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Dissertation on the Impact of Tax on Capital Structure

Info: 14727 words (59 pages) Dissertation
Published: 11th Nov 2021

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Tagged: BusinessFinanceInternational Studies


The paper seeks to view the impact of tax on the Serbian capital structure. Taxation has various implications to the corporate world, these implications in-turn affect businesses in many ways. These effects may negatively or positively influence the laid finance structures of corporate institutions. The study, therefore, is focused on evaluating these effects based on the laid policies and their impact on the Capital structure in Serbian corporate firms. Effects of tax vary from one country to another; this is because of the different business structures. The study is also focused on viewing the various determining factors and how they influence the capital structure in the Serbian business environment. The study is bent on outline all implications of tax and how the Serbian government is dealing with them.


Tax policies have been seen to affect the capital structures in most western countries. As a result, policy makers and various cabinet heads have opted for alterations in the tax system. Various policies put in place tend to have an impact on the financial structures one way or another. These effects may negatively or positively influence the laid finance structures of corporate institutions. The recent changes in the economy have brought more complications on the Serbian market dynamics which has caused negative effects to corporation’s administration, specifically the management sector. The study, therefore, is focused on finding out these effects as a result of the laid policies and their impact on the Capital structure in Serbian corporate firms (Jaelani La Masidonda, 2013). The reason for conducting a study on Serbia is due to the minimal studied on the subject. The small size of Serbia is also attractive given that it will be easier to collect samples within a short time.

Background on effects of tax on capital structure

Most governments raise revenue through tax and the Serbian government is not an exception. Globalization in this century has seen multi-billion corporations become a force to reckon with culturally, economically, politically and environmentally. Taxation is the most talked about areas when it comes to public finance it is among the main sources of government revenue (Margaritis, 2007). Tax policy is a rule by the government to decide on what, whom to tax and at what rate thus unifying the corporate world, the public and the government. When policies regarding tax are being made in Serbia and generally every country, various institutions are considered, since any policy relating to tax has an effect on the business sector. (Foo, 2011). The effects of tax are not similar in every country; this is because capital market structures differ from one environment to another. Capital structure refers to the adoption of a policy and decisions related to the use of finances and the resultant composition of the financial obligations of a company (Roberts, 2011).  The proposal is focused on finding relations between tax policy and capital structure hence arriving at the ultimate goal of the dissertation of determining the effects of tax policy on capital structure. The proposal will also explore and find out more about the determining factors and how they impact on the Serbian capital structure.

Tax policies in regions that have high interests rates have a relatively huge effect compared to regions will low interest rates (Awan and Amin, 2014). As such, the probability of corporation in these regions to issue debt is high. According to Rauh and Sufi (2010), large shifts are also experienced between public and private companies when debt cost is relatively low. Firms are operating with more debt than equity and this has become the new normal since it serves as a motivation due to the allure of tax deductible interest paid on debt (Kamath and Kulkarni 2013). Borrowed money when invested back into the business helps in covering the production costs, which is beneficial to the growth and development of an organization.

Policymakers advocate for the reduction of tax rates on firms hence encourage lowering debts and firms are able to operate on more equity than debt, thus maximizing profit (Sufi, 2009). Their argument is that the lower the level of debt leads to reduced bankruptcy and aggregate risk in the economy. The research will use demand estimates to study the effect of corporate tax cut theoretically on firm financing choices (Chava, 2011). This discussion points out that, altering the corporate tax rate has no effect on the behavior of a firm’s issuance of debt. Due to this reason, companies are forced to stop borrowing from public entities and start borrowing from the private banks, and this change can be detected in the market when the levels of borrowing are high (Anhin and Wenhe 2014). These companies need loans and the loans are easily available in the private sector. Private sectors do not have much bureaucracy like the public sectors thus companies use them to secure business loans within a short period.

Since companies raise same debt amount in both the public and private borrowing sectors, the replacement does not, in the end, lead to a reduction in leverage ratio (Leary, 2009). However, other reasons may lead to tax improvement in the corporate world thus the effect on leverage becomes less important. According to Petrin (2010), the tendency of firms demanding for their dues is rapidly depreciating in cost. Large profitable corporations are associated with higher marginal tax rates, negligible risk; therefore cost associated with pre-tax borrowing is also very low for these corporations (Milic, Milosevic and Ercegovac, 2014). Looking at the ancient regression of monetary measures on policies, it is clear that incentives and cost differences are integrated (Demodaran, 2010). Tax impact is minimized on total usage of debt when the two sources of variations are divided.

Capital structure formation does not limit a firm to debt, financing the operations of a firm using debt is less profitable compared to other sources of funds such as sale of stock. There are also other factors to consider such as; debt characteristics, payment deadline and the costs of transaction involved and the asymmetric information.

Statement of the study

Tax policy has significant effects on the financial structure of an organization hence the need to understand how one’s business can be affected by a change in tax policy. The research aims at indentifying the effects of different tax policies and how firms can use the knowledge in making financial decisions.

Aims of the proposal

The research objective is to find how tax policy affects the capital structure of organizations. The specific objectives include:

  • To find out how tax policy affects the capital structure of an organization.
  • To find the relations between tax policy and capital structure.
  • To find the effects of tax policy.

Research problem

Due to features that are related to security’s cost, a company’s demand for a specific security is affected. Given that characteristics of unusual omission are of minimal importance, time fixed effects and characteristics of a firm are used to calculate the cost since these omitted characteristics are not accurate, there is no relationship between them and the imputed cost (Margaritis and Psillaki, 2010). According to Kaya (2014), these imputed costs are closely correlated with omitted characteristics. Studying the cost of debt equation in an upward movement, it shows that the coefficient is biased by this type of endogeneity.

