The impact of capital structure on performance

Zongjun Wang

107 citations0/0 files storedInternational Journal of Commerce and Management

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Corporate Finance and Governance Financial Analysis and Corporate Governance Working Capital and Financial Performance

Abstract

Abstract Purpose The purpose of this paper is to investigate whether capital structure affects the performance of non-financial firms in Pakistan. Design/methodology/approach Panel econometric techniques namely pooled ordinary least squares (OLS), fixed effects, and random effects were used to investigate the impact of capital structure on performance of non-financial firms listed on the Karachi Stock Exchange Pakistan during 2004-2009. Findings Empirical results indicate that all measures of capital structure (i.e. total debt ratio, long and short-term debt ratio) are negatively related to return on assets in all regressions. Moreover, total debt ratio and long-term debt ratio are negatively related to market-to-book ratio under the pooled OLS model, whereas these measures are positively related to market-to-book ratio under the fixed effects model. Short-term debt ratio is positively related to market-to-book ratio in all regressions, however the relationship is found insignificant. A negative relationship between capital structure and performance indicates that agency issues may lead the firms to use higher than appropriate levels of debt in their capital structure. This overleveraging may increase the lenders' influence which in turn limits the managers' ability to manage the operations effectively, hence negatively affecting the firm performance. Practical implications Empirical results indicate that capital structure has material effects on firm performance. Thus, corporate managers should consider the impact of leverage on performance before adjusting the debt levels. Moreover, lenders should tenderly inflict the debt covenants considering their impact on firm performance. Finally, investors should consider the firm's debt level before making investment decisions. Originality/value This may probably be the first study that explores the impact of capital structure on performance using the most recent data set of Pakistani firms. Moreover, this paper lays some groundwork upon which a more detailed evaluation of Pakistani firms' capital structures and their impact on performance could be based.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1978Specification Tests in Econometrics 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1958The Cost of Capital, Corporation Finance and the Theory of Investment 1977Determinants of corporate borrowing 1996Agency costs of free cash flow, corporate finance, and takeovers 2008The cost of capital, corporation finance and the theory of investment 1988The Determinants of Capital Structure Choice

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