Profitability and Financial Leverage: Evidence from a Quasi-Natural Experiment

2021 ◽  
Author(s):  
Davidson Heath ◽  
Giorgo Sertsios
Keyword(s):  
Capital Structure ◽  
Market Power ◽  
Treatment Period ◽  
Small Firms ◽  
Natural Experiment ◽  
Adjustment Costs ◽  
Large Firms ◽  
Financial Leverage ◽  
Trade Off ◽  
The Relationship

The relationship between profitability and leverage is controversial in the capital structure literature. We revisit this relation in light of a novel quasi-natural experiment that increases market power for a subset of firms. We find that treated firms increase their profitability throughout the treatment period. However, they only transiently reduce financial leverage, gradually reverting to their preshock level. Firms respond differently according to size with large firms gradually adjusting their leverage toward a new target and small firms reducing it. The patterns are broadly consistent with dynamic trade-off models with both fixed and variable adjustment costs. This paper was accepted by Gustavo Manso, finance.

Does intellectual capital impact firms' capital structure? Exploring the role of firm risk and profitability

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
A. D'Amato
Keyword(s):  
Capital Structure ◽  
Intellectual Capital ◽  
Value Added ◽  
Firm Risk ◽  
Financial Leverage ◽  
Data Set ◽  
Content Type ◽  
Novel Approach ◽  
Firm Profitability ◽  
The Relationship

PurposeThe purpose of this paper is to analyze the relationship between intellectual capital and firm capital structure by exploring whether firm profitability and risk are drivers of this relationship.Design/methodology/approachBased on a comprehensive data set of Italian firms over the 2008–2017 period, this paper examines whether intellectual capital affects firm financial leverage. Moreover, it analyzes whether firm profitability and risk mediate the abovementioned relationship. Financial leverage is measured by the debt/equity ratio. Intellectual capital is measured via the value-added intellectual coefficient approach.FindingsThe findings show that firms with a high level of intellectual capital have lower financial leverage and are more profitable and riskier than firms with a low level of intellectual capital. Furthermore, this study finds that firm profitability and risk mediate the relationship between intellectual capital and financial leverage. Thus, the higher profitability and risk of intellectual capital-intensive firms help explain their lower financial leverage.Research limitations/implicationsThe findings have several implications. From a theoretical standpoint, the paper presents and tests a mediating model of the relationship between intellectual capital and financial leverage and its underlying processes. In terms of the more general managerial implications, the results provide managers with a clear interpretation of the relationship between intellectual capital and financial leverage and point to the need to strengthen the capital structure of intangible-intensive firms.Originality/valueThrough a mediation framework, this study provides empirical evidence on the relationship between intellectual capital and firm financial leverage by exploring the underlying mechanisms behind that relationship, which is a novel approach in the literature.

scholarly journals The relationship of capital structure decisions with firm performance: A study of the engineering sector of Pakistan

2012 ◽  
Vol 2 (1) ◽  
pp. 245 ◽  
Author(s):  
Abdul Ghafoor Khan
Keyword(s):  
Firm Performance ◽  
Capital Structure ◽  
Negative Relationship ◽  
Engineering Industry ◽  
Tobin’S Q ◽  
Financial Leverage ◽  
Short Term ◽  
Tobin's Q ◽  
Relationship Of ◽  
The Relationship

Purpose: The purpose of this study is to find the relationship of capital structure decision with the performance of the firms in the developing market economies like Pakistan.Methodology: Pooled Ordinary Least Square regression was applied to 36 engineering sector firms in Pakistani market listed on the Karachi Stock Exchange (KSE) during the period 2003-2009.Findings: The results show that financial leverage measured by short term debt to total assets (STDTA) and total debt to total assets (TDTA) has a significantly negative relationship with the firm performance measured by Return on Assets (ROA), Gross Profit Margin (GM) and Tobin’s Q. The relationship between financial leverage and firm performance measured by the return on equity (ROE) is negative but insignificant. Asset size has an insignificant relationship with the firm performance measured by ROA and GM but negative and significant relationship exists with Tobin’s Q. Firms in the engineering sector of Pakistan are largely dependent on short term debt but debts are attached with strong covenants which affect the performance of the firm.Originality/Value: This is first paper to study an individual sector like engineering industry in Pakistan on the mentioned topic.