According to Serdyuk et al (2012), the zero error mark is attained when the relationship between idiosyncratic characteristics of omission and debt cost is broken through imputation. The problem is solved when the relationship between measurement error and the imputed cost is broken. After imputation breaks the relationship, the constant of debt cost becomes zero (Berk, 2009). The rest of the coefficients may be biased depending on how they are related to the cost of debt. The three vulnerabilities in the calculation of debt arising from pre-tax cost are; measurement error, the omission of security characteristics and constant biases (Blouin, 2010). Demand and supply are constant determinants of pre-tax cost. Hence, the availability of cost of debt is directly dependent on the corporations’ demand for debt. There is an upward bias when calculating the impacts of pre-tax cost of debt.


As much as tax policies affect the finance structures of a firm, it still narrows down to how the policy influences the factor of supply and demand of a firm (Karacaovali, 2013). Established firms with increased margin rate are frontrunners in terms of future development and profitability hence less risk has a chance of borrowing at a low rate (Lupi and Myint, 2017). These corporations have less risk hence their major focus becomes development and growth to greater standards. This shows how developing firms are favored by the margin tax rate. It is also highlighted that firms with high margin tax rate are not affected by pre-tax capital debt like those with low margin tax rate (Fisher and Wassmer, 2014). However, when the pre-tax debt has gone beyond the normal rate, both firms with higher margin rates and that with low rates react with the same rate to ensure they make the most of the situation at hand. The effects of pre-tax cost debt lead to a rapid reduction in the demands of a firm (Gupta et al 2011). Current interest rate environment influences the reaction of both high margin rate and low margin rate firms when it comes to a pre-tax cost of debt.

Issuance choice rate becomes different for both high and low margin rate firms in the case of unusual rise of the pre-tax cost of public debt. Regardless of the size, profitability, and capital base, all firms will respond and will be affected by the tax. In short, in the business world tax is simply unavoidable, and the effects it has will be felt differently by each firm due to the structures corporations have which are not similar. The size of the firm will also play a major role in how the impact is going to affect the firm. The business environment will also matter as regions with low tax margin rate will favor firms operating in that environment as opposed to firms operating in areas with high tax margin. From the survey conducted, it can be concluded that tax rates affect the capital structure of firms.



The chapter seeks to analyze differences on effects of tax policy and how it affects the capital structure in transitioning economies, in this the Serbian economy. The literature review in this chapter is organized to include a theoretical framework related to the proposed study, reviews of empirical studies conducted on the topic. There will then be a summary covering every detail in this chapter at the end.

Theoretical framework for the study

Various policies formulated by policy makers have the resulting effect on the capital structures of firms (Akhtar and Muhammad 2011). In this section, the paper seeks to take a close look at the theoretical approaches that seek to explain how tax policy affects the capital structure of the Serbian economy. Among the theories include The Tradeoff capital structure model, the model of the Pecking order, Dynamic tradeoff model, Market timing theory, Static tradeoff theory and irrelevance theory by Modigliani and Miller. All these theories outlined above give their views or perspective of the literature in question.

Trade-off theory

In this model, arguments are based on the fact that a company weighs the options it has and chooses the amount of debt finance and the amount of equity finance to use in the daily operations (McLean, Pontiff and Zhao, 2013). According to Myers (1984), there is a balance between the cost of bankruptcy and debt (Oruç, 2009). The balance between bankruptcy cost and debt includes agency cost. Considering the current theories on the Capital structure, proposed theory by Modigliani and Miller on optimum capital trade structure and expenses of capital, the theories are closely related to the current theories. Conversely, a difference lies in the factors bringing changes to the usual cost of capital and the firm’s value. The initial article of Modigliani and Miller (1958), states that the inclusion of debt benefits had no relevance to the capital trade structure. Nonetheless, this was corrected by a new conclusion that inclusion of debt into the capital trade structure has a high value as opposed to the earlier conclusion. This theory points out that firms are partially financed by both debt and equity. It explores the benefits of financing with debt. An increase in debt results to a decrease in marginal benefits, whereas marginal cost increases. Hence a stable optimum firm will major on when deciding the financing amount to use as equity and debt.

Modigliani’s and Miller’s irrelevance theory

In this theory, all the problems and consequences associated with the capital market are irrelevant, the problems do not exist. Modigliani and Miller (1958) states; the capital trade structure is of no value to the firm in a problem free market environment. The instruments related to finance put into action by the firm are of no effect to the rate at which the firm produces products. A firm’s decision on investment has no impact on the value, especially when the decision is finance related. There is an assumption in the theory regarding the trading market; it assumes the market has no challenges; taxes and transaction cost.

The theory lays down perfect foundation for a firm to thrive in (Reddy, 2011). However, these assumptions are not close to the truth in the whole world. There is a perfect market that does not charge a fee on the transaction and does not have any costs on bankruptcy, no form of risk for firms, there is only a neutral form of tax the rest are simulated and no moral conduct for the manager. Since these assumptions cannot be applied in the real market, the theory only remains theoretical (Danso and Adomako, 2014). Hence it may not relate to happenings in the business world.

The theory of Market timing

The theory of Market timing is a new theory and therefore not tested widely in the financial market (Danso and Adomako, 2014). In this theory, firms tend to time their equity issue, and release new stock in the market when the stock value is high and buy new stock when the price are low (Mostafa and Boregowda, 2014). Hence this fluctuation of stock prices has some effect to the firm in capital structure. When relating to issuing equity, the equity market is an important tool of financial policy in the corporate world (Alti, 2004). The only important finding will be that during high market valuations, low leverage firms raise capital while high leverage firms raise funds in low markets.

