Examining The Capital Structure Determinants: Empirical Analysis of Companies traded on Abu Dhabi Stock Exchange.

Dr. Nejla Ould Daoud Ellili Finance Department, University of Abu Dhabi, UAE E-mail: nejla.ellili@adu.ac.ae Tel: +971 2 5015720; Fax: +971 2 5015990 Dr. Sherine Farouk Accounting Department, University of Abu Dhabi, UAE E-mail: sherine.farouk@adu.ac.ae Tel: +971 2 5015654; Fax: +971 2 5015990

Abstract: The choice of the financial policy is one of the most important decisions that the company will ever take. It consists on determining the optimal capital structure of the companies. Recently, the capital structure has increasingly gained importance sine many companies have experienced financial distress and bankruptcy caused by the last financial crisis, it has drawn the interest of many researchers and it was a subject of considerable debate in both theoretical and empirical studies. This paper analyzes the explanatory power of some of the theories that have been proposed in the literature to explain changes the in the capital structures across companies. In particular, this study investigates capital structure determinants of Emirati companies based on a panel data set over 2008 and 2009 comprising 33 companies from different industries. In the literature, there are many potential factors that could affect the capital structure such as: the tangibility (asset structure), the non-debt tax shield, the profitability, the size, the expected growth, the uniqueness, the income variability, the time dummies, the industry classification dummies). The purpose of this study is to examine the link between a number of potential capital structure determinants and the debt level of the Emirati companies. In the financial literature, there are several measures of the financial leverages (long-term, short-term, and convertible debt divided by market and book values of equity) but because of the non availability of the data, we will limit our study to the leverage measures in terms of the book values rather than the market ones. Our book leverage measures are decomposed into short-

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term and long-term debt ratios to highlight the magnitude of the components of the capital structure. At the first look of the capital structure of the Emirati companies, we can easily confirm that they are on average highly leveraged but it stays to determine the relationship between the potential determinants of the capital structure and the different leverage measures. Keywords: Capital structure, Agency Theory, Informational Asymmetry, Pecking Order, Trade-Off JEL Classification: C21, G32, G34.

1. Introduction: This paper examines the explanatory power of the theories proposed in the financial literature to explain the variations in capital structures across companies. In particular, this study analyzes the capital structure determinants of Emirati companies based on a panel data set over 2008 and 2009 comprising 33 companies. At the first look of the capital structure of the Emirati companies, we can easily confirm that they are highly leveraged. Our analysis of the capital structure is not only based on total debt ratios, but also based on short-term and long-term measures of the leverage. Hence this study will utilize panel data regression analysis to empirically examine the impact of different determinants on three leverage measures: total debt ratio, short-term debt ratio, and long-term debt ratio. To our knowledge, there is no single analysis conducted on the capital structure determinants of the
UAE firms and taking into consideration, among others, the effects of the industry classification, the research and development expenses, the managerial ownership and the age of the company. Therefore, our analysis provides the first insight regarding this topic.

This paper proceeds as follows. In section 2, we provide an overview of capital structures explanatory theories, in section 3, we present the potential determinants of the capital structure. In section 4, we explain the data, variables and econometrical methodology. In section 5, we present and discuss the empirical results of the study and we conclude in section 6. 2. Literature Revue: The capital structure is the mix of debt and equity maintained by a company. The determination of the capital structure has been one of the most controversial topics in the finance since Modigliani and Miller (1958) introduced their capital structure irrelevance theory. In brief, the MM states that the value of the company is independent from its corporate financing decisions under certain conditions (no taxes, no transaction costs, no bankruptcy costs, perfect contracting assumptions, an efficient and a perfect market assumption). To address some of the imperfections of the irrelevance theory, Modigliani and Miller (1963) relaxed the assumptions related to taxes and showed that their model is no more effective since
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debt interest payments are deductible from taxes (tax- shield) and lead to a rise of in the value of the company. However increasing debt results in an increased probability of bankruptcy. Hence, the optimal capital structure represents a level of leverage that balances the bankruptcy costs and the benefits of the debt finance. The next step of the capital structure theory was the introduction of the personal taxes. In fact, Miller (1977) argued that the personal taxes reduced but does not eliminate the benefits of debt financing and the leverage gains may not be as great as previously. More recently, the capital structure was revisited by many theories: the agency cost (2.1.), the signaling (2.2.), the informational asymmetry (2.3.), the static trade-off (2.4.) and the pecking order (2.5.).