Industrial Research and Firm Size, Survival, and Growth in American Manufacturing, 1921–1946: An Assessment

1983 ◽  
Vol 43 (4) ◽  
pp. 953-980 ◽  
Author(s):  
David C. Mowery
Keyword(s):  
Firm Size ◽  
Small Firms ◽  
Firm Growth ◽  
Industrial Research ◽  
Large Firms ◽  
Research Activity ◽  
Growth And Survival ◽  
Survival And Growth ◽  
The Impact ◽  
The Relationship

The literature on the development of American industrial research suggests that during the twentieth century large firms “dominated” industrial research, and reaped the majority of the benefits from such activity. This paper utilizes new data to analyze both the relationship between firm size and research employment and the impact of research activity on firm growth and survival during 1921–1946. The results suggest that large firms were no more research-intensive than were small firms during the 1921–1946 period. Research activity significantly enhanced the probability of firms' survival among the ranks of the 200 largest manufacturing firms during 1921–1946. Research employment also improved the growth performance of both large and small firms during 1933–1946.

scholarly journals Profit Margin And Capital Structure: An Empirical Relationship

2011 ◽  
Vol 18 (2) ◽  
Author(s):  
Nikolaos P. Eriotis ◽  
Zoe Frangouli ◽  
Zoe Ventoura-Neokosmides
Keyword(s):  
Panel Data ◽  
Capital Structure ◽  
Market Power ◽  
Empirical Relationship ◽  
Font Size ◽  
Fixed Assets ◽  
Equity Ratio ◽  
Strategic Variable ◽  
Investment In Fixed Assets ◽  
The Relationship

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="mso-bidi-font-style: italic;"><span style="font-size: x-small;"><span style="font-family: Batang;">This study constitutes an attempt to investigate the relationship between debt-to equity ratio and firm&rsquo;s profitability, taking into consideration the level of firms&rsquo; investment and the degree of market power.<span style="mso-spacerun: yes;">&nbsp; </span>The study uses panel data for various industries, covering the period 1995-96.<span style="mso-spacerun: yes;">&nbsp; </span>The main conclusions of our study are: a) firms which prefer to finance their investment activities through self-finance are more profitable than firms which finance investment through borrowed capital; b) firms prefer competing with each other than cooperating; c) firms use their investment in fixed assets as a strategic variable to affect profitability. </span></span></span></p>

Market power and R&D investment: the case of China

2021 ◽  
Author(s):  
Xiaohua Sun ◽  
Fang Yuan ◽  
Yun Wang
Keyword(s):  
Market Power ◽  
Small Firms ◽  
Market Competition ◽  
Industry Concentration ◽  
Alternative View ◽  
Large Firms ◽  
Industry Level ◽  
Depth Analysis ◽  
The Impact ◽  
D Investment

Abstract This article presents an in-depth analysis of market power and its impact on firm research and development (R&D) investment in China. Two opposing theories have been proposed in the literature. The first, due to Schumpeter, suggests that monopoly power has a positive effect on firms’ propensity to innovate hence their investment in R&D. The alternative view, first proposed by Arrow, suggests that firms invest in R&D in order to escape competition, and thus market competition stimulates innovation. In testing these theories, prior studies have measured market power in different ways. Some use the so-called Lerner index, which measures the profit margin of a particular firm. Others use measures of industry concentration, for example, the Herfindahl index. This article tests the competing theories using a sample of 300,095 Chinese manufacturing firms in 29 two-digit manufacturing industries. We unify the two measures of market power, using a hierarchical linear model, to determine whether industry-level measures add power to specifications based on firm-level markups alone. We find, first, that firms are less likely to carry out R&D activities as their market power intensifies. The effect is nonlinear: firms with higher markups spend even less on R&D than a linear specification predicts. This finding supports Arrow’s theory and contradicts Schumpeter’s theory. Second, for the sample as a whole, the impact of industry-level concentration is negligible. However, when we break the sample into large, medium, and small firms, industry concentration has a significant effect on large and medium-sized firms but no impact on small firms. Thus, large firms with high markups in concentrated industries spend less on R&D than large firms with high markups in less concentrated industries. We interpret this as further evidence in support of the escape competition theory: less concentrated industries are more competitive, forcing the leaders to invest more heavily on R&D.

Firm Size and the Relationship Between Wage Dispersion and Firm Performance

2010 ◽  
Author(s):  
Homero Zambrano
Keyword(s):  
Theoretical Model ◽  
Firm Performance ◽  
Firm Size ◽  
Small Firms ◽  
Wage Structure ◽  
Wage Dispersion ◽  
Large Firms ◽  
Empirical Results ◽  
Simple Theoretical Model ◽  
The Relationship

A simple theoretical model explains the divergent empirical results concerning the effect of wage dispersion on firm performance. First, causality in the relationship is clarified. Then, through the model, it is shown that firm performance is non-monotonic with respect to wage dispersion. Likewise, it is shown that large firms are more likely to benefit from a dispersed wage structure than small firms.

Does dynamic trade-off theory explain Portuguese SME capital structure decisions?