According to Luigi and Sorin, (2009), firms only create market time to get capital for financing their projects. Baker & Wurgler (2002) puts forth another story which according to them the managers of firms does not need to time the market for stock purchase and release. To be in a position of explaining the empirical evaluations, both stories need to be adjusted. Luigi & Sorin (2009) are in coalition with the story of market picking by firm managers. In this theory, managers have the ability to time the market but are poor when differentiating between proper price and distorted market timing information. Baker and Wurgler (2002) made an analysis on market timing opportunities and found out that firms that raise funds in high valuations were firms with low leverage. While those that raised funds in low valuations were firms with high leverage (McLean, Pontiff and Zhao). They also concluded that fluctuation has great effects that these effects are carried to capital structures. Equity market timing guides the manager on the capital trade structure since the market timing theory does not include capitalization.

The model of Pecking order

The model assumes that all the market hindrances are all eliminated; the theory operates in a perfect market (Myers and Majluf 1984). In this theory, supply and demand factors are very essential, as they are the main determinants of debt (Mostafa and Boregowda, 2014).  Sheikh and Wang (2010) states that firms finance investments by using the cheapest sources, this way they in turn increase their value. In this theory, the preference of the firm determines where their source of finance is based (Chen, 2011). If the internal finance is inadequate, firms may acquire finance externally. When they do so, they do it in a way so as not to increase more cost of asymmetrical information (Luigi & Sorin, 2009).

In this theory, the decisions on finance in these corporate firms are catapulted by financing cost (Danso & Adomako, 2014). The situation here is that issuers of debt have no exposure to information asymmetry and debt is given first priority before equity (Anderson and Nayar, 2010). According to Kim and Stulz (1988) immediately debt issue is announced also share price increases. When making decisions in relation to capital structure, transaction costs cannot be ignored as they play an important role (Vranjes and Milenic, 2014). These costs are important is because they help the firm to acquire finance from the external source which is more than the internal financing source (Chen, 2011). The theory assumes that firms finance their budget from their own funds while issuing less debt. Firms in the theory borrow after exhausting their funds and consider issuing equity as the only remaining option.

In contradiction to tradeoff model, this theory of pecking order indicates an objective neither does it have an ideal capital trade structure. However, it implies that firms will give debt and equity in regards to the firms’ laid regulations on requirements on funding. Empirical studies have been carried out to prove this by researchers have tested this by determining how firms’ finance shortages in a given period of time examining the relation between companies financing deficits in one period besides their changes in capital structure in the similar period of time and the next period. According to the results that Myers and Shyam-Sunder found, they differed in that, firms’ pecking order model, the behavior of finance choices in large firms while Goyal and Frank concluded differently for a larger sample.

Just like the other theories, the pecking order assumes that in reality, the business cannot attain satisfaction. In the pecking order, a major issue is the assumption that management of these firms take the interests of shareholders into consideration in any decision they make and that these shareholders are inactive. This assumption may hold in public firms with so many small equity holders. However, this theory is not applicable in situations where shareholders have shares worth lots of money.

The Static tradeoff theory

According to this model, firms acquire perfect market structures through balancing the use of equity and debt versus costs (Agnihotri, 2014). Here debt is shielded from tax; however, it is limited by distress as a result of finance at the point when the company is dependent on debt. As a result, it leads to giving up either the tax benefits or the financial distress (Overesch and Voeller, n.d.). The theory claims that the firm’s main hope for change only occurs in the equity-debt ratio since there cannot be any notable change in asset and the operation.

According to Litzenberger (1973), a firm’s value of leverage can be separated into three constituents; company value that is not under leverage, advantages of tax deductible interest and bankruptcy expenses in relation to tax. Given that a levered firm’s value comprises of the above features, and among the three components only one is not levered. This indicates that by the value of the levered company when the two last features are balanced. Therefore it can be concluded that a firm is an optimum capital trade structure. A firm’s value can be increased by other firms through an issuance of debt until an increase in bankruptcy expenses offsets benefits of tax of issuing debt.

This model indicates that firms will at all times be at their optimum ratio of debt-equity. This continuous equilibrium will mean that any small change in the capital structure affecting equity value, firms will immediately change the capital trade structure. “Realistically this seems unlikely as issuance or repurchasing of debt or equity will inevitably be associated with transaction costs and it is, therefore, more likely that companies adjust their capital structures only infrequently, reflecting the imposed transaction costs” (Myers 1984). The original version does not talk about expenses of a transaction. However, this latest version refers to it as one of the likely explanations as to why changes in the capital structure did not take place regularly as tradeoff theory expected.

The static theory, as suggested before to be particularly a single period model so as to tackle issues affecting a firm’s capital structure (Myers 1984). The model is, as previously mentioned, a one-period model so that it deals with a company’s capital structure while secluding the other periods. However, firms have made the static tradeoff theory faulty due to the fact that firms operate in more than one period. The periods will be correlated with each other’s capital structure. As a result, firms will be able to determine their financial future and what they expect in a single period as they put into place respective decisions concerning the capital structure.

In the last few years, many empirical research analyses of determining factors of capital trade structure have been conducted. From the research, there have been findings of the correlation between the leverage ratio of firm and specific characteristics of a firm. In the findings, it was determined that high profits are linked to low leverage in a given firm. This was the most consistent finding. Whereas an inconsistent finding was that as suggested by static tradeoff theory, more profits increases leverage hence gain from high-interest tax shield. In addition, the model proposes that firms are at all times at optimum capital structure, and they right away adjust with a change. These changes do not last long, hence are unreliable with the empirical results. There has been so much unreliability shown between the static tradeoff model and the empirical results. In addition, failure of the static tradeoff models to evaluate firms operating in the multi-period settings. As a result, the emergence of a new result oriented theory, the dynamic tradeoff theories that correct some of the flaws of the other theories.

