Determinants of Capital Structure of Insurance Companies in Ethiopia
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Date
2015-06
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Addis Ababa University
Abstract
The impact of firm characteristics on the capital structure of the insurance industry is considered to be an important issue in a current business world of solid competition we are living. This study empirically examines the determinants of capital structure of insurance companies in Ethiopia. The study attempt to highlight the critical firm characteristics that managers should consider when setting their “optimal” capital structure. The study employed panel regression model in examining the capital structure of insurance companies in Ethiopia with financial statements of eight insurance companies covering the period of ten consecutive years, 2005-2014. The study used panel data techniques specifically Fixed Effect (FE) robust standard error regressions analyzed using STATA. To purposefully forward conclusion, normality, multicollinearity, heteroscedastcity, autocorrelation and robustness tests were conducted on the data. The results show that pecking order, the static trade-off and agency cost theories are important in explaining the capital structure of insurance companies in Ethiopia, even if the Pecking order theory appears to be dominant. Profitability, asset tangibility, growth and liquidity were found to be significant in relation to leverage. The negative relationship between profitability and leverage is an indication that profitable insurance companies prefer internal sources of finance to external sources, hence less debt in their capital structure. The negative relationship between asset tangibility and leverage is an indication that companies with smaller share of tangible assets tend to be more subject to information asymmetries. It is because intangible assets are more difficult to price and hence the cost of debt increases. The other significant determinant variable, growth opportunity of the firm, had a positive relationship with debt ratio proving that insurance companies depend more on debt to finance their growth. However, liquidity found to be negatively associated with leverage and indicated that Ethiopian Insurance firms with liquid assets will prefer internal sources than debt to finance future investments. The other hypothesized firm level variables, business risk and size of the firm were insignificant.
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Capital Structure of Insurance Companies