermined by: assets structure, business risk (BR), growth opportunities and firm size. Finally, theresults reveal that assets tangibility, firm size, growth opportunities and BR are considered to be jointdeterminants of ownership structure and capital structure.Practical implications – The practical implication of the study is that investors and managers shouldconsider both capital structure and ownership structure when they take their investment decisions.Originality/value – This is the first study of the interaction between institutional ownership andcapital structure in Jordan where there are differences, as regards institutional and financial structures,relative to those in developed markets.

Keywords Corporate ownership, Capital structure, Jordan

Paper type Research paper

1. IntroductionThe relationship between firm’s ownership structure and financial policy is notable inthe financial literature. Leland and Pyle (1977) and Jensen (1986) are considered to beamongst the first scholars to address this issue. In addition, there is empirical evidenceof a relationship between capital structure and institutional ownership. Chaganti andDamanpour (1991), Jensen et al. (1992), Grier and Zychowicz (1994), Moh’d et al. (1998)and Brailsford et al. (2002) are among those who recognize such a relationship betweencapital structure and institutional ownership structure. This relationship has beenfairly neglected in the emerging markets, especially in Jordan. Therefore, this studyaims to investigate the interaction between capital structure and ownership structurein emerging markets by using data from Jordan.

The paper is organised as follows: section 2 discusses the institutional ownershipand capital structure, while section 3 demonstrates the determinants of capitalstructure and ownership structure. In sections 4 and 5, the data and the methodologyare discussed. In section 6, the statistical results are presented and discussed, whilesection 7 covers the conclusions of the study. Finally, section 8 concludes the study.

2. Capital structure and institutional ownershipInstitutional investors are considered to be the major players in financial markets andtheir influence in corporate governance has been increasing as a result of the

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privatization policy adopted by different countries. Accordingly, one can argue thatinstitutional investors are of central importance in many corporate governancesystems.

Institutional owners play a key role in monitoring the firms in which they holdequity. Owners (shareholders) of the firm have different rights; such rights include theelection of the board of directors, who will act as an agent to monitor the performanceof the firms’ managers. Institutional activism arises when the owners (shareholders)are disappointed with the performance of the board of directors (Gillan and Starks,2002). Chidambaran and John (2000) argue that large shareholders play an importantrole in transmitting information to other shareholders. Large shareholders can obtainprivate information from management and transmit that information to othershareholders.

In the modern corporate finance literature, the capital structure debate is closelyrelated to the work of Modigliani and Miller (1958, 1963). Modigliani and Miller (1958)suggest that, in a world without friction, there is no difference between debt and equityfinancing as regards the value of the firm. Thus, financing decisions add no value andare therefore of no concern to the manager. Evidence would suggest that this does nothold in reality. Thus, it is important to investigate what determines firms’ capitalstructure. Much research in corporate finance has been devoted to explaining theconditions under which capital structure does affect a firm’s value. However, empiricalresearch on this issue has been largely restricted to the USA and other developedcountries which have similar institutional characteristics. The capital structuredecision in developing countries has not received the same attention in the literature.However, Booth et al. (2001) analyse data from ten developing countries: India,Pakistan, Thailand, Malaysia, Zimbabwe, Mexico, Brazil, Turkey, Jordan and Korea.They state that:

In general, debt ratios in developing countries seem to be affected in the same way and by thesame types of variables that are significant in developed countries. However, there aresystematic differences in the way these ratios are affected by country factors, such as GDPgrowth rates, inflation rates and development of capital market (Booth et al., 2001, p. 118).

2.1 The relationship between capital structure and institutional ownershipInstitutional investors have considerable experience in collecting and interpretinginformation on firms’ performance. Agency theory suggests that an optimal capitalstructure and ownership structure can minimize agency costs ( Jensen and Meckling,1976; Jensen, 1986). Thus, a relationship between capital structure and ownershipstructure is expected to be found in the relevant data. Empirical studies in this fieldfind mixed results. Chaganti and Damanpour (1991), Grier and Zychowicz (1994),Bathala et al. (1994) and Crutchley and Jensen (1996) find a negative relationshipbetween institutional ownership and leverage. On the other hand, Leland and Pyle(1977), Berger et al. (1997) and Chen and Steiner (1999) show that managerialownership and leverage are positively related. In addition, Tong and Ning (2004) claimthat firms with high leverage ratios provide a negative signal that the firm faces afuture of financial difficulties. Therefore, institutional investors prefer firms with lowleverage ratios.

The capital structure variable used is the leverage measure: total debt divided bytotal assets (LEV). Two variables are used to capture the ownership structure: the firstis the natural logarithm of the number of shares owned by institutional investors (IO),and the second is the percentage of institutional ownership from the subscribed shares

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(PIO) (Tong and Ning, 2004). These indices are therefore an absolute (size) measure anda proportion measure, respectively.