The Dynamic tradeoff theory

The works and concept contained in this theory can be traced back to one by the name Fischer. In this model he developed, companies have the liberty to move away from the ideal capital trade structure. This theory was developed as a result of dissatisfaction of the static trade-off theory. In this model, the capital structure of firms is taken as a series of decisions and considering other factors. The decisions also put under this model are a cost of restructuring and decisions about investments. It does not only put under consideration the tradeoff decisions. In this theory, unlike the static tradeoff model, firms may shift for a long time from the capital trade structure due to the expenses involved in altering the structure of capital trade. The model developed by Fischer was developed in such a way that replaced the ideal capital structure with an ideal capital structure range. In this ideal capital trade range, fluctuation of the capital structure would be allowed.

The aim of the ideal capital range is that when a change that changes the value of assets occurs in the market, firms do not rush to make any adjustment in the capital structure. Alternatively, they let the fluctuation continue to the point that the expenses of adjustment at this point are greater than the benefits of adjusting the capital structure. In the model, a firm adjusts since the threat of bankruptcy and finance distress is increased in comparison to the adjustment cost when the ratio of debt to equity is higher. The same applies at the lower limit once benefits as a result of increasing debt (resulting from tax deducted interest) surpass expenses of adjusting. The model of dynamic tradeoff raises interesting issues in relation to decisions of finance in firms. However, it is limiting in that it does not show what impacts are poses on practical research.

A dynamic trade model was developed by Strebulaev (2007) incorporating all the expenses incurred in adjusting the capital structure, developed a dynamic trade-off model that incorporates costs associated with capital structure adjustments and demonstrates by simulating that results produced by the model are steady and has an observed capital trade structure. Strebulaev’s crucial finding is the difference in firms’ capital trade structure at points of re-financing and their true capital structure after data collection.

According to Fischer and Strebulaev, taking the expenses of adjustments into account, firms can attain the perfect capital structures when they get to a point when they can re-finance themselves. The use of cross-section to analyses may not be accurate due to the fact that companies may not have reached refinancing point and they may even be so far from attaining the ideal capital structure. Fischer and Strebulaev have a model that has inviting features; however, it only focuses on the expenses associated with adjustment of the capital structure and takes firm’s investment decisions as external.

These models of tradeoff debated above show promising characteristics. Due to the development and consistent research on this dynamic tradeoff model, this indicates that a suitable explanation to dynamic theory will be found. Since the model’s findings and results are based on simulation of data, this will probably produce good results. These primary hypothetical advances lead towards improving the base. The improved foundation will enhance further empirical studies; this will, in turn, make the theory even stronger. Lastly, more empirical studies are concentrating on the adjustment of firms’ capital trade structure focused on determining the rate of these firms’ adjustment.    

Relevance of the theories

The theories named above have a vital role in the research process. The theories assist in explaining the different changes experienced in the Serbian capital structures of firms. Through understanding the theories, one can be able to understand why a change in policy related to the corporate world may lead to various effects in business. The theories above are all related to the capital structure and how it is affected by changes in certain features in the Serbian capital trade market (Jahanzeb & Ahmadimousaabad 2014). Each of the theories has a unique view on the topic of capital structure. However, the pecking order and the trade-off are often said to better explain the issues affecting the capital structure. Hence the importance of the theories cannot be ignored in addressing the effects of tax on the capital structure.



This chapter presents the methods used to carry out the planned research. By offering information on the research design, the policies considered and data collection methods used, the research seeks to offer a deeper understanding of the approaches chosen for the research. Hence reach the major goal of the research, finding out how tax effects affect the Serbian capital structure hence the economy of the country in question.   

Research design

The research uses a case study to highlight some of the effects of tax policy on capitalization to a transitioning economy. And the case study for the research is Serbia. The information is gathered from the Serbian corporate community. Both small scale and large scale businesses provided the required data to be used in the research. Information is gathered in conjunction with the objectives defined at the beginning of the research.

Research hypothesis

Due to the Seriousness and complicated nature of the issues in the study, these hypotheses will be tested by the use of proper methods in accordance with empirical trade data in the economic period 2008 to 2013.  In the research the numerous hypothesis formulated that need to be answered in the research carried out in the Serbian trade structure include;

  • A firm’s growth and leverage raids have a positive correlation.
  • Leverage raid and the size of a firm have the positive link between them.
  • Profitability relates in a negative way with leverage raids.
  • A firm’s leverage raids are positively linked to the structure of assets.
  • Leverage raids are negatively correlated with the risk associated with the business.
  • A firm’s liquidity is linked negatively to leverage raids.
  • A firm’s tangible assets, the size, development and profitability have a notable impact on the leverage raids.

Case study

At the dawn of globalization in Eastern Europe, it has been difficult to explain how countries with transitioning economies have been increasing their income and enhancing better living conditions for the people (Denčić-Mihajlov, Malinić and Grabiński, 2015). Serbia is not an exception, hence she has insisted on reduction of a tax rate on firms hence encourage lowering debts (Sufi, 2009). The study aims to identify factors that hinder economic development and relate them to Serbia hence evaluate what are the reasons for the stagnation in the Serbian economy. This stagnation has led to rise and development of various issues affecting the Serbian economy and the people. The stagnation in the economy has resulted to high inflation in the Serbian economy. The prices of commodities skyrocketed beyond the ordinary citizen’s reach. Price has risen while the pay rates of the Serbian civil servants remains constant, leading to poor living standards among the people. These effects have led to the contraction of economy, hence high rates of unemployment in the Serbian capital. Most companies have been forced to reduce their employees and stop hiring. These companies resort to these measures to deal with the situation, reducing input and maximizing on the output while other companies have opted to shut down and relocate to other areas rendering most formerly employed people jobless.

