Capital Structure Choices: The Role of Financial Development and Institutional Quality

Abstract

This study explores the influence of financial development encompassing financial market development and financial institution development as well as institutional quality (IQ) on capital structure decisions. The analysis is based on a dataset comprising 206 non-financial firms listed on the Pakistan Stock Exchange (PSE) and the Nifty50 index over the period 2016–2022. The empirical findings indicate a significant positive relationship between financial development, institutional quality, and capital structure, suggesting that improvements in these areas facilitate greater reliance on debt financing among firms. To ensure the robustness of the results, multiple estimation techniques are employed, including Ordinary Least Squares, fixed-effects regression, Feasible Generalized Least Squares, and Panel-Corrected Standard Errors, effectively mitigating econometric issues such as heteroscedasticity and autocorrelation. The study’s findings have important implications for policymakers, financial regulators, and corporate decision-makers, underscoring the need to enhance financial development and institutional frameworks to improve firms’ access to capital and promote economic growth.