3. The determinants of capital structure and ownership structure3.1 DividendsBhaduri (2002) suggests that if a firm can credibly signal its quality to outsiders, it canavoid an information premium and so may gain access to external sources of funds,mainly the equity market. John and Williams (1985) and Miller and Rock (1985) arguethat a firms with a reputation for paying a constant stream of dividends face lessasymmetric information when entering the equity market. Thus, if dividend paymentsrepresent a signal of sound financial health and hence of higher debt-issuing capacity,one would expect a positive relationship between dividend payments and leverage.

In addition, firms with a reputation for paying a stream of dividends will bemonitored by the capital market (Short et al., 2002). Institutional ownership may act asalternative monitoring device, and so this will reduce the need for capital markets asexternal monitoring system (Zeckhauser and Pound, 1990). Thus, according to agencytheory, there is a positive relationship between dividend payments and institutionalownership ( Jensen, 1986; Zeckhauser and Pound, 1990; Short et al., 2002). However, theexistence of institutional ownership mitigates the need for dividends to signal goodperformance (Short et al., 2002). Therefore, signaling theory suggests a trade-offbetween dividends and institutional ownership, i.e. a negative relationship. This studyuses the dividend payout ratio (DPO) to analyse the dividend policy effect on the firm’scapital structure and ownership structure.

3.2 ProfitabilityAccording to the pecking order theory in the presence of asymmetric information, afirm would prefer internal finance over other sources of funds, but would issue debt ifinternal finance was exhausted. The least attractive alternative for the firm would beto issue new equity. Profitable firms are likely to have more retained earnings. Thus, anegative relationship is expected between leverage and past profitability (Donaldson,1961; Myers, 1984; Myers and Majluf, 1984).

It is expected that institutional investors will prefer to invest in profitable firms.This is because the more profitable the firm is, the lower the likelihood of default and ofhaving to face financial difficulties and bankruptcy. Therefore, a positive relationshipis expected between profitability and institutional ownership. However, Tong and Ning(2004) find that there is limited evidence that institutional investors prefer to invest in aprofitable firms. They find that profitability (measured as the return on equity) isnegatively related to average shares held by institutional investors. The return onequity is used as an index for firm profitability in this study (return on equity ratio(ROE)).

3.3 Business riskBR is considered to be one of the key factors that can affect the capital structure of thefirm. Bhaduri (2002) states that:

Since debt involves a commitment of periodic payment, highly leveraged firms are prone tofinancial distress costs. Therefore, firms with volatile incomes are likely to be less leveraged(Bhaduri, 2002, p. 202).

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Thus, according to the bankruptcy theory, there is a negative relationship between BRand capital structure.

Institutional investors tend to invest in firms with low BRs because firms with highvolatility in their returns are likely to have a high probability to default and to becomebankrupt. Therefore, a negative relationship is expected between firm’s BR and thefirm’s institutional ownership. The current study uses the standard deviation of returnon assets as an indicator for firms BR.

3.4 Asset structureAccording to the agency cost theory, the shareholders of a leveraged firm have anincentive to invest sub-optimally (Titman and Wessels, 1988). However, the moretangible the firm’s assets are, the more such assets can be used as collateral.Collateralized assets can restrict such opportunistic behaviour. Therefore, a positiverelationship between tangible assets and debt is expected (Bhaduri, 2002; Huang andSong, 2006; Jensen and Meckling, 1976; Rajan and Zingales, 1995; Titman and Wessels,1988).

In addition, agency theory suggests that the optimal capital and ownershipstructures may be used to minimize agency costs ( Jensen and Meckling, 1976; Jensen,1986). Thus, a negative relationship between asset tangibility and ownership structureis expected. This is because tangible assets can act as collateral for higher levels ofdebt. Therefore, institutional investors prefer to invest in firms with low tangibleassets. The current study uses the fixed assets to total assets ratio as indictor of firmstangibility (TANG).

3.5 LiquidityLiquidity ratios have both a positive and a negative effect on the capital structuredecision, and so the net effect is unknown. First, firms with high liquidity ratios mayhave relatively higher debt ratios due to their greater ability to meet short-termobligations. This argument suggests a positive relationship between a firm’s liquidityand its debt ratio. Alternatively, firms with more liquid assets may use such assets assources of finance to fund future investment opportunities. Thus, a firm’s liquidityposition would have a negative impact on its leverage ratio. A further argument for anegative relationship is provided by Myers and Rajan (1998) who argue that whenagency costs of liquidity are high, outside creditors limit the amount of debt financingavailable to the company. Thus, a negative relationship between debt and liquiditywould be expected.