Some of the factors often associated with economic stagnation include; unevenness in income for the people and lack of proper investment in physical capital (Degryse, et al. 2012). This challenge of stagnation leaves firms unable to make proper investments in production factors. However, other scholars may give conflicting information as to which issues have more weight in regards to impeding economic growth. As a result, many theories have been formulated to find a solution hence effect economic change to these transitioning countries (Luckic 2014 A and B).  This will bring the Serbian economy from the rocky path towards a growth oriented position. In transition economy, if properly analyzed there is a relationship between growth in the economy and financial stability. Financial stability in these transitioning economies will act as a ladder for the country to enhance development and growth in the economy. This will enable a country to sustain itself and at the same time, make future investment plans. With a stable economy, Serbia will attract more investors and increase employment opportunities for the people as a result. Having a large workforce will be beneficial as this will lead to an increase in the country’s economy.

In this regards policy makers in countries with transitioning economy should put in motion policies that encourage the stabilization of microeconomic (Fisher et al 1998). Policies emphasizing on stability are key to growth and the development of any country. A country with stable economy will definitely focus on development agendas be it future development or short term development. In every country, macroeconomic stabilization is an important requirement regardless of the capital structure reforms (Luckic 2013 A and B). However, Winkler (2000) argues that the stabilization may be caused by a difference in the performance of a transitioning economy.

Winker (2000) also states that to shift from low growth, stable policies in regards to privatization and sufficient firm governance have an essential part in the growth of a company. However, to manage the capital structure and spearhead growth, the firm has to identify the determining factors as in the case of Serbia, internal factors for trading companies (Mokhova and Zinecker 2013). The focus is kept on the Capital structures of trade and the major factors affecting it internally between trading periods of 2008 to 2013. Capital structures of firms have multiple determinants affecting them internally, among them include; techniques of analyzing capital structures, tax shield and risks involved in doing business (Abdout et al. 2012). Furthermore, according to Köksal and Kühnhausen (2014) there are also external determinants affecting the capital structures of firms in the, they include; inflation, industrial leverage, economies GDP, tax policies, policies of other lending institutions and behaviors of rates of interests. These factors cause various impacts to the operations of firms. These implications caused may delay or hinder the growth and development of firms. These factors are beyond the control of firms. However, the management of these firms tries hard enough to reduce the effects these external factors pose to the progress of their corporations. Factors such as policies initiated by lending institutions are minimized by opting to get loans from institutions with relatively lower lending rates so as not to incur losses in the process. Tax policies are often put into motion by governing authorities of a country hence firms have no control over them.

In-spite the impact caused by internal and external determinants, the research aims to analyze the determinants distressing the capital trade structure hence improve their use and the general performance of firms in the Serbian economy (Lovreta, 2011) (Lukić, 2011, 2012). Industrial leverage is an external determinant that affects the capital trade structure; hence it is a force that has to be viewed with caution when examining impacts of capital trade determinants in the Serbian market environment (Moatti. et al. 2014). The paper seeks to find adequate solutions to the gaps left in the paper in accordance with the stipulation in the theory of capital structures with an aim to make improvements in performance in the near future in financial trading firms in Serbia, hence a general improvement in the Serbian economic structure.

Participants in the research

The research was carried out in the Serbian business environment set-up. The participants in the research included large and small business set-up. All the contributors to the Serbian economy were included in the research. Both large and small corporations were included in the research since they are the major contributors in the Serbian trade hence the overall economy for the country.

Data collection

The data for the research included firms in the Serbian trade structure. Among the companies that provided data include; manufacturing firms, processing firms, financial and insurance firms, agricultural firms and construction firms. The data for these companies were taken from the agency for Serbian business registry. The data was obtained from the Serbian business registry for an accuracy of trade data. Given the research purpose, using the data from the Serbian business agency registers, the data was for duration of 6 years between 2008 and 2013. The collected data samples for every single year for the six years were put under analysis. Data used is due to the strict rule which mandates every company to submit financial reports to the business registry and the data used in 2013 involves 33341.



This chapter seeks to offer the results in line with the research conducted in the Serbian business environment. By highlighting the data obtained and the results, a discussion follows on the effects of tax policy on the Serbian capital structure.


From the Serbian trade market, it is evident that relying on debt to finance the firm’s operations has both advantages and disadvantages. Borrowing of funds is a disadvantage in that it limits the firm from getting a potential finance base in the future (Berent, 2015). It also exposes the firm to more bankruptcy costs. Due to large amounts of loans, a firm focuses on repayment of these loans hence investment and development plans are not considered, this is very risky for these firms as it is easy for them to be bankrupt. This leaves the firm tied to the lenders and the firm may miss out an investment opportunity. The firm is likely to miss out on investment opportunities since investments require capital and the firm do not have money.  The debts are also beneficial to firms in that it makes the firm managers be cautious of the financial decisions they make and always be on their toes in regards to making progressive decisions (Afza and Hossain 2011). The use of debts in the management of firms is essential as it shields them from tax. Tax shield is beneficial to a firm as it may defer the taxes owed by the business to the future. Tax shield is also very essential to a business as it lowers all tax amounts owed by a business. Lowering of tax amounts or deferring of tax to future years may, be important to a business as it provides more time for the business to find stability hence come out of all debts.

