Relationship Between Capital Structure And Credit Rating:a Study Of Banking Sector Of Pakistan

Credit rating and capital structure is an issue of great concern from last decades.Credit Rating is very sensitive matter of corporations and also for the countries, ratingagencies evaluates them on some specific information and this rating help the investor tomake a choice for investment in different securities mostly in bonds securities. In capitalstructure firms are always confused that at what proportion they financed through equityor debt. There is no universal theory of the debt-equity choice, no reason to expect one.The main purpose of this research is to check the bilateral effect of one of the part ofcapital structure (debt) on credit rating and also to investigate that how credit ratings helpin the formation of optimal capital structure decision through different factors like capitalstrength, profitability, liquidity, expense management, asset quality and size in thebanking sector of the Pakistan.This study applies econometrics modeling and in this model Credit rating asdependent variable and capital structure is independent variable. We collect a sample of20Pakistani banks for the period from2006to2010. Granger causality test is applied tocheck the unilateral or bilateral effect of credit rating and capital structure. Regressionanalysis was applied to check the relationship of determinants of both credit rating andcapital structure.Unilateral Causality is found that is directed from credit rating to capital structure. Sixspecific banks variables are Capital Strength, Profitability, Liquidity, ExpenseManagement, Asset Quality and Firm Size are used as determinants of credit rating. Theresults, except for Asset quality, were found to be significant. Five exogenous variableshas chosen Working capital to total assets, Retained earnings to Total assets Earningsbefore Income&Tax to total assets, Market value of Equity to Book value of totalLiabilities and Firm size and further analyzed their effect on Capital structure. Amongthese variables all were found to be significant, except Working capital to total assets.