Similarly, the effect of asset liquidity is an ambiguous signal to institutionalinvestors. A high liquidity ratio may be considered to be a negative signal because itindicates that the firm faces problems regarding opportunities for its long-terminvestment decisions. Hence a high liquidity ratio may be considered to be a negativesignal for institutional investors. However, a high liquidity ratio may be considered tobe a positive signal from the firm, because it indicates that the firm can easily pay itsobligations and hence faces lower risk of default. Thus, high liquidity would be apositive signal for institutional investors. Whatever, in order to measure the effect ofliquidity, the study uses the ratio of current assets to current liabilities as a proxy forthe liquidity of the firm’s assets (LIQ).

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3.6 GrowthAgency problems are likely to be more severe for growing firms, because they are moreflexible in their choice of future investments. Thus, the expected growth rate should benegatively related to long-term leverage.

Moreover, firms with high-growth opportunities provide a positive signal about thefirm’s future performance. Hence institutional investors prefer to invest in high-growthfirms rather than lower ones. In addition, Hovakimian et al. (2004) suggest that high-growth firms may bring more capital gains to institutional investors than lowergrowth ones. This is because institutional investors, as taxpayers, would prefer toinvest in capital-gain stocks to delay tax payments and to avoid double taxation. Thus,a firm’s growth opportunities is considered to be a positive signal for institutionalinvestors. The study uses market-to-book ratio (MB) as an indicator of the growthopportunities of a firm.

3.7 SizeThere is considerable evidence that the size of a firm plays an important role in thecapital structure decision. Large firms tend to be more diversified and less prone tobankruptcy. Therefore, a positive relationship is expected between a firm’s size and itsleverage (Titman and Wessels, 1988; Bhaduri, 2002).

Institutional investors prefer to invest in large firms in the belief that they have alow risk of bankruptcy. This is because large firms have the required resources andability to minimize the risk of their stock investment. Therefore they are less subject tofinancial distress and bankruptcy risk (O’Brien and Bhushan, 1990; Tong and Ning,2004). The natural logarithm of total assets is used as a proxy for firm size (ln SIZE).

4. DataThe current study investigates the interaction between capital structure andownership structure in emerging markets using Jordanian non-financial companies.The data for this analysis are drawn from the Jordanian Shareholding CompaniesGuide (1999, 2000, 2001, 2002 and 2003). From this data set, firms that have maintainedtheir existence and reported their annual accounts without any significant gaps for theperiod from 1994 to 2003 were selected. Screening for data consistency on the basis ofthis criterion led to the selection of a sample of 86 non-financial Jordanian firms. Thedata set is therefore composed of a panel of 86 firms observed over a ten-year-period.However, due to missing observations, the total number of observations used in themodels estimated was 743.

The Amman Stock Exchange (ASE) is considered to be one of the most up-to-dateemerging markets with a market capitalization of 76.8 per cent of the country’s GDP atthe end of 2001. Foreign ownership represents 40 per cent of the listed stocks. The ASEshare price index rose by 30 per cent in 2001, hence the ASE may be considered to be atthe fore in terms of stock exchange share performance.

5. MethodologyThe generally accepted theoretical causal relationships and the empirical modelling ofcapital structure and ownership structure that have appeared in the literature are suchthat both structures share approximately the same set of causal variables. However, itmay be argued that the determinants of ownership structure are a subset of thedeterminants of capital structure. However, this would still leave the capital structureequation under-identified. Alternatively, it may be argued that capital structure and

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ownership structure are jointly determined rather than simultaneously determined,that is, they are not truly interdependent. This state of affairs is probably the result ofcurrent theoretical shortcomings. Whatever, the approach used in this paper is not todevelop and estimate a true simultaneous model but, after estimating all-encompassingmodels, to estimate reduced-form models. Reduced-form models capture both the directand indirect influences, which may, in any case, be the essence of our currenttheoretical understanding of the relationships. The all-encompassing models are anattempt to examine the interdependencies although it is recognized that these aresubject to simultaneous equation bias as well as being under-identified. However, theydo give an idea of the relative statistical strength of the influences.

