Alternative Proxies for Estimating Firm Growth in Empirical Corporate Finance Literature: Evidence from Indian Manufacturing Sector

Empirical tests of theoretical propositions necessitate quantitative estimation of qualitative firm level attribute. The challenges of such estimation are nowhere more pronounced than it is the context of estimating firm growth as evinced from the multiplicity of proxies used. However in using or theorizing about the validity of these alternative proxies in their quest to measure a common intangible called 'firm growth', the issue of inter-relationship between these variables and the dimensions of growth, it is capable of capturing has never been explored. This research paper is an attempt to address this issue. This paper uses a sample of 459 listed manufacturing firms for the period 2004-05 to 2010-11, and employs correlation analysis as well as a panel data model to reach its conclusion. Findings of this research suggest that the alternative financial statements based measures of firm growth are not correlated to an extent that can warrant substitution or interchangeable use. And in certain cases correlations are stronger with time lags than without. Furthermore, it is also observed that financial statements based measures of growth have limited explanatory power when it comes to explain variations in market-to-book ratio of firms. Findings of this paper coupled with studies on the linkage between macroeconomic and capital market conditions with equity prices, provides indirect evidence that market-to-book ratio factors in the forward looking perspective of growth that the other alternative measures are not capable enough to capture, given their historical nature. (ProQuest: . denotes formulae omitted.)INTRODUCTIONThe seminal work of Modigliani and Miller (1958) on the irrelevance of capital structure choice in determining firm value remains the genesis of the most enduring debate in corporate finance literature; how do firms determine their (optimal) capital structure? However, even after five and a half decade of theoretical and empirical research and the emergence of a plethora of theories (based on agency costs, asymmetric information, product/input market interactions, corporate control consideration, taxes, market timing, etc.), the question is still largely unanswered and continues to puzzle, both theoreticians and prac titioners alike. The problems associated with objectiv ely estimating firm level attributes (Titman and Wessels, 1988) and, the qualitative and non-exclusive nature of alternative theories (Barclay and Smith, 1999 and 2005), are viewed as biggest stumbling blocks in solving this puzzle. While several research papers have explored the issue of non- exclusivity (for instance, Cotei and Farhat, 2009; Serrasqueiro and Nunes, 2010; and Mukjerjee and Mahakud, 2012), not many have focused attention on the challenges involved in choosing proxies for firm level attributes even when these problems are omnipresent in almost all empirical studies. This research is primarily motivated at highlighting problems of this latter category; and focuses on the attribute 'firm growth'. Objectively identifying the proxy for this attribute for estimation purposes has enormous implications not just in the field of applied corporate finance, but also for economic policy making; identifying the appropriate variable is the first most important step in understanding how the same can be influenced by micro management of firms and macroeconomic management of the economy. And the context of a developing nation further compounds its importance.The rest of this paper is organized as follows. The next section provides a brief review of the alternative measures of firm growth, issues related to leading and lagging as well as the problems of avai lability, relevance and estimation, alon g with the propositions to be tested in paper. The methodology for this research is discussed next, followed by the findings and their analysis. The last section discusses the implications, before discussing the limitations of this paper before concluding. …