2.1. The Agency Cost Theory: Jensen and Meckling (1976) were the pioneers in introducing the agency theory and in relaxing the assumption of no conflict of interest between the managers (agent) and the shareholders (principal). In particular, the managers do not always act in the interest of the shareholders and consequently the goal is not always to maximize the value of the company. This conflict of interest will create agency cost that may be reduced by a choice of a capital structure. More particularly, a higher leverage reduces the agency costs of outside equity and increases the firm value by constraining the managers to act more in the interests of the shareholders. 2.2.The Signaling Theory: Ross (1977) introduced the notion of signaling in the capital structure theory. According to this theory, the managers know the true distribution of the firm returns, but investors do not. He argued that higher financial leverage can be used by the managers to signal an optimistic future of the firm since the debt is a contractual obligation to repay both principal and interests. The failure to make those payments could lead to bankruptcy and by consequence the managers would lose their jobs. Therefore adding more debt to the capital structure could be interpreted as a good signal of the managers optimism about their firms. In a related study, Leland and Pyle (1977) argue that the higher is the managerial ownership in the capital of the company, the larger is the debt capacity. Such strong ownership is highly recognized by the bondholders and signals confidence in the company future investments. 2.3. The Informational Asymmetry (Adverse-Selection)Theory: Myers and Majluf (1984) assumed that firm managers have more information about the true value of the company than the investors. Managers will therefore time a new equity issue if the market price exceeds their own assessment of the stock value if the stocks are overvalued by the market. Since investors are aware of the existence of the information asymmetry they will

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interpret the announcement of an equity issue as a signal that the listed stocks are overvalued, which subsequently will cause a negative price reaction 2.4. The Static Trade-Off Theory: The trade-off theory has dominated the capital structure literature. The tax benefitbankruptcy cost trade-off models predict that firms seek to maintain an optimal capital structure by balancing the benefits and the costs of debt (DeAngelo and Masulis, 1980). The benefits include the tax shield whereas the costs include expected financial distress costs. This theory predicts that firms maintain an optimum capital structure where the marginal benefit of debt equals the marginal cost. The implication of the trade-off model is that firms have target leverage and they adjust their leverage toward the target over time. 2.5. The Pecking Order Theory: The pecking order theory is based on the idea of asymmetric information between managers and investors. Managers know more about the true value of the firm and the firms riskiness than less informed outside investors and this affects the choice between internal and external financing (Myers and Majluf, 1984 and Myers, 1984). To avoid the problem of underinvestment, the managers seek to finance the new project using a security that is not undervalued by the market, such as internal funds or riskless debt. The pecking order theory is able to explain why firms tend to depend on internal sources of funds and prefer debt to equity if external financing is required. 3. The potential determinants of the capital structure: In this section, we present the different factors determined by the capital structure theories and that may affect the financial leverage choice. According to Harris and Raviv (1991), the debt ratio increases with fixed assets, non-debt tax shield, growth opportunities and firm size and decreases with volatility and profitability. While Titman and Wessels (1988) confirm that asset structure, non-debt tax shields, growth, uniqueness, industry classification, size, earnings volatility, and profitability are factors that may affect leverage according to different theories of capital structure. Even when there is no consensus in the financial literature, the most common cited factors are: asset structure (tangibility) (3.1.), non-debt tax shield (3.2.), the profitability (3.3.), size (3.4.), expected growth (3.5.), uniqueness (3.6.), operating risk (3.7.), industry classification (3.8.), managerial ownership (3.9.) and the age of the company (3.10.). 3.1. The asset structure: The asset structure plays an important role in determining the capital structure. According to Harris and Raviv (1991) and Titman and Wessels (1988), the higher is the tangibility of the asset, the better is the company liquidation value. In fact, the tangible assets are considered as collateral for the debt and in case of bankruptcy, they have higher value than the intangible assets