In addition, the study investigates the relationship between capital structure andownership structure using both pooled and panel regression analyses of the followingforms:

Yit ¼ �þ �0Xit þ "it ðPooled modelÞYit ¼ �i þ �0Xit þ "it ðFixed effects modelÞ

Yit ¼ �þ �0Xit þ ð"it þ �iÞ ðRandom effects modelÞ

where Yit ¼ (1) LEV ¼ the leverage measure: total debt/total assets of firm i in year t.(2) IO ¼ the natural logarithm of the number of shares owned by institutionalinvestors. (3) PIO¼ the proportion of institutional ownership in the firm. �¼ interceptcoefficient of firm i. �0 ¼ row vector of slope coefficients of regressors. Xit ¼ columnvector of financial variables for firm i at time t, this vector is made up of this following:X1 (DPO) ¼ dividend payout ratio: dividend per share/earnings per share. X2 (ROE) ¼return on equity ratio: net income/owners equity. X3 (BR) ¼ �ROA, the standarddeviation of the firm’s return on assets: net income/total assets. X4 (TANG) ¼ fixedassets ratio (tangibility): fixed assets/total assets. X5 (LIQ)¼ current ratio: currentassets/current liability. X6 (MB) ¼ market-to-book ratio: market value per share/bookvalue per share. X7(ln SIZE) ¼ size: the natural logarithm of total assets. "it ¼ residualerror of firm i in year t.

6. Statistical resultsIn this section, the empirical analysis of the relationship between ownership andcapital structure is presented and discussed. Table I shows the descriptive statistics ofthe variables.

Table I.Descriptive statistics

Variables Observed Minimum Maximum Mean SD

Leverage 826 0.00 0.93 0.03048 0.19784IO 853 10.31 20.10 14.564 1.4569PIO 853 0.0032 49.19 0.6818 3.34007DPO 826 �6.00 12.50 0.2885 0.7532ROE 826 �2.85 0.48 0.0109 0.17548BR 853 0.01 0.17 0.0553 0.03357TANG 826 0.00 0.96 0.4365 0.26281LIQ 826 0.01 4,421,470 23,802.6 291,047.94473MB 744 0.00 7.53 1.1405 0.77549ln SIZE 826 13.68 20.10 16.1547 1.21217

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From Table I, the following points emerge:

. Low debt ratios: On average firms use only 30 per cent debt financing in theircapital structure; one explanation is that Jordanian firms tend to minimize theprobability of bankruptcy by reducing debt financing.

. Very low dividend payments: On average Jordanian firms paid 0.064 JordanianDinars per share, and the maximum payment was less than 1 Jordanian Dinar. Thismay indicate that any dividend is considered to be a signal of a good performance.

. A high percentage of institutional ownership: On average 68.18 per cent of ownersare non-individual owners (institutions). Hence one can expect that theinstitutional ownership play a key role in monitoring and governing the firm.

. Low profitability of Jordanian firms: On average, returns of only 1 per cent comefrom shareholders’ equity investment.

The first regression analyses estimated all-encompassing equations involving all of thevariables, including those that are jointly determined. The results for the capitalstructure equation are reported in Table II and those for the ownership structureequation in Table III. As discussed above, two measures are used to capture ownershipstructure (IO and PIO), and so both of these are included as independent variables inthe estimated models in Table II. In turn, this means that two separate equations are

Table II.OLS regression resultsof the capital structure

model

Independent variables Pooled model Fixed effects Random effects

Dependent variable: leverage (LEV)Constant �0.7132* (0.000) �0.9299* (0.000)IO �0.0395* (0.000) �0.0218** (0.0132) �0.0256* (0.000)PIO 0.987E�3* (0.0020) �0.0013** (0.0310) �0.891E�3 (0.5089)DPO �0.0031 (0.5382) 0.961E�3 (0.8544) 0.246E�3 (0.9693)ROE �0.3121* (0.000) �0.2382* (0.000) �0.2483* (0.000)BR �0.4841* (0.0063) – –TANG 0.1399* (0.000) 0.0934** (0.0144) 0.1065* (0.0001)LIQ 0.537E�07* (0.000) 0.352E�7 (0.2650) 0.400E�7*** (0.0860)MB 0.0284* (0.0001) 0.0188** (0.0275) 0.0197* (0.0055)ln SIZE 0.0954* (0.000) 0.0985* (0.000) 0.0960* (0.000)Number of observations 743 743 743R 2 (%) 36.38 69 35.79Lagrange multiplier test 559.29* (0.000)Hausman test 12.03 (0.1500)

Notes: The dependent variable is leverage measured as the total debt to total assets ratio, andthe independent variables: DPO is the dividend per share divided by earning per share, IO is thenatural logarithm of the number of shares owned by institutional investors, PIO is the percentageof institutional ownership, ROE is the return on equity measured by net income divided byowners equity, TANG is the tangible asset ratio measured by fixed assets to total assets ratio,LIQ is the liquidity ratio measured by current assets to current liabilities, MB is the market-to-book ratio measured by market price per share divided by book price per share, BR is thebusiness risk measured by the standard deviation of the return on assets, and ln SIZE is thenatural logarithm firm size measured by total assets. *, **, *** significant at 10, 5 and 1 per cent,respectively. The pooled model and the fixed effects model are tested and corrected forheteroskedasticity using Breusch-Pagan, and White methods, respectively. Figures in brackets areprobability levels

