Abstract

Capital structure of the financial institutions and banks determine agency cost of financial sector of the economy. In this study we explore the agency cost hypothesis of banking sector of Pakistan using panel data of 22 banks for the period 2002 to 2009. We  employed the idea of using profit as a measure of efficiency of banks following Berger (2002) and the idea of using Tobin’s Q as a measure of firm’s performance following Morck, Shleifer, and Vishny (1988); Treece et al. (1994). Our study differs from the others in terms of methodology of panel data models which provide a better substitute for SUR and simultaneous equations employed by the other studies. Pooled data results prove agency cost hypothesis and the findings are in accordance with those of Pratomo and Ismail (2007) Berger and Di Patti (2002). Size of banks and consumer banking seem to have played significant role in their profit efficiency during the period from 2002 to 2009. Random effects and fixed effects models nevertheless, proved Miller-Modigliani (1958) proposition that capital structure does not affect value of the banks.

Key words: Capital structure, agency cost, equity capital ratio, return on equity.