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(Jensen and Meckling, 1976; Myers, 1977; Abor, 2008). By pledging the firms tangibles assets as collateral, the cost associated with adverse selection and moral hazard are reduced. 3.2. Non-debt tax shield: In the literature, the impact of taxation on the leverage is ambiguous. On the one hand, the trade-off theory predicts that the companies have incentive to take debt since they can benefit from the tax shield. On the other hand, DeAngelo and Masulis (1980) argue that tax deduction for depreciation and investment tax credits are substitutes for the tax benefits of debt financing. As a result, the companies with large non-debt tax shield include less debt in their capital structure. In our analysis, the non-debt tax shield factor will not be included in our analysis since in the United Arab Emirates, there is no taxation. 3.3. Profitability: The financial literature provides conflicting evidence on the relationship between the companys profitability and the companys capital structure. According to Myers and Majluf (1984), the companies have a pecking order in the choice of financing their activities and the relationship between the leverage and the profitably is negative since the internal funds are more preferred than the debt. In consequence, there is a negative relationship between the firms profitability and the level of its debts. However, the more profitable companies are, in general, more able in tolerating high level of debt since they may be in a good position to meet easily and on time their financial obligations, therefore, they can easily add more debt in their capital structure (Peterson and Rajan, 1994). 3.4. Size: In the financial literature, there is no consensus on the impact of the companys size on the capital structure decisions and the nature of the relationship is still unclear. From one side, Titman and Wessels (1988) and Rajan and Zingales (1995) confirm that there is a positive relationship between the size and the leverage. Titman and Wessels (1988) argue that the larger companies are more diversified and have lower variance of their earnings, making them able to tolerate high debt ratios. Rajan and Zingales (1995) argue that the larger companies should have lower debt because of less asymmetric information. From the other and according to the pecking order theory, there is a negative relationship between the size and the leverage because the larger companies are more closely observed and they should be more able to issue equity. 3.5. Expected growth: The relationship between the expected growth and the capital structure is ambiguous. First of all and according to the pecking order theory, the relationship between the growth and the leverage is positive since higher growth opportunities implies a higher demand of fund through the preferred source of debt. On the other hand, Myers (1977) argues that due to the agency

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problems, firms investing in assets that may generate high growth opportunities in the future face difficulties in borrowing against such assets. 3.6. Uniqueness: In the financial literature, there is a consensus on the negative relationship between the uniqueness and the leverage. According to Titman and Wessels (1988), the more unique the companys asset, the thinner is the market for such asset and a lower value recoverable by the lender in case of bankruptcy. In consequence, the companies with high research and development expenses may use less debt in financing their activities. 3.7. Operating risk: The operating risk is caused by fluctuations of operating income and it depends on variability in demand, sales price, input prices, and amount of operating leverage. In the financial literature, there is a consensus on the negative relationship between the operating risk and the debt ratio (Titman and Wessels, 1988; Frank and Goyal, 2007). According to Frank and Goyal (2007), the firms with more volatile cash flow face higher expected costs of financial distress and should use less debt in the objective of maintaining a moderate total risk profile. 3.8. Industry classification: The relationship between the capital structure and the industry classification has been the subject of both theoretically and empirical research. In their review of the capital structure literature, Harris and Raviv (1991) noted that it is generally accepted that firms in a given industry will have similar leverage ratios while leverage ratios vary across industries. Empirically, the regression results of Abor (2008) indicate clearly that the industry effect is important in explaining the capital structure and that there are variations in capital structure across the various industries. The agriculture, pharmaceutical, medical, manufacturing, construction and mining industries are more likely to use the long term debt while information and communication, wholesale and retail trade industries are more likely to use short-term debt. 3.9. Managerial ownership: In the corporate governance literature, the financial policy seems to be a device helping the managers to entrench themselves rather than to be a mechanism of control. Harris and Raviv (1988) affirm that the managers increase the debt ratio in order to reinforce their control. In fact, the managers try to change the capital structure of the firms to control a large fraction of voting rights. Novaes and Zingales (1995) and Zwiebel (1996) confirm that the threat of a takeover forces the managers to issue debts and to prove their alignment. By the issue of bonds, the managers avoid investing in projects with a negative net present value in order to decrease the bankruptcy risk. Contrary to the previous studies, Amihud and Lev (1981) affirm that the managers having a non diversifiable human capital are more interested in minimizing their risk of employment through the viability of the firms by reducing the debts. In the same kind of
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results, Berger, Ofeck and Yermack (1997) find that the entrenched managers avoid the debts and, more particularly, the relationship between the managerial ownership and the debt ratio of the firms is curvilinear. Specifically, for a low level of managerial ownership, the interests of the managers are aligned on those of the shareholders leading to a high level of debts. However, for a high level of the managerial ownership, the level of debt is low. 3.10. The age of the company: In the financial literature, the age of the company is considered as an important determinant of the capital structure. The longer is the company in business, the higher is its ability in taking on more debt, and therefore there is a positive relationship between the age and the leverage. In general the older companies have stronger reputation and good name built up over the years. The managers concerned with the reputation of their companies tend to act more prudently and avoid risky projects ensuring by consequence a higher quality (Peterson and Rajan, 1994). 4. Data and Methodology: 4.1. Data: The objective of this paper is to determine the potential factor affecting the capital structure of the companies listed on Abu Dhabi Stock Exchange (ADX) using data over 2008 and 2009. The data was hand collected and the choice of the companies was based on the availability of data. The number of firms included in our analysis is 33. The banks and the financial institutions were excluded from our sample because of their specific financial activities and their supervision under the central bank. 4.2. The variables choice: The data used in our analysis can be divided into two groups: the capital structure determinants variables (4.2.1.) and the capital structures variables (4.2.2.). 4.2.1. The capital structure determinants variables: In our analysis, we take eight potential capital structure determinants as presented by the following table: Table 2: The capital structure determinants variables: Variables Notation Measures (Proxy) Expected impact Asset Structure Profitability Size Expected Growth Uniqueness
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AS PR SZ GR UN

