Capital structure and firm performance: a panel causality test

Abdullah, Hariem and Tursoy, Turgut (2021): Capital structure and firm performance: a panel causality test.

Abstract

This study attempts to empirically investigate the reverse causality between firm performance and capital structure for German listed firms in the non-financial sectors over the period 1993-2016. We measure firm performance based on both financial and market indicators while capital structure is measures by leverage ratio of total debt to assets. In addition to two-step GMM estimator, panel causality test of Dumitrescu and Hurlin (2012) is performed to specify the causality direction of causation. The findings provide evidence for the existence of homogeneous causality between capital structure and the two selected proxies of firm performance. Financial performance and financial leverage can positively affect each other. Capital structure could negatively determine market performance whereas stock price has a positive influence on leverage ratio. Our results rather support trade-off theory, probably indicating that non-financial firms in Germany bear more debt to benefit from tax shield.

• Item Type: MPRA Paper
• Language: English
• Keywords: firm performance, capital structure, panel causality, and Germany
• Subjects: G - Financial Economics > G3 - Corporate Finance and Governance

References

Abdullah, H. (2013). An analysis of the value relevance of accounting information within the UK after the adoption of International Financial Reporting Standards. Master Thesis, University of Leicester, UK

Abdullah, H., & Tursoy, T. (2019). Capital structure and firm performance: evidence of Germany under IFRS adoption. Review of Managerial Science, 1-20.

Adair, P., & Adaskou, M. (2015). Trade-off-theory vs. pecking order theory and the determinants of corporate leverage: Evidence from a panel data analysis upon French SMEs (2002–2010). Cogent Economics & Finance, 3(1), 1006477.

Adedeji, A. (2002). A cross-sectional test of Pecking Order Hypothesis Against Static Trade-off Theory on UK data. SSRN. http://dx.doi.org/10.2139/ssrn.302827

Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. The review of economic studies, 58(2), 277-297.

Bandyopadhyay, A., & Barua, N. M. (2016). Factors determining capital structure and corporate performance in India: Studying the business cycle effects. The Quarterly Review of Economics and Finance, 61, 160-172.

Berger, A. N., & Di Patti, E. B. (2006). Capital structure and firm performance: A new approach to testing agency theory and an application to the banking industry. Journal of Banking & Finance, 30(4), 1065-1102.

Cevheroglu-Acar, M. G. (2018). Determinants of Capital Structure: Empirical Evidence from Turkey. J. Mgmt. & Sustainability, 8, 31.

De Jong, A., Verbeek, M., & Verwijmeren, P. (2011). Firms’ debt–equity decisions when the static tradeoff theory and the pecking order theory disagree. Journal of Banking & Finance, 35(5), 1303-1314.

Detthamrong, U., Chancharat, N., & Vithessonthi, C. (2017). Corporate governance, capital structure and firm performance: evidence from Thailand. Research in International Business and Finance, 42, 689-709.

Dickey, D. A., & Fuller, W. A. (1981). Likelihood ratio statistics for autoregressive time series with a unit root. Econometrica: journal of the Econometric Society, 1057-1072.

Dumitrescu, E. I., & Hurlin, C. (2012). Testing for Granger non-causality in heterogeneous panels. Economic modelling, 29(4), 1450-1460.

Enders, W. (2008). Applied econometric time series. John Wiley & Sons.

Fama, E. F., & French, K. R. (2002). Testing trade-off and pecking order predictions about dividends and debt. The review of financial studies, 15(1), 1-33.

Farrar, D. E., & Glauber, R. R. (1967). Multicollinearity in regression analysis: the problem revisited. The Review of Economic and Statistics, 92-107.

Fosu, S. (2013). Capital structure, product market competition and firm performance: Evidence from South Africa. The quarterly review of economics and finance, 53(2), 140-151.

Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: which factors are reliably important?. Financial management, 38(1), 1-37.

Geske, R., Subrahmanyam, A., & Zhou, Y. (2016). Capital structure effects on the prices of equity call options. Journal of Financial Economics, 121(2), 231-253.

Ghosh, A., & Cai, F. (1999). Capital structure: New evidence of optimality and pecking order theory. American Business Review, 17(1), 32.