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used to estimate ownership structure, as shown in Table III. Given that the data set is apanel, all the specified equations are estimated first using the data pooled across theyears, then using a fixed effects model and finally using a random effects model. Thelatter two techniques enable time-invariant inter-firm heterogeneity to be controlled. Inorder to distinguish the preferable set of results statistically, the results of the Lagrangemultiplier and Hausman tests are presented. If the Lagrange multiplier test gives asignificant result, then the panel results are preferred over the pooled results, i.e. firmheterogeneity has a significant effect. If the Hausman test gives a significant resultthen the fixed effect results are statistically preferred to the random effects results.Finally, all the models presented in Tables II and III were re-estimated as reduced-formequations and the results are presented in Tables VI and V, respectively.

In Tables II-V, the Lagrange multiplier test is statistically significant for all modelswhich indicates the preference of the panel models over the pooled models. This meansthat there are differences between Jordanian firms that are important in determiningcapital structure and ownership structure in addition to differences between theindependent variables included in the models. The Hausman test is not statistically

Table III.OLS regression resultsof ownership structuremodels

Dependent variable: IO PIOIndependentvariables

Pooledmodel

Fixedeffects

Randomeffects

Pooledmodel

Fixedeffects

Randomeffects

Constant 1.1004*(0.0525)

– 2.5140**(0.0014)

4.4735***(0.0588)

– 1.2343(0.6066)

LEV �1.778**(0.000)

�0.9281*(0.0102)

�1.0757**(0.000)

0.2797(0.2121)

–1.193*(0.0378)

–0.18462(0.8375)

DPO �0.0411(0.3433)

0.184E�3(0.9969)

�0.0022(0.9568)

0.1122(0.2539)

�0.2383(0.3549)

�0.0644(0.7122)

ROE �0.8528**(0.0031)

�0.518**(0.0256)

�0.5480**(0.0061)

0.6378**(0.1497)

�0.7219***(0.0894)

0.2770(0.7292)

BR �2.1501(0.1478)

– – �5.8502***(0.0590)

– �

TANG �0.0240(0.8901)

�0.7377*(0.0210)

�0.5909**(0.0008)

�0.8128*(0.0377)

�0.9300*(0.0253)

�0.9010(0.1490)

LIQ 0.204E�06**(0.000)

0.113E�7(0.3275)

0.133E�7(0.3897)

0.715E�07***(0.0648)

0.331E�6(0.0962)

0.109E�7(0.9842)

MB 0.1021*(0.0255)

0.1035*(0.0443)

0.1025*(0.0272)

0.4595*(0.0360)

0.2607(0.1362)

0.36731*(0.0483)

ln SIZE 0.8691**(0.000)

0.7258**(0.000)

0.7761**(0.000)

�0.2305**(0.0929)

0.4988*(0.0357)

�0.0289(0.8499)

Number ofobservations 743 743 743 743 743 743R2 (%) 48.21 76.527 48 2.18 28.395 1.93Lagrangemultiplier test 550.44**

(0.000)77.82**(0.000)

Hausman test 7.73(0.3573)

18.74**(0.0090)

Notes: The variables have the same previous definitions. *, **, *** significant at 5, 1 and 10 percent, respectively. The pooled model and the fixed effects model are tested and corrected forheteroskedasticity using Breusch-Pagan, and White methods, respectively. Figures in brackets areprobability levels

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significant for the capital structure models and for the institutional structure modelsthat used the number of shares held by institutions (IO) as the dependent variable. Thisindicates that for capital structure and for IO institutional structure, the random effectsmodel is preferred over the fixed effects model. From this it can be concluded that themeans of these differences between firms are normally distributed, that is, random innature. However, when the dependent variable is the percentage of shares owned byinstitutions (PIO), the Hausman test gives a significant result. This means that thefirm-specific factors that determine differences between the percentage of shares heldby the institutional owners of Jordanian firms are not randomly determined.

Taken as a whole, Table II results indicate a negative relationship between the sizeof institutional ownership and the proportion of debt in capital structure. Most of theother variables are highly significant and have consistent signs across the three sets ofresults. The strongest exception is the DPO for which there is no statistical influence oncapital structure. It would be reasonable to conclude that the impact of liquidity (LIQ)is just about significant, given that the Hausman test indicates that the random effectsmodel is preferred. Finally, BR would appear to be negatively related to the level ofdebt given its significance in the pooled model. Note that it cannot be included in thepanel model as, by its nature, it varies across firms but not across time and so becomesa part of the inter-firm variation accommodated in the panel techniques.