Total Fixed Assets/ Total Assets (Harris and Raviv, 1995) EBIT/ Total Assets (Song, 2005) Log (Total Assets) (Titman and Wessels, 1988) Percentage change in Total Assets (Song, 2005) Research and Development expenditures/

+ Ambiguous Ambiguous Ambiguous -

Operating Risk

OR

Industry IC Classification Managerial MO The part of the capital held by the manager Ownership (Berger, Ofeck and Yermack, 1997) Age of the AGE The number of years in business Company (Peterson and Rajan, 1994) Note: EBIT is the abbreviation of Earning Before Interest and Taxes.

Sales (Titman and Wessels, 1988) Standard Deviation of EBIT/ Total Assets (Song, 2005) Dummy variable

Different Curvilinear +

4.2.2. The capital structures variables: In our analysis, the capital structure is the dependant variable and it is measured by the leverage. To examine the source of debt in more details, the total leverage is decomposed into short-term leverage and long-term leverage (as presented by Table 1). This decomposition provides more information about the magnitude of the leverages components (Song, 2005). Table 1: The capital structures variables: Variables Notation Total Leverage TL Short-Term Leverage Long-Term Leverage STL LTL

Measures Total Liabilities/ Total Assets (Rajan and Zingales, 1995) Short-Term Debt/ Total Assets (Song, 2005) Long-Term Debt/ Total Assets (Song, 2005)

4.3. Methodology: This study employs multivariate regression analysis of panel data to measure the impact of the different factors on the firms capital structure. The panel data analysis helps to explore cross-sectional and time series data simultaneously. The general form of model is: LEV it= 0 + 1AS it + 2PR it + 3SZ i+ 4GR it + 5UN it + 6OR it + IC+ 8MO + 9 MO2+ 10 AGE + t The above model tests the following null hypothesis there is no significant impact of the factors upon the capital structure choice. The dependent variable is the leverage (total leverage, short term leverage and long term leverage) and the independent variables are the different factors previously determined (Asset Structure, Profitability, Size, Expected Growth, Uniqueness, Operating Risk, Industry Classification, Managerial ownership and the Age of the company).

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5. Empirical results: 5.2. Descriptive statistics: Table 6 provides a summary of the debt ratio by industry. On average, the real estate companies have the highest total and short term debt ratios, 65.07% and 33.80%. The higher debt ratio of the real estate companies means that they borrow more than the companies of other industries. The construction companies have the lowest total debt ratio, 20.79%, while the energy companies have the lowest short term debt ratio, 4.50%, and the highest long term leverage, 57.19%. This means that the energy companies are more interested in financing their activities by the long term debts. The consumer companies have the lowest long term debt ratio, 6.43% indicating that those companies avoid the long term debts.
Table 6: Debt ratios by Sector (%) Sector Definition Sector 1 Telecommunication Sector 2 Construction Sector 3 Consumer Sector 4 Health care Sector 5 Industrial Sector 6 Energy Sector 7 Real state