Gleason, K. C., Mathur, L. K., & Mathur, I. (2000). The interrelationship between culture, capital structure, and performance: evidence from European retailers. Journal of business research, 50(2), 185-191.

Gok, O., & Peker, S. (2017). Understanding the links among innovation performance, market performance and financial performance. Review of Managerial Science, 11(3), 605-631.

Guner, A. (2016). The determinants of capital structure decisions: New evidence from Turkish companies. Procedia economics and finance, 38, 84-89.

Herciu, M., & Ogrean, C. (2017). Does Capital Structure Influence Company Profitability?. Studies in Business and Economics, 12(3), 50-62.

Hoffmann, R., Lee, C. G., Ramasamy, B., & Yeung, M. (2005). FDI and pollution: a granger causality test using panel data. Journal of International Development: The Journal of the Development Studies Association, 17(3), 311-317.

Hull, R. M., & Dawar, V. (2014). Agency theory, capital structure and firm performance: some Indian evidence. Managerial Finance.

Ibhagui, O. W., & Olokoyo, F. O. (2018). Leverage and firm performance: New evidence on the role of firm size. The North American Journal of Economics and Finance, 45, 57-82.

Im, K. S., Pesaran, M. H., & Shin, Y. (2003). Testing for unit roots in heterogeneous panels. Journal of econometrics, 115(1), 53-74.

Iyoha, A. O. I., & Umoru, D. (2017). Capital Structure And Firm Financial Performance In Nigeria: Empirical Evidence Of The Causal Link. Contemporary Economy Journal, 2(4), 69-83.

Jarallah, S., Saleh, A. S., & Salim, R. (2019). Examining pecking order versus trade‐off theories of capital structure: N ew evidence from J apanese firms. International Journal of Finance & Economics, 24(1), 204-211.

Jouida, S. (2018). Diversification, capital structure and profitability: A panel VAR approach. Research in International Business and Finance, 45, 243-256.

Kalkan, A., Bozkurt, Ö. Ç., & Arman, M. (2014). The impacts of intellectual capital, innovation and organizational strategy on firm performance. Procedia-Social and Behavioral Sciences, 150, 700-707.

Karadeniz, E., Yilmaz Kandir, S., Balcilar, M., & Beyazit Onal, Y. (2009). Determinants of capital structure: evidence from Turkish lodging companies. International Journal of Contemporary Hospitality Management, 21(5), 594-609.

Koralun-Bereźnicka, J. (2018). Determinants of capital structure across European countries. In Contemporary Trends and Challenges in Finance: Proceedings from the 3rd Wroclaw International Conference in Finance. Springer International Publishing, 199-209.

Kraus, A., & Litzenberger, R. H. (1973). A state‐preference model of optimal financial leverage. The journal of finance, 28(4), 911-922.

Le, T. P. V., & Phan, T. B. N. (2017). Capital structure and firm performance: Empirical evidence from a small transition country. Research in International Business and Finance, 42, 710-726.

Lemmon, M. L., & Zender, J. F. (2016). Asymmetric information, debt capacity, and capital structure. SSRN. https://doi.org/10.2139/ssrn.2152505

Levin, A., Lin, C. F., & Chu, C. S. J. (2002). Unit root tests in panel data: asymptotic and finite-sample properties. Journal of econometrics, 108(1), 1-24.

Li, L., & Islam, S. Z. (2019). Firm and industry specific determinants of capital structure: Evidence from the Australian market. International Review of Economics & Finance, 59, 425-437.

Lopez, L., & Weber, S. (2017). Testing for Granger causality in panel data. The Stata Journal, 17(4), 972-984.

Lopez-Gracia, J., & Sogorb-Mira, F. (2008). Testing trade-off and pecking order theories financing SMEs. Small Business Economics, 31(2), 117-136.

Luigi, P., & Sorin, V. (2009). A review of the capital structure theories. Annals of Faculty of Economics, 3(1), 315-320.

Margaritis, D., & Psillaki, M. (2007). Capital structure and firm efficiency. Journal of Business Finance & Accounting, 34(9‐10), 1447-1469.