Tax reliefs are beneficial to firms as it helps in channeling the tax money to other beneficial use (Alzahrani, 2011). Firms should always use the shares and use debts as a source of finance when necessary (Damodaran 2010). A firm’s market value, capital cost and a firm’s tax shield are the major determinants in making of the firm’s capitalization; in accordance to Tradeoff theory (Anzuini and Fornari, 2012). However, problems arising from lack of finance and bankruptcy should also not be ignored when forming the capital structure as they are also essential (Bernardo and Welch, 2013). Ignoring these problems may later haunt the business, these problems should be addressed adequately not to be a challenge later as the business develops and grows to a world class corporation. Firms should be more informed of the market so as to make sound decisions not to be in a state with no funding due to poor choices.

As a result of a negative impact of the capital trade structure on the economic performance, there is more borrowing by firms (Janošević, Dženopoljac and Bontis, 2013). The results of debts by firms lead to a negative output by firms in terms of profit. All firms regardless of their line of business aim for success in their operations and obtain high profits; hence they ensure the capital trade structure is at peak (Mukerjee, 2013). The static theory points out that for the ideal capital structure to the correlation between company value and cost of capital must be inversely proportional (Komnenic and Pokrajčić, 2012). The company value must be at maximum whereas the cost of capital must be reduced to the lowest point possible. Lowering capital cost may be beneficial to a company as it will enhance on profitability with less liabilities. Companies with little or no liabilities tend to have a high rate of development compared to one with liabilities. Hence corporations at all times try to reduce liabilities and enhance on profitability.

The relationship shown in the below table is that of the capital structure theories and their relationship with the determining factors and the firm’s leverage.

Table 1

Theory Determinants






Growth Assets
Pecking order Negative effects on it Negatively affects it Positive effects Positive effects
Theory of Tradeoff Positive impact on it Positively influence it Negatively affect it Positive effects

The table above shows theories related to the capital structure of trade and shows the correlation between the determining internal factors of a firm and leverage. The table is made according to Ajanthan (2013) in his publication of determinants of capital structure.

The Overall characteristics of Determinants in Serbian Capital Structure


  Ratio of a firm’s internal funds Ratio of interest coverage
2013 2012 2013 2013
Firm’s Overall 36.7 37.2 1.22 0.38
Forestry, Agriculture and fishing 46.5 42.3 3.46 1.69
Manufacturing firms 23.3 24.5 0.18 1.14
Building firms 35.3 36.0 -0.22 -2.31
Wholesale and



22.9 22.3 23.5 1.31
Finance and




47.6 51.9 -4.31 -4.67

“The ratio of own funds/resources – share of equity in total capital, whose extent is dictated by the needs of financing fixed assets and the effects of financial leverage. Interest coverage ratio – the ratio of net results and the interest paid on one side, as well as the other” (The Serbian business registry).

Figure 1

The figure1 graph highlights the figures of table two.

The table shows firms’ own fund base and the interest ratio they cover in the economy in selected economic sector, trade being one of the selected sectors. It covers the economic period 2012-2013. The interest ratio shown in the graph and table 2 is an indication that in 2013 the debt ratio was very high.

Calculation of Dependent and Independent variables


Variable Formula
Reliant  variable  
Z ratio of debt to equity Overall burdens/Assets
Independent variables  
Y1 Current liquidity Current assets /current liabilities
Y2 Accelerated liquidity Current assets/inventories/current liabilities
 Y3 Yield of operational income Net profit/operating revenue
Y4 Yield on assets Net income/Overall assets
Y5 asset growth Overall Assets ( O ) – Overall Assets ( o – 1 ) /


Overall Assets ( o – 1 )

Y6 asset structures Fixed assets / Overall assets




Y7 Growth of company – percentage change in


Operational  income



Operational income ( O ) – Operating income ( O – 1 ) / Operational income ( O – 1 )

Y8 company size Log 10 –operating income
Y9 Risks associated with the business 6 years annual net profit’s std deviation


/ 6 years annual average net profit

Y10 Gross operation surplus –amortization(  expressed in percentage) of operational income Gross operating surplus – amortisation (expressed in percentage) of operational income
Y11 turnover of asset Operating income / Assets
Y12 return on equity capital Operating income / Equity capital


The table shows the use of variables both dependent and independent. It also shows the analysis of factors determining trade in the Serbian capital structure

Table 4

  2008 2009 2010 2011 2012 2013






0,631 0,708 0,686 0,62






1,038 1,005 1,004 1,007 1,018 0,996



0,682 0,679 0,669 0,662 0,658 0,658
Yield of


Operating income

3,59 3,30 3,23 3,40 3,09 3,10
Assets return 4,03 3,35 3,88 4,26 3,95 3,73
Asset growth 14,09 5,02 -5,72 3,46 9,29 1,92



46,76 45,75 35,38 33,03 33,06 33,05
Growth of Company



change in



  • 5,13
11,23 7,73 11,47 -4,05
Size of company 9,374 9,351 9,398 9,440 9,430 9,477
Risks associated with the business 0,993 0,867 0,943 1,071 1,085 1,043
Gross operation excess- amortization(expressed in percentage) of


operation income

6,029 5,467 5,570 4,474 5,175 5,020
 Turnover of assets 1,126 1,015 1,198 1,248 1,274 1,223
Returns on equity capita 10,66 9,23 13,53 13,78 13,15 12,02

The table above and figure 2 show the summary of baseline variables from table 3. The tables are used in analyzing the trade determining factors in the Serbian capital structure. The variables from the tables show the overall trade performance in Serbia. A notable factor from the table is the steady growth in debt levels throughout the years an exception being 2012.

In accordance with the rules of banking in the Serbian economic market, liquidity has complied according to the laws especially in the year 2013 (Lazic, 2014). Profits were not encouraging, given the decrease in buying of products. In this year the general profit output is very low compared to the other economic years. Profitability is also affected negatively due to a high rate of unemployed youths and negative contributions from production factors. The issue of unemployment impacts negatively to the profitability of firms in that the larger population does not have money to spend on the products being produced into the market. As a result, the growth rate of a firm is also not increasing at an encouraging rate since it faces low purchasing power from the market. Due to this reason there is reduced profit gained by the firm. Since a company’s growth and development is majorly determined by the returns it brings to the business, the growth is also stalled.