Number of firms 4 10 8 2 4 3 2

TL 32.23 20.79 19.06 38.67 55.52 61.69 65.07

STL 18.74 9.98 12.63 16.77 31.78 4.50 33.80

LTL 13.49 10.80 6.43 21.89 23.74 57.19 31.27

Table 7 below provides summary statistics of the mean, standard deviation, minimum and maximum of all the variables for both dependant and independent variables. Table 7: Descriptive statistics for all variables: Variables Mean Std. Dev. 0.5898 .2679 AS 0.0551 0.0562 PR 7.584 1.4965 SZ 0.3109 1.7674 GR 0.0124 0.0563 UN 0.5406 2.9407 OR 0.0436 0.1431 MO 20.0606 12.0076 AGE 0.3609 0.2475 TL 0.1724 0.1432 STL 0.1885 0.2147 LTL

Min 0 -.0787 4.057 -.9989 0 .0003 0 3 0.0113 0 0.0012

Max .9768 .2169 9.7167 10.0028 .3166 16.92 0.7408 37 0.8649 0.6011 0.771

Table 8 below shows the correlation matrix of the independent variables. As shown in the table, the highest correlation coefficient is (-0.4321) between the asset structure and the expected growth. All the other correlation coefficients are less than 0.4 which means that there is no multicollinearity problem. In addition, the results show that the size is positively correlated to the profitability, while the asset structure and the growth opportunities have negative correlations with the profitability. This implies that larger companies tend to have higher profitability; and profitable companies tend to have fewer tangible assets and less growth opportunities.
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Table 8: Correlation Matrix for the variables: AS PR SZ GR UN OR MO AGE 1.0000 AS -0.2118 1.0000 PR -0.0360 0.0921 1.0000 SZ -0.4321 -0.0114 0.0547 1.0000 GR 0.1910 -0.1225 -0.1377 -0.0411 1.0000 UN 0.2021 -0.1674 -0.3143 -0.1353 -0.0317 1.0000 OR 0.2072 0.0438 0.3132 0.0051 -0.0716 -0.0575 1.0000 MO 0.1188 0.1244 0.3845 -0.2259 -0.2277 -0.2530 0.1174 1.0000 AGE 5.3. The regression results: Here we present the results of the regression of three models. An important part of the analysis below is to separate between the short term and the long term leverages. Therefore, each of the tables below will show the regression results for the total leverage, short term leverage and long term leverage in the objective of detecting any difference between short term and long term leverage. Table 9: The Regression Results Dependent Variables Independent Variables Total Leverage Short-Term Long-Term Leverage Leverage (t statistics) (t statistics) (t statistics) Constant Asset Structure Profitability Size Expected Growth Uniqueness Operating Risk
Telecommunication Construction Consumer Health care

0.0107 (-1.19) 0.9265 (1.50)* -0.4307 (-1.06) 0.0423 (1.28) 0.0339 (1.00) 0.0847 (1.18) 0.0029 (1.68)* -0.5906 (-1.25) 0.2896 (1.26) -0.2389 (-1.94)** -0. 5807 (-1.20)

0.3644 (1.47)* -0.1201 (-1.10) 0.3891 (1.90)** 0.0190 (1.98)** -0.0285 (-1.43)* 0.0280 (1.07) 0.0023 (1.23) 0.1340 (1.97)** -0.3022 (-2.24)** 0.3016 (2.02)** 0.2425 (1.44)*

0.3535 (1.10) 0.2128 (1.51)* -0.4324 (-1.77)** 0.0232 (1.93)** 0.0624 (2.44)** 0.8195 (1.50)* 0.0271 (2.03)** -0.0749 (1.42)* 0.0126 (1.07) -0.0627 (1.33)* -0.1843 (1.85)**

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Industrial Energy Real state Managerial Ownership (Managerial Ownership)2 Age of the Company R Square R Square Adjusted Inflection Point

0.1592 (1.63)** -0.1031 (-1.01) 0.3423 (1.08) -5.3555 (-1.44)* 18.0883 (1.58)* -0.0056 (-1.11) 0.6973 0.3297 14.80%