Margaritis, D., & Psillaki, M. (2010). Capital structure, equity ownership and firm performance. Journal of banking & finance, 34(3), 621-632.

Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American, 1, 3.

Modigliani, F., & Miller, M. H. (1963). Corporate income taxes and the cost of capital: a correction. The American economic review, 53(3), 433-443.

Moradi, A., & Paulet, E. (2019). The firm-specific determinants of capital structure–An empirical analysis of firms before and during the Euro Crisis. Research in International Business and Finance, 47, 150-161.

Myers, S. C. (1984). The capital structure puzzle. The journal of finance, 39(3), 574-592.

Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of financial economics, 13(2), 187-221.

Peterson, W., G. Gijsbers, and M. Wilks. 2003. An Organizational Performance Assessment System for Agricultural Research Organizations: Concepts, Methods, and Procedures. ISNAR Research Management Guidelines No. 7. The Hague: ISNAR.

Reilly FK, Brown KC (2011) Investment analysis and portfolio management. Cengage Learning, Boston. Roberts, M. R., & Whited, T. M. (2013). Endogeneity in empirical corporate finance1. In Handbook of the Economics of Finance (Vol. 2, pp. 493-572). Elsevier.

Roodman, D. (2009). A note on the theme of too many instruments. Oxford Bulletin of Economics and statistics, 71(1), 135-158.

Salawu, R. O., & Agboola, A. A. (2008). The determinants of capital structure of large non-financial listed firms in Nigeria. The International Journal of Business and Finance Research, 2(2), 75-84.

Salim, M., & Yadav, R. (2012). Capital structure and firm performance: Evidence from Malaysian listed companies. Procedia-Social and Behavioral Sciences, 65, 156-166.

Saona, P., & San Martín, P. (2018). Determinants of firm value in Latin America: an analysis of firm attributes and institutional factors. Review of Managerial Science, 12(1), 65-112.

Serrasqueiro, Z., & Caetano, A. (2015). Trade-Off Theory versus Pecking Order Theory: capital structure decisions in a peripheral region of Portugal. Journal of Business Economics and Management, 16(2), 445-466.

She, R., & Guo, J. (2018). Capital Structure and Firm Performance: Empirical Research Based on Global E-Retailing Companies. 15th International Conference on e-Business Engineering (ICEBE) (pp. 251-256). IEEE.

Shubita, M. F., & Alsawalhah, J. M. (2012). The relationship between capital structure and profitability. International Journal of Business and Social Science, 3(16). 104-112.

Titman, S., & Wessels, R. (1988). The determinants of capital structure choice. The Journal of finance, 43(1), 1-19.

Tong, G., & Green, C. J. (2005). Pecking order or trade-off hypothesis? Evidence on the capital structure of Chinese companies. Applied economics, 37(19), 2179-2189.

Tursoy, T., & Faisal, F. (2016). Causality between stock price and GDP in Turkey: an ARDL bounds testing approach. Romanian Statistical Review, 64(4), 3-19.

Verboncu, I., & Zalman, M. (2005). Management si performanþe. Universitara House of Publishing, Bucharest. Viviani, J. L. (2008). Capital structure determinants: an empirical study of French companies in the wine industry. International Journal of Wine Business Research, 20(2), 171-194.

Vo, X. V. (2017). Determinants of capital structure in emerging markets: Evidence from Vietnam. Research in International Business and Finance, 40, 105-113.

Vo, X. V., & Ellis, C. (2017). An empirical investigation of capital structure and firm value in Vietnam. Finance Research Letters, 22, 90-94.

Wang, F. & Wu, N. (2014). Empirical research on the influence of capital structure on profitability based on data from the pharmaceutical industry. International Conference on Management Science & Engineering, 21th Annual Conference Proceedings. IEEE.

Welch, I. (2004). Capital structure and stock returns. Journal of political economy, 112(1), 106-131.

Wiwattanakantang, Y. (1999). An empirical study on the determinants of the capital structure of Thai firms. Pacific-Basin Finance Journal, 7(3-4), 371-403.

Yazdanfar, D., & Öