According to (Myers & Majluf, 1984) firms may

According to (Myers & Majluf, 1984) firms may find it profitable to sell
secured debt because there are some costs that are linked with issuing the
securities, about which the firm’s managers have more appropriate information
than the outsider shareholders. Because of this, by issuing the debt secured
through the property with known figures cancels these expenses and costs. These
types of findings and information suggests that there is a positive
relationship between the tangibility of a firm with its leverage because firms
that hold more assets will tender its assets more to lenders as the collaterals
and will try to issue more debts so that they will take advantage of this
opportunity. Another information to be noted from the pioneering paper of (Jensen & Meckling, 1976) & Myers (1977) suggested that
shareholders from highly leveraged firms encourages to invest minimally to
dispose wealth from the debt holders of firm. But at the same time, the debt
holders can restrict these opportunistic behaviors in order to force to them to
present their tangible assets as the collaterals before the issuance of loans,
but no such restriction is possible for the projects that are impossible to be
collateralized. With the help of these incentives, a positive relationship is
made and induced between the leverage of the firm and its capacity to
collateralize its debt. There are lots of empirical studies that are reported
and concludes a positive relationship between the leverage and tangibility of a
firm.

However if we note that if managers
have tendency to consume more than high levels of bonuses, can result in a
negative correlation between the leverage and its collateralizable assets (Titman & Wessels, 1988). A firm having a less
collateralizable assets or tangibility may prefer high levels of the debt to
stop the managers from using high levels of perquisites. According to this
agency explanation, there is a negative relationship between the leverage and
tangibility.

2.3 Liquidity

The Net effect of the liquidity ratio
is concealed because they have negative and positive effect on capital
structure. A firm with the higher liquidity ratios may have comparatively
higher debit ratios anticipated to their greater ability to meet their short
term agreements. This dissension shows that there is positive relation between
a firm liquidity along with its debt ratios.(Myers & Rajan, 1998). Companies with the higher liquidity
ratio should borrow more anticipated to their capacity in order to encounter
contractual obligations on time as according to trade-off theory. Consequently
this theory forecasts a useful relation between the liquidity and its leverage.
Furthermore, there is a negative relation between liquidity and leverage
according to pecking order theory. Since companies with the favorable
liquidities prefers to use inside generated funds while trying to finance the
new investments.(Deesomsak, Paudyal, & Pescetto, 2004).
Liquidity may have many reasons to not increase leverage. This dissension show
that the effect of liquidity on leverage based on whether limitations are
placed on asset disposition. When the selling asset and higher liquidity values
will be lower than the higher liquidity make asset sale more suitable. If we
impose limitations on firm asset it will reduce the asset sale and will
increase expected asset value in liquidation for creditors. Therefore predicts
a positive relation between liquidity and leverage when asset spend therefore
predicts a positive relation between asset liquidity and leverage when assets
serve as collateral for debt contracts and managers have no discretion over
those assets, and a negative relation between asset liquidity and leverage when
the assets are not tied up as collateral.(Jean?Laurent, 2008).

2.4 Profitability

 

We can get
capital with three ways, by debt, by equity and by retain earning. The
performance could be being the cost of issuing new equity. The cost could be
considered in (Myers & Majluf, 1984) these appear due to asymmetric data
or they could be transaction costs. On other hand, the previous profitability
of a company along with therefore the amount of earning available to be
retained should be a significant motive of its recent capital structure. We use
the ratios of operating income by sale and operating income by total asset as
measure of profitability.(Tong & Green, 2005). There is positive relationship
between profitability and leverage due to high profitability improve the use of
debt along with it provide an encouragement to get the advantage of tax shield
on interest payment according to trade off theory. In either case the firm
promotes to use internally generated funds when available and choose debt by
equity when external financing is needed according to pecking theory. Therefore
this theory says that there is negative relationship between profitability and
leverage. (Huang & Song, 2006).

We calculate profitability as the
ratio of net income before taxes divided by total asset. Past knowledge show
that earning before (EBIT) divided by total assets is measurement of
profitability and that is an independent effect of leverage.it is most
significant object of financial management because there goal is to maximize
the owner’s wealth. (de Jong, Kabir, & Nguyen, 2008).