Table III results, taken as a whole, strongly reinforce Table II results regarding anegative relationship between capital structure (LEV) and the magnitude of ownershipstructure. The results will be discussed as a whole across both institutional ownershipproxy variables IO and PIO, and again across all pooled and panel analyses. However,it is worth noting that the tests, as discussed earlier, indicate that the random effectsmodel is preferred for the IO measure and the fixed effects model is preferred for thePIO measure.

Again the DPO is not significant. The effects of the ROE variable is consistentlynegative and significant for the IO models, as it is for the (preferred) fixed effects modelof the PIO measure. The impact of BR is negative and probably significant. It can be

Table IV.The reduced-form

equation of the capitalstructure model

Independent variables Pooled model Fixed effects Random effects

Dependent variable: leverage (LEV)Constant �0.8095* (0.000) �1.0235* (0.000)DPO �0.0015 (0.7437) 0.0013 (0.7897) 0.565E�3 (0.9303)ROE �0.2988* (0.000) �0.2309* (0.000) �0.2400* (0.000)BR �0.4357** (0.0126) – –TANG 0.1507* (0.000) 0.1133* (0.0020) 0.1243* (0.000)LIQ 0.492E�7* (0.000) 0.33E�7 (0.2979) 0.371E�7 (0.1179)MB 0.0267* (0.0005) 0.0165*** (0.0554) 0.0172** (0.0161)ln SIZE 0.0654* (0.000) 0.0838* (0.000) 0.0783* (0.000)Number of observations 743 743 743R 2 (%) 31.55 68.40 31.07Lagrange multiplier test 671.20* (0.000)Hausman test 6.83 (0.3370)

Notes: The variables have the same previous definitions. *, **, *** significant at 10, 5 and1 per cent, respectively. The pooled model and the fixed effects model are tested and corrected forheteroskedasticity using Breusch-Pagan, and White methods, respectively. Figures in brackets areprobability levels

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concluded that tangibility (TANG) is negative and significant, while MB is positive andon balance significant. The size of the firm (ln SIZE) and liquidity (LIQ) are most likelyboth to have a positive and significant effect.

The joint determinants of capital structure and ownership structure are analysedusing reduced-form models. The reduced-form equations for the analysis are:

LEV ¼�0 þ�1DPOþ �2ROEþ �3BRþ�4TANGþ �5LIQ

þ �6MBþ �7SIZEþ "it

IO½PIO� ¼�8þ�9DPOþ �10ROEþ�11BR

þ�12TANGþ�13LIQþ �14MBþ �15SIZEþ �it

The results are provided in Tables IV and V.The results for the reduced-form equations in Table IV show that the estimated

effects on leverage (LEV) of the independent variables are the same in terms of signs asin Table II and much the same in terms of levels of significance. The main difference isthe (preferred) random effects model for liquidity (LIQ) for which the probability level

Table V.The reduced-formequation of theownership structuremodels

Dependent variable: IO PIOIndependentvariables

Pooledmodel

Fixedeffects

Randomeffects

Pooledmodel

Fixedeffects

Randomeffects

Constant 2.5404*(0.000)

3.6719*(0.000)

4.2470**(0.0563)

1.3956(0.5349)

DPO �0.0342(0.3573)

�0.0010(0.9823)

�0.0027(0.9840)

0.1118(0.2554)

�0.2398(0.3482)

�0.0650(0.7079)

ROE �0.3212(0.1702)

�0.3036(0.1420)

�0.2921*(0.1318)

0.5542(0.1595)

�0.4462(0.1550)

0.3226(0.6735)

BR �1.3751(0.3522)

– – �5.9721**(0.0595)

– –

TANG �0.2921(0.1195)

�0.8429*(0.0079)

�0.7317*(0.000)

�0.7706***(0.0358)

�1.0653***(0.0183)

�0.9279(0.1294)

LIQ 0.116E�6*(0.000)

0.825E�7(0.4750)

0.931E�7(0.5532)

0.852E�7**(0.0669)

0.292E�6**(0.0968)

0.308E�8(0.9956)

MB 0.0545(0.2644)

0.0882(0.1027)

0.0845**(0.0710)

0.4670***(0.0366)

0.2409(0.1668)

0.3631***(0.0499)

ln SIZE 0.7526*(0.000)

0.6479*(0.000)

0.6885*(0.000)

�0.2122**(0.0929)

0.3987**(0.0754)

�0.0415(0.7646)

Number ofobservations 743 743 743 743 743 743R2 (%) 44.30 76.03 44.21 2.17 28.26 1.91Lagrangemultiplier test 655.15*

(0.000)78.89*(0.000)

Hausman test 4.11(0.6618)

16.26***(0.012)

Notes: The variables have the same previous definitions. *, **, *** significant at 1, 10 and 5 percent, respectively. The pooled model and the fixed effects model are tested and corrected forheteroskedasticity using Breusch-Pagan, and White methods, respectively. Figures in brackets areprobability levels

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of significance has fallen from 8.6 to nearly 12 per cent; hence conclusions regardingliquidity depend on the level of significance that one is willing to accept.

