Capital Structure Decisions: Balancing Debt and Equity in the Pakistan Corporate Sector

Abstract

This study empirically investigates the determinants of capital structure and the applicability of theoretical frameworks for non-financial firms listed on the Pakistan Stock Exchange (PSX). Against a backdrop of macroeconomic volatility, high inflation, and a developing capital market, understanding how Pakistani firms balance debt and equity is crucial for corporate governance, investment, and policy. Utilizing a quantitative research design, a stratified random sample of 100 firms from five key sectors (Cement, Energy, Chemical, Automobile, and Textile) was analyzed over a ten-year period (2014-2023) using panel data regression techniques. The findings reveal a significant negative relationship between profitability and leverage, indicating that more profitable firms prefer internal financing, a core tenet of the Pecking Order Theory. Conversely, asset tangibility and firm size showed a positive and significant relationship with debt usage. The study also identified substantial sectoral disparities in leverage ratios. The results challenge the pure Trade-Off Theory, suggesting that the Pecking Order Theory provides a more descriptively accurate model of firm behavior in Pakistan’s unique economic context. The research offers practical implications for managers to prioritize internal funds and strategic debt usage, for investors to contextually interpret leverage ratios, and for policymakers to deepen capital markets and enhance stability to support robust corporate financing.

Keywords: Capital Structure, Trade-Off Theory, Pecking Order Theory, Leverage, Pakistan Stock Exchange (PSX), Corporate Finance, Firm-Specific Determinants