-0.1177 (-1.80)** -0.2436 (-1.13) -0.2452 (-1.31)* -1.0426 (-1.65)* 4.5096 (2.31)** -0.0004 (-0.55) 0.6489 0.2226 11.56%

0.2769 (1.45)* 0.2425 (1.88)** 0.5876 (2.43)** -2.0089 (-1.17) 3.9688 (1.23) -0.0051 (-1.61)* 0.8165 0.5936 25.31%

*Significant at a level of 10% ** Significant at a level of 5%. As we can see from the above table, the coefficients of the asset structure are different from one model to another. More particularly, the asset structure has a positive and significant impact at a level of 10% on both the total leverage and the long term one. While the impact of the asset structure on the short leverage is negative and not significant. This finding is consistent with the empirical result of Song (2005) confirming that, in general, there is a respect of the maturity matching principle: the fixed assets are financed by the long term debts and the current assets are financed by the short term debts. The profitability is negatively correlated to both total leverage and long term one. Only the impact on the long term leverage is significant at a level of 5%. This finding is consistent with the predictions of the pecking order theory confirming that the companies prefer using the surplus generated from their profit to finance investments. Therefore, the companies may prefer using their internal funds rather than external funds in financing their assets. The impact of the profitability on the short term leverage is negative and significant at 5%. This finding indicates that the more profitable companies may use the short term debts in financing their operating activities and use the long term debts in financing their investments. The size has a positive impact on all the leverages. Only the coefficients of both models of short term leverage and long term leverage are significant at 5%. This finding is consistent with the result of Titman and Wessels (1988) arguing that the larger companies are more able to tolerate high debt ratios. The expected growth of the company has a positive impact on both total leverage and long term leverage (only the coefficient of the long term leverage model is significant at a level of 5%), while the impact on the short term leverage is negative (the coefficient is significant at 10%). This result is consistent with the predictions of the pecking order theory confirming that the relationship between the growth and the leverage is positive since higher growth
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opportunities implies a higher demand of fund through the debt. More particularly, the companies do prefer financing their growth by the long term debt rather than the short term debts. The uniqueness is positively correlated to all the three leverage (only the coefficient of the long term leverage model is significant at a level of 5%). This result shows that the research and development expenses are not significant factor that may affect the total leverage or the short term leverage but it does affect the long term leverage. This finding is not consistent with the result of Titman and Wessels (1988) and show that the companies with unique products or services do not have difficulties in adding the long term debts in their capital structure. It could be explained by the contribution of the research and development in increasing the long run performance of the companies. The operating risk of the company has a positive impact on all the leverages but approximately zero. The coefficient of the total leverage model is significant at 10% while the one of the long term leverage model is significant at 5%. This finding is absolutely different from the predictions of the trade-off theory (more volatile cash flow and higher probability of default). This may be due to the time period studied (2008 and 2009) coincided with an economic recovery after the global financial crisis. Regarding to the impact of the industry classification on the leverage, we can divide the different industries into three major groups. The first group contains Telecommunication, Consumer and Health Care. The second group contains Construction, Industrial and Real Estate and the third group contains only Energy. For the first group, the industry classification has a negative impact on both total leverage and long term leverage (the coefficients of all the industries are significant at least at 10%), while the impact on the short term leverage is positive (the coefficients of all the industries are significant at least at 10%). This finding suggests that all the Telecommunication, Consumer and Health Care sectors depend more on short term debts and this not surprising since the activity of all these sectors is based on providing short term products or services. The second group of industries has a positive impact on both total leverage and long term leverage but the impact on the short term leverage is negative (the coefficients of all the industries are significant at least at 10%). This finding suggests that the industries of Construction, Industrial and Real Estate do not depend on the short term leverage. This result is not also surprising since these sectors are providing long term products or services. The third group of industries has a negative but not significant impact on both long term leverage and short term leverage, only the impact on the long term leverage is positive and significant at 5%. This result is not surprising in UAE where the government sees the energy as very strategic to the growth of the economy and as such, needs much support through long term debts. The results of both the long term leverage and the short term leverage show that both coefficients of the managerial ownership and the squared managerial ownership are significant at least at a level of 10%. In the three models, the coefficient of the managerial ownership is negative whereas the coefficient of the squared managerial ownership is positive. These results corroborate the finding of Berger, Ofeck and Yermack (1997) who have confirmed that the
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relationship between the managerial ownership and the debt ratio of the firms is curvilinear. More particularly, for our sample, we found that for a low level of managerial ownership, the interests of the managers are not yet aligned on those of the shareholders leading, in consequence, to a low level of debts. However, for a high level of the managerial ownership, the managers are more committed in improving the performance of their companies and therefore they are more interested in adding more debt in the capital structure of their companies. The calculations made on the coefficients of managerial ownership and the squared managerial ownership show that the points of inflection are respectively 14.80% for the total leverage1, 11.56% for the short term leverage and 25.31% for the long term leverage. From the regression results, the age affects negatively but not significantly the leverage of the company (only the coefficient of the long term leverage model is significant at a level of 5%). Our finding is not consistent with the result of Peterson and Rajan (1994) confirming that, in general, the longer companies are able to take more credit because of their reputation and their good name in business. For our sample, the age seems to not be very important in the choice of the debt level in the capital structure. In addition, the longer companies are not interested in getting more long term debts and this result could be explained by the fact that those companies got already enough long term debts in that past years. Conclusion: This paper provides the first empirical evidence regarding the capital structure determinants of UAE firms. It tests several predictions on leverage using data of Emirati companies traded on Abu Dhabi Stock Exchange. Overall, the companies exhibit different financing behavior from each other. The asset structure was found to have a positive relationship to the long term debt but negative to the short term debts. This finding shows clearly that the companies match the duration of assets and liabilities by financing the fixed assets with the long term liabilities and the current assets by the short term liabilities. We also found that the profitability is negatively correlated to the long term leverage and positively correlated to the short term leverage. This result reveals that the profitable companies use their internal funds in financing their long term investments and use the short term debt in financing their operating activities. The size has a positive impact on all the leverages which confirms that the larger companies are, in general, more able to tolerate high debt ratios. The expected growth of the company has a positive impact on the long term leverage and a negative impact on the short term leverage. This result confirms that the companies do prefer financing their growth by the long term debt rather than the short term debts. The uniqueness is positively correlated to all the three leverage because of the contribution of the research and development in increasing the long run performance of the companies. The operating risk of the company has a positive impact on all the leverages and this
1