Similarly, the estimated coefficients of the reduced-form equations reported inTable V are generally in line with the estimates presented in Table III. Again the DPO isnot significant in any model. There is slightly stronger evidence of a negative effect asregards BR. The results for asset tangibility (TANG) are negative and significant as inTable III. The size of the firm (ln SIZE) is again likely to have a positive and significanteffect, but liquidity (LIQ), although again positive, does not have such overall evidenceof significance. However, although the signs of the estimated coefficients for ROE arethe same as in Table III, there is little evidence of significance. The results for MB aremuch the same as in Table III and again suggest a significant positive effect.

7. Discussion of the results7.1 The determinants of capital structure and ownership structureThe above analyses show that the following are the main determinants of firms’ownership and capital structure:

7.1.1 Dividend policy (DPO). The results indicate that there is no significantrelationship between dividend policy and leverage. In addition, the results show that thereis no relationship between institutional ownership and dividend payments. Therefore,there is no evidence that Jordanian institutional investors consider the dividend policy ofthe firm when deciding on the extent of their investment decisions in Jordanian firms.

7.1.2 Profitability (ROE). The results indicate that there is strong evidence of anegative relationship between profitability and leverage. This indicates that theJordanian firms prefer internal financing rather than debt financing. This result is inthe line with the pecking order theory of capital structure. Other studies in the financialliterature reveal the same result, for example: Rajan and Zingales (1995) and Booth et al.(2001). However, there is only limited evidence that institutional investors consider theprofitability of the firm when deciding the extent of their investment in it. The onlysignificant results are found in Table III but with a negative sign, and the reduced-formequations in Table V provide no evidence of statistical significance. It is worth notingthat Tong and Ning (2004) also find significant negative relationship between theaverage number of shares held by institutional investors and return on equity. Theyconclude that there is limited evidence that institutional investors prefer firms withhigh profitability ratios.

7.1.3 Business risk[1](BR). The results indicate that there is strong evidence of anegative relationship between BR and the debt ratio. Debt financing involves acommitment to periodic payment. Firms with a high debt ratio tend to face highfinancial distress costs. Thus, firms with volatile incomes are likely to be lessleveraged. This result is in the line with the bankruptcy theory of capital structure. Inaddition, there is evidence of a negative relationship between institutional ownershipand the BR of the firm. Institutional investors tend to invest in low BR firms, becausefirms with higher volatility in their returns are likely to have a higher probability ofdefault and to become bankrupt.

7.1.4 Asset structure (TANG). There is strong evidence of a positive relationshipbetween asset tangibility and leverage. This means that firms with more fixed assetscan use such assets as collateral. This result is in the line with the agency theory ofcapital structure. Other studies in the finance literature find the same result (Bhaduri,2002; Huang and Song, 2006; Jensen and Meckling, 1976; Rajan and Zingales, 1995;Titman and Wessels, 1988). In addition, there is strong evidence of a negative

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relationship between institutional ownership and assets tangibility. Therefore,institutional investors consider tangible assets as an indication of the debt capability ofthe firm. Hence institutional investors prefer to invest in firms with low tangible assets.

7.1.5 Liquidity (LIQ). The study finds some evidence that liquidity may play a rolein determining firms’ capital structure. According to trade-off models of capitalstructure there is a positive relationship between the liquidation value of the firm andits leverage. Thus, expected liquidation values are higher for firms with more liquidassets, which implies that firm’s debt is positively associated with asset liquidity(Harris and Raviv, 1990). In addition, there is some evidence of a positive relationshipbetween ownership structure and the asset liquidity of the firm. Thus, a high assetliquidity ratio could be considered by institutional investors to be a positive signalbecause it indicates that the firm can easily pay its obligations and hence face a lowerrisk of default.

7.1.6 Growth rate (MB). The study finds that there is a strong significant positiverelationship between the potential growth rate, as indicated by the market to bookvariable, and leverage. This contradicts the expected negative sign predicted by theagency theory. This means that Jordanian firms with high-growth opportunities preferdebt financing as a way to finance their investment opportunities. In addition, one canargue that such firms have a low probability of bankruptcy and hence have betteraccess to debt financing than low growth firms. The result is consistent with Bhaduri(2002). In addition, evidence is found of a positive relationship between firms’ growthopportunities and institutional ownership. This may be because high-growth firmsbring more capital gains to institutional investors than lower growth firms. Tong andNing (2004) find the same result when they use the average sales growth rate as anindicator of growth rates.