2017 ◽  
Vol 24 (3) ◽  
pp. 485-502 ◽  
Author(s):  
Filipe Sardo ◽  
Zelia Serrasqueiro
Keyword(s):  
Capital Structure ◽  
High Speed ◽  
Small Firms ◽  
Trade Off ◽  
Content Type ◽  
Speed Of Adjustment ◽  
Two Samples ◽  
Structure Adjustment ◽  
Negative Effect ◽  
Target Ratio

Purpose The purpose of this paper is to analyse if capital structure decisions of small- and medium-sized Portuguese firms are in accordance with the predictions of dynamic trade-off theory, more precisely, the speed of adjustment of short-term debt (STD) and long-term debt (LTD) towards the respective target debt ratios. Design/methodology/approach Based on two samples of Portuguese firms, 1,377 small-sized firms and 811 medium-sized firms, dynamic estimators were used for the treatment of data obtained from the Amadeus database for the period 2007-2011. Findings The results indicate that small- and medium-sized firms adjust their STD and LTD ratios towards the respective target ratios. Small- and medium-sized firms present a high-speed adjustment towards the target STD ratio, suggesting that both types of firm face costs of deviating from the target capital structure, which are, probably, greater than the costs of adjustment associated with STD. However, considering the distance from the target ratio as a determinant of the adjustment speed, the results show the predominance of the negative effect of the costs of adjustment on capital structure adjustment speeds. Originality/value The results obtained for the speed of adjustment of STD and LTD, in a recession context, show that for small firms and medium-sized firms, mainly for the former, the costs of external market transactions are prohibitively high, slowing the speed of adjustment towards the target capital structure.

scholarly journals Determinants of Capital Structure: Evidence from Jordan

2019 ◽  
Vol 8 (4) ◽  
pp. 186
Author(s):  
Sufian Radwan Almanaseer
Keyword(s):  
Capital Structure ◽  
Fixed Effects ◽  
Stock Exchange ◽  
Negative Relationship ◽  
Firm Characteristics ◽  
Financial Leverage ◽  
Significant Negative Relationship ◽  
Amman Stock Exchange ◽  
Fixed Effects Regression ◽  
The Relationship

This study aimed to explore the determinants of the capital structure of the banks listed in the Amman Stock Exchange. A sample of 13 Jordanian commercial banks of 16 banks listed on the Amman Stock Exchange selected for the period 2008-2017. The current study applied a fixed-effects regression model by using e-views to analyze the relationship between financial leverage and firm characteristics such as Risk, Size, profitability, Growth, liquidity, Tax, Age, tangibility, and macroeconomic variables such as Gross Domestic Product, Inflation. The study finds a significant positive relationship between financial leverage, age, growth, risk, size, and tax. Also, the study finds a significant negative relationship between financial leverage with GDP, inflation, liquidity, profitability, and tangibility.

THE CAUSAL RELATIONSHIP BETWEEN BANK CAPITAL AND PROFITABILITY

2007 ◽  
Vol 03 (01) ◽  
pp. 0750002 ◽  
Author(s):  
DAVID E. HUTCHISON ◽  
RAYMOND A. K. COX
Keyword(s):  
Capital Structure ◽  
Causal Relationship ◽  
Positive Relationship ◽  
Equity Capital ◽  
Bank Capital ◽  
Financial Leverage ◽  
Return On Assets ◽  
Return On Equity ◽  
The Us ◽  
The Relationship

The relationship between capital structure and return on equity (ROE) is examined. It is shown that for banks in the US, for the relatively less regulated 1983–1989 period as well as the more highly regulated 1996–2002 period, there is a positive relationship between financial leverage and the ROE. The analysis is extended to determine the relationship between return on assets (ROA) and equity capital. The evidence supports the hypothesis that there is a positive relationship between equity capital and ROA.

scholarly journals The trade-off theory revisited: on the effect of operating leverage

2014 ◽  
Vol 10 (1) ◽  
pp. 2-22 ◽  
Author(s):  
Kristoffer J. Glover ◽  
Gerhard Hambusch
Keyword(s):  
Negative Relationship ◽  
Direct Result ◽  
Optimal Timing ◽  
Financial Leverage ◽  
Trade Off ◽  
Content Type ◽  
Corporate Earnings ◽  
Operating Leverage ◽  
The Relationship ◽  
Negative Earnings

Purpose – The purpose of this paper is to investigate the effect of operating leverage, and the subsequent abandonment option available to managers, on the relationship between corporate earnings and optimal financial leverage, thereby providing an alternative (rational) explanation for the observed negative relationship between these two quantities. Design/methodology/approach – Working in a dynamic capital structure setting, where corporate earnings are modelled as an exogenous stochastic process, the paper explicitly adds fixed operating costs to the firm's value optimisation. This introduces a degree of operating leverage (DOL) and a non-zero value to the implicit abandonment option of the firm's manager. Solving for the firm's optimal timing and financing decisions the paper is able to derive the relationship between current corporate earnings and optimal financial leverage for a large class of earnings uncertainty assumptions. The theoretical implications are then tested empirically using a large selection of S&P 500 firms. Findings – The analysis reveals that the manager's flexibility to abandon the project introduces nonlinearities into the valuation that are sufficient to reconcile the trade-off theory with the empirically observed negative earnings/financial leverage relationship. The paper further finds theoretical and empirical evidence of a positive relationship between operating and financial leverage. Originality/value – Previous studies have used mean-reverting earnings as an explanation for the observed negative earnings/financial leverage relationship in a trade-off theory setting. The paper shows that the relationship does not need to be process specific. Instead, it is a direct result of the financial flexibility of managers.

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