Figure 2

The Statistical Analysis of Determining factors in the Serbian Capital Trade Structure

Table 5-

  N Minimum Maximum Mean Standard Deviation



6 ,61 ,72 ,6578 ,03925



6 1,01 1,05 1,0104 ,01486


d liquidity

6 ,68 ,70 ,6689 ,00907
Yield of




6 3,10 3,60 3,2851 ,19067
Asset returns 6 3,38 4,27 3,8635 ,30351
Growth of Asset 6 -5,75 14,12 4,6835 6,74684
Structures of Assets 6 33,04 46,77 37,8252 6,59254
Growth of company


– percentage

change in operation income

6 -5,15 19,31 6,7569 8,57430
Size of company 6 9,36 9,49 9,4091 ,04520
Risks associated with the business 6 ,88 1,09 ,9998 ,08400
Gross operating


excess –

amortization(expressed in percentage) of

operation income

6 4,47 6,03 5,2892 ,53063
Turnover in assets 6 1,03 1,28 1,1808 09535
Return on equity



6 9,24 13,79 12,0618 1,80433
Valid N


(list wise)


The table shows the determining factors in capital trade structure in the Serbian market in 2008-2013.

The values of the indicators in principle as shown in the table are not reassuring. These values in comparison with those of countries with superior market economies are not promising (Sutrisno, 2016). These poor conditions are mostly affected by low rate of product purchase, relatively high costs banking and negative factors of production.

Table 6

The table below shows the relationship between determinants in Serbian capital structure and the financial leverage.

  Financial leverage


Pearson Correlation

Sig. (2-tailed)  
Finance leverage 1   6
Current liquidity -,708 ,117 6



-,492 ,324 6
Returns on


business income

-,278 ,597 6
Return on assets ,187 ,728 6
Asset growth -,903* ,015 6
Structures of assets -,615 ,196 6
Growth of company


– percentage change

in operational income

-,211 ,691 6
Size of company ,454 ,367 6
Risks associated with the business ,067 ,902 6
Gross operating


surplus – amortization (in percentages) of

operating income

-,455 ,367 6
Turnover in Equity ,393 ,444 6
Returns on equity



,613 ,198 6

There is a significant correlation at 0.05 marks.

From the results analyzed above, in the Serbian trade in regards to leverage on financial matters, there is the variation on the effects of specific determinants (Sabir and Malik 2012). Various determinants have different effects on the financial leverage; others affect it negatively whereas others positively affect it (Cabrilo, Uzelac and Cosic 2009). The use of technology has a positive notable effect on financial leverage in the Serbian economy. Similarly, it has shown great importance in countries with developed economies; it has catalyzed the growth and development of the economy.

According to Shin (2014), the continued use of technology in the Serbian economy will be of great importance for the future growth and development to the Serbian market. Similarly, Phillips (2010) has the same line of argument; he says that development of sustainability concept if applied accordingly is important in the development of Serbian trade in future.  This move will propel the Serbian economy from a transitioning economy to a more stable economy.

From the data analyzed above, conclusions can be made that;

  • The association between liquidity and negative raids is negative. Liquidity and negative raids do not interact in a friendly way.
  • The size of the firm correlates positively with leverage raid.
  • A firm’s Profitability negatively correlates with leverage raids.

The above analysis is proven from the research hypothesis, while those not proven include;

  • The growth of a firm correlates in a positive manner with leverage raids.
  • The structure of assets has a positive link with leverage raids.
  • Business risk has a negative link with leverage raid.

Using the regression method, all determining factors of capital trade structure in the Serbian market are examined and their effects determined.

Statistical Analysis for Descriptive determining factors

Below is table7, it uses selected figures to describe chosen determining factors in the Serbian capital trade structure.


  Mean Std. Deviation N



,6578 ,03925 6



1,0104 ,01486 6


income yield

3,2850 ,19066 6
Company size


– percent

change in



6,7565 9,57429 6
Company size 9,4090 ,04519 6

The values shown in the table are an average of the determining factors in the Serbian capital trade structure. The values are shown above as compared to similar trade values of a developed economic structure is very low.

Below is table8.

The table shows the relationship that exists in the backgrounds of selective determining factors.







Yield of




Growth of Company







Size of company






1,000 -,707 -,278 -,211 ,454



-,708 1,001 ,670 ,802 -,442
Yield of




-,278 ,670 1,001 ,504 -,586
Growth of company


– percentage





-,211 ,801 ,503 1,000 -,191
Size of company ,453 -,441 -,585 -,191 1,000






  ,058 ,299 ,346 ,184



,059   ,074 ,029 ,192
  Yield of




,298 ,073   ,155 ,111
  Company growth


– percent





,345 ,028 ,155   ,358
Size of Company ,183 ,195 ,111 ,358 6
N Financial



6 6 6 6 6



6 6 6 6 6
Yield of




6 6 6 6 6
Company growth


– percent





6 6 6 6 6
Company size 6 6 6 6 6


From the above analysis, it can be concluded that in the Serbian trade market, financial leverage is negatively affected by liquidity. Percentage change in the income of a business, company growth and operating business yield are negative and have the small impact on finance leverage. While the firm’s size is positive and moderately impact the financial leverage in the Serbian trade market.

Regression model results for selected determining factors in the Serbian Capital Structure


The table below shows the regression model outcome of some determining trade factors in the Serbian trade.