7.1.7 Size (ln SIZE). The results show that there is a strong significant positiverelationship between firm size and leverage. This means that large Jordanian firms,being more diversified, are less likely to be susceptible to financial distress. This resultis in the line with the bankruptcy theory of capital structure. Other studies in thefinancial literature find the same result (Bhaduri, 2002; Booth et al., 2001; Rajan andZingales, 1995). In addition, there is strong evidence of a positive relationship betweeninstitutional ownership and firm size. Large firms have the required resources andability to minimize the risk of their stock investment and hence are less subject tofinancial distress and bankruptcy risk. The evidence suggests that institutionalinvestors would prefer to invest in large firms.

7.2 The relationship between ownership structure and capital structureThe results indicate that there is strong evidence of a negative significant relationshipbetween leverage of the firm and the institutional ownership. This means thatinstitutional owners have a significant effects as regards monitoring the firm’smanagers and hence reducing the agency problems. Chaganti and Damanpour (1991),Grier and Zychowicz (1994), Bathala et al. (1994) and Crutchley and Jensen (1996) findthe same result. The result is consistent with agency theory and so institutionalinvestors would prefer to invest in firms with low leverage ratios. However, Tong andNing (2004) find only limited evidence that institutional investors in the USA prefer toinvest in firms with low debt ratios[2].

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8. Summary and overall conclusionsThis study investigated the interaction between ownership structure and capitalstructure using data relating to Jordanian non-financial firms. Firms selected for thestudy had to have maintained their identity and reported their annual accounts withoutany significant gaps for the financial years 1994-2003. There were 86 non-financialfirms selected as a sample for this study. The study estimated both interdependent andreduced-form equations using pooled and panel regression analysis in order toinvestigate the determinants and the joint determinants of capital structure andownership structure.

The results show that the Jordanian firms are subject to the same determinants ofcapital structure as firms in developed markets, namely: profitability, firm size, growthrate, MB ratio, asset structure and liquidity. In addition, the structure of institutionalownership was found to be determined by: asset structure, BR, growth opportunitiesand firm size. Moreover, the results reveal that asset tangibility, firm size, growthopportunities and BR are considered to be joint determinants of ownership structureand capital structure.

Myers (1984, p. 575) asked the question ‘‘how do firms choose their capitalstructures?’’. His answer was ‘‘we do not know’’. We can argue that our results supportthe view that capital structure is still a puzzle because there is still no clear theoreticalexplanation of how firms choose between the different methods of financing. Inaddition, our paper addresses another puzzle: that of the relationship between capitalstructure and ownership structure. What is clear is that theoretical puzzles still remainand that empirical results are not yet sufficiently consistent to resolve them.

Notes

1. The BR variable is the standard deviation of the ROA, i.e. different for each firm butconstant throughout the period analysed. Because of the lack of variation through time,the BR variable cannot be included the panel effects models. Thus, only the pooledmodel can be used to model the effects of BR.

2. The pooled model in Table II shows mixed results: a negative relationship between thenumber of shares owned by institutions and a positive relationship between percentageof institutional ownership and the leverage of the firm. This would indicate mixedevidence of institutional investors preferring firms with a higher leverage ratio. Thisresult is inconsistent with agency theory that predicts a negative relationship. It can beargued that the institutional owners can act as managers in the board of directors in thefirm, and hence the institutional ownership is the same as managerial ownership.Accordingly, this result is consistent with Leland and Pyle (1977), Berger et al. (1997) andChen and Steiner (1999) who show that managerial ownership and leverage arepositively related. Alternatively, the Hausman test rejects the pooled model in favour ofthe panel data models, both of which indicate a negative relationship.

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Further reading

Homaifar, G., Zietz, J. and Benkato, O. (1994), ‘‘An empirical model of capital structure: some newevidence’’, Journal of Business Finance & Accounting, Vol. 21, pp. 1-14.

Huang, S.G. and Song, F.M. (2002), ‘‘The determinants of capital structure: evidence from China’’,Working Paper No. 1042, Hong Kong Institute of Economics and Business Strategy,Hong Kong.

Voulgaris, F., Asteriou, D. and Agiomirgianakis, G. (2004), ‘‘Size and determinants of capitalstructure in the Greek manufacturing sector’’, International Review of Applied Economics,Vol. 18, pp. 247-62.

Corresponding authorBasil Al-Najjar can be contacted at: basil2.al-najjar@uwe.ac.uk

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