Impact of liberalization on cost of capital-A case study of associated cement companies limited

Liberalization policies of Government of India have been structured to revitalize Indian industry by infusing it with a greater degree of competition. The Indian financial system has undergone transformation over the last four decades and now comprises of an impressive network of financial institutions, financial markets and a wide range of financial instruments. The Govt. of India also launched reform programmes for capital market in 1991. The reforms in capital market enabled firms to raise funds cheaply and contributed to diversification of corporate finance. Cost of capital has been one of the most important and heavily emphasized issues in the theory of corporate finance. Cost of capital for a firm is the average rate of return that the investors in a firm would expect for supplying funds to firm or in other words, it is the cost of obtaining funds. It is the cut-off rate for allocation of capital to investment of projects that will leave unchanged the market price of stock (Van Horne, 2002). The excessive use of debt may endanger the survival of firm while its conservative use may deprive the equity shareholders from magnifying their return by using debt as cheaper source of finance. Thus, the importance of an appropriate and sound capital structure with low cost of capital is obvious from the perspective of corporate enterprises, its owners and other stakeholders. The present study is an attempt to study cost of capital of one of the leading companies in cement industry i.e. ACC Limited over a period of 31 years i.e. 1979–80 to 2009–10. The period of study has been segregated into two parts i.e. pre-liberalization period (1979–80 to 1989–90) and postliberalization period (1990–91 to 2009–10). Overall cost of capital (K_o1 and K_o2) are taken as dependent variables, whereas size, leverage, non-debt tax shields, reserves and retained earnings to total assets, liquidity, growth, profitability, collaterals and age are taken as explanatory variables for the purpose of study. The results of study exhibit declining trend in cost of debt (K_dat) but an increasing trend in cost of equity capital (K_e) and overall cost of capital (K_o) during post-liberalization period. Using multiple regression analysis, it has been observed that leverage (L₃), non-debt tax shields (NDTS), growth (G₁ and G₃) and profitability (P₁) are significant determinants of overall cost of capital (K_o1 and K_o2). The regression coefficient of dummy variables appear with negative signs in both the cases and it turns out to be significant at 5 percent level of significance with overall cost of capital (K_o1) as dependent variable. It is a healthy sign as it indicates decline in overall cost of capital (K_o1 and K_o2) of this company during post-liberalization period as compared to pre-liberalization period.