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Financing decision is one of the most critical and challenging job for financial managers to as it has a direst impact on the performance of the company therefore according to the managers of the pharmaceutical company there financial manager are always looking to maximize the share of the company in the market, maximize the share of all the stakeholders of the company. We have only two possible options to select that is to either finance our company by borrowing loan from bank or other financial institutions that is called DEPT financing and second is to use our own resources that we have which is called EQUITY financing.
Q2: What are the factors that affect the financing decision of the pharmaceutical companies of Pakistan?
H2: Profitability is negatively related to the debt financing decision. Q1: Does profitability affect the debt financing decisions?
The respondents strongly agreed that corporate performance as determined by the net income profitability does affect the financing decisions of firms (whether to use internal source of financing or external debt based financing). Because the net income indicates the financial strength of firm that how much wealth the firm has for its shareholders after interest and tax payments from the operating profit. So, it plays a key role in evaluating the sources of financing that the firm has sufficient profitability to meet its operating expenses otherwise short or long term debts are taken according to needs.
The pharmaceutical companies in our sample of study are all profitable firms so according to the financial managers of these firms they possess the ability to generate the required operating funds through internal sources such as having high retained earnings rather than opting for debt financing. One of the respondents further explained that in case of higher requirements of funds, when the firms profitability is not enough then they go for raising debt. However internal financing remains their first priority. This result is in line with the pecking order theory (Myers and Majluf, 1984), firms follow a financing hierarchy; they finance their investments first with internal funds, then external debt, and finally with equity as a last resort. Firms with high profitability can obtain high retained earnings. And if there is any financial deficit, firms would use internal fund rather than fund from outside. Hence the findings make our hypothesis true that higher the profit, lower will be the debt ratio of pharmaceutical firms. So profitability would be negative to firms leverage.
H2: Growth is positively related to debt based financing decision. Q1: Does growth affect the debt financing decisions?
Mix responses were obtained regarding impact of growth with debt financing decision. Managers agreed that when the firms grow they need immense funds to finance their growth plan so debt financing is considered. However according to some managers growth does not directly affect the debt financing because growing firms have themselves good earnings and market share that they do not need to take debt and in fact the firms financial position that lead to its growth is its indicator of not highly debited or risky firm. Further, firms with higher growth might need more cash to expand their business. Managers would reduce the level of debt to avoid huge interests. Whereas, the financial plan does include increase in leverage because of vast investments required for growth.
The results approve the above mentioned hypothesis that growth is positively related to debt based financing. According to the respondents, the pharmaceutical industry has shown a progressive growth over the years, particularly over the last one decade and hence the industry has used debt financing parallel with equity financing to invest substantially to upgrade itself in the last few years and today the industry is following Good Manufacturing Practices (GMP), in accordance with the domestic as well as international Guidance. This milestone was achieved by huge investment in updated technological equipments, talented human resource, as well as one of the major expenditure in pharmaceutical industry is in research and development that helps to continuously innovate for better health as per the vision and mission of company. For this, the respondents generally agreed that no matter the firms are highly profitable but growing firms have to incur heavy expenditures for above mentioned purposes particularly so they do need to make debt based financing decision after evaluating the feasibility of such financing decision. Hence, our findings are in contrary with Rajan and Zingales (1995), and Barclay and Smith (1996) who argue about negative relationship between growth and dbt financing decision.
H3: The asset tangibility is positively related to capital structure. Q1: Does asset tangibility (ratio of net property, plant, and equipment; PPE to total assets) affect the debt financing decisions?
To some extent the responses of financial managers affirms that the asset tangibility does affect the decision of financing by debt. Because when the asset structure comprises more of tangible assets so it allows the managers for easily getting debt on collateral of tangible assets.
Q2: Does asset tangibility affect debt financing decision positively or negatively?
The responses are in line with findings of Myers and Majluf (1984) that tangible assets have collateral ability and can thus be associated with higher debt capacity. So, higher
the asset tangibility, higher will be the liquidation value which indicated that asset tangibility is positively associated with debt financing decision and hence the hypothesis is true similar to findings of (Arrow (1985) Stulz and Johnson, 1985).
H4: The size of the firm is positively related to debt financing decision. Q1: Does size (sales revenue) of the firm affect the debt financing decisions?
The respondents agreed that size of the firm plays a vital role in making financing decision. Managers particularly consider the size of firm to evaluate the sources of financing. Because the financing decisions are very critical and also the size of firm has great significance so managers take size of firm into consideration when taking financing decision.
Q2: Does size (sales revenue) affect debt financing decision positively or negatively?
The responses about effect of size of firm on debt financing imply that the hypothesis is true that positive association is found between decision of debt financing and size of firm. As the size of firm measured by the sales revenue shows the performance of firm and if it is satisfactorily competitive in the industry so it enables the company to borrow at better conditions. However, if due to any reason sales revenue are not up to mark so the company comes under financial distress position and the creditor estimates higher risk of default in such scenario. Due to this, the cost of borrowing increases which does not encourage the managers much to borrow. Whereas, the big size firms, means firms with higher sales revenue have lower expected bankruptcy costs so accordingly they employ more debt than smaller ones. These findings of researcher are in line with results of previous studies (Harris and Raviv, 1990; Berger et al., 1997; Barelay and Smith, 1996; Bhaduri, 2002; Bevan and Danbolt, 2002).
Such as Small firms have small budget of employees, production, market, taxes and etc where as large firms have large budget of all these units, In Pakistan all the pharmaceutical
company are large in size, registered in Karachi stock exchange, recognized internationally, therefore financial managers while making financial plans keep all the point in their mind and after long study and discussion with the head office the formulate the financial plan.