  Dependent Variable: Finance leverage






Standard Errors o Sig
Constant 3,629 2,474 1,468 ,381



-4,611 ,991 4,656 ,135
Yield of




,103 ,057 1,803 ,322
Growth of company



change in



,005 ,002 2,981 ,206
The size of a company ,142 ,209 ,675 ,622



R Square ,967      
Adjusted R



f ,830      
Sig ,275      
Durbin-Watson 2,201      

From the above table, as shown by the model regression, it can be concluded that individual determining factors have no notable effect on the Serbian capital trade structure. But together the determining factors significantly affect the trade structure.  In the regression model, independent residuals do not in any way have auto-relation (Hossain and Ali 2012). From the tested determining factors, there are other determining factors.


Contributions and Recommendations of the study

The purpose of the study is to add more knowledge to the author as well as educate people on the Serbian trade environment. It may be a source of information to potential investors to the Serbian market. I may prove useful to investors as it may give them an overview of how the Serbian market operates. The investors may know when the economy is at peak and when it low, hence investing while aware of the potential risks associated with the Serbian economy. It is among the few types of research carried out by the Serbian capital trade structure and how it is being affected by both internal and external features. Although the methods used may be similar with those of other studies in different countries but it has special distinctive features which make Serbian case stand out. The study leaves a window for numerous research opportunities in future. A study by conducted by Malinić (2012a) could produce a wonderful experience together with this current study can insight to the reader. In the future studies, more time should be provided so as to get a chance to have enough time to examine each determinant to come up with conclusive evidence towards their effects on the capital trade structure.

Most countries with developed economies embrace the use of technology and in return get high yield from their production. The impact of technology should not be ignored by any country as it has proven to be a beneficial catalyst worth exploring. The Serbian trade should also encourage the use of technology for efficiency. The Serbian firms should at all times strive to maximize the firm value and reduce capital cost. For productivity in trade, the Serbian government should consider reducing corporate rate of tax. With a reduced corporate tax, the Serbian market will be a hotspot for development of companies. Reduction of tax will attract major investments of firms and industries into the country hence an increase of employment opportunities to Serbian locals. Serbia having a large workforce will enhance improvement of the economy. This will also propel the country to initiate more investment agendas in the country. Since the Serbian market is still a developing economy, it should encourage sustainability development. This will contribute to a development of firms in the future. Policies should be formulated to encourage trade in the Serbian trade market and lure more investors into the market. By doing this, there will be increased employment opportunities for a large number of unemployed people.


According to the study, it is evident that specific factors affecting a company internally function the same way among the countries with transitioning economies. Regardless of the means used to attain leverage, whether it is measured using short or overall debt ratio it is still reduced by certain factors. Among them include; profits of the firm, a firm’s cash-gap, liquidity and tangibility whereas an opportunity of growth enhances increase. Due to the study, it may be concluded that most firms in the Serbian market of trade are aligned according to the pecking order hypothesis. The Serbian capital structure is not developed; hence the capital trade structure is not flexible. As seen from the case study, there is lack of flexibility in the Serbian capital structure.

A conclusion can be reached that most Serbian corporations do not like long term financing; their preference lies in the basis of financing in a short period of time. When it comes to liabilities, these firms have less overall liabilities and high shareholding equity in comparison to firms in both developed and developing economy.

Countries with developed market structures with similar determinants of trade have the higher value of trade than Serbia (Ajanthan 2013). This contributes negatively to the economic conditions of Serbia. Some of the determinants with the negative impact on the financial leverage include; asset structures and growth, current liquidity (Guida and Sabato, 2016). While equity capital yield is a positive determining factor (Akinyomi & Adebayo 2013). Serbia uses technologies in the capital market; this makes the constant of structure and asset growth to cause notable effects on financial leverage. It is also evident that these determinants on their own, their impact is insignificant to Serbia’s capital structure of trade (Li, C. et al. 2014). However, collectively they have major effects on the structure of capital trade.

According to Phillips (2010), for there to be an improved trade in the future, Serbia must shift focus to sustainable growth model just like it is done in countries with developed economies. As this cost reducing strategy would lead to increased profitability in the Serbian market (Barjaktarovic Rakocevic, n.d.). Modern technology should be adopted in business as this is a great means of business improvements (Shin, 2014). Technology usage is widely encouraged in countries with developed economic trade structure.  Though technology is being used in Serbia, it is not used to the optimum. Hence it should be encouraged for better business results and economic growth just like in the countries with developed economies (Lee 2014). The use of modern technology will enhance positive results to the financial leverage and improvement in a corporate world and the economy of Serbia.

As seen in the Serbian case, tax and tax-related policies have numerous influences in the trade structure (Moersch, 2013). Hence policy makers ought to investigate the market environment carefully so as to know what policies are effective in the development of trade in the Serbian market structure (Little, et al. 2011). Since the tax policies have both negative and positive effects on the trade structure. Knowing the capital trade structure will give them the idea of what policies to implement hence maximise on trade in Serbian trade to be in a position to compare with economic structures of other countries (Lovreta et. al. 2013). The Serbian firms should at all times strive to maximize the firm value and reduce capital cost. For productivity in trade, the Serbian government should consider reducing corporate rate of tax. As observed in the study, tax policies have great influence on the development and growth of companies in the Serbian market environment. Hence, policies that favor economic development should at all times be implemented. Favorable corporate policies are essential to any transitioning economy, as this is a sure way of ensuring business is encouraged and at the long run growth in the economy. The study from the Serbian market ought to be a lesson to other transitioning economies. They should learn from the mistakes made in the Serbian case and take the best solutions and implement in their economies. Learning from each other is the best way to enhance growth. Hence the problems the Serbian market went through should not be ignored but be an encouragement to other countries.


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