The point of inflection is determined as follows: supposing that all the other variables are constant and noting he managerial ownership by X: Q = -5.3555 X + 18.0883 X . The Point of inflection is found by deriving Y (TL) by X, yx=0 and solving the equation.

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may be due to the time period studied (2008 and 2009) coincided with an economic recovery after the global financial crisis. The impact of the industry classification on the leverage is different from one industry to another. Overall the industries of Telecommunication, Consumer and Health Care depend more on short term debts while the industries of Construction, Industrial, Real Estate and Energy depend more on long term debts. In addition, we have determined the impact of the ownership structure, and more particularly of the managerial ownership, on the leverage of the companies and we found a non curvilinear relationship between both variables. Our results confirm that a low managerial ownership is associated to low leverage and a high managerial ownership is associated to a high leverage. For the companies traded on ADX, the age seems to not affect the short term leverage of the company while it affects negatively the long term leverage. Therefore, the longer companies are not interested in more accumulating long term debts in their capital structure. The results of this study have delivered some insight on the capital structure of companies traded on ADX since the choice of the capital structure is an important financing decision that the companies have make. We believe that our analysis contributes to the literature on the relationship between the managerial ownership and the leverage of the companies. Our non linear function strengthens the power and the insight gained from the previous studies. We provide evidence that the managers do not prefer issuing debt unless they hold a relatively a high part in the ownership of their companies. Future work in this area may focus on other structural aspects that can influence the choice of the capital structure of the firm such us: the blockholders ownership, the institutional ownership and the board of directors.

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References: [1] Abor, J. (2008). Industry classification and the capital structure of Ghanaian SMEs. Studies in Economics and Finance 24(3): 207-219. [2] DeAngelo H. and Masulis, R. (1980). Optimal Capital Structure under Corporate and Personal Taxation. Journal of Financial Economics 8: 3-29.
[3] [4] Frank M.Z. and Goyal, K.V. (2007). Trade-Off and Pecking Order Theories of Debt. Handbook of Corporate Finance: Empirical Corporate Finance 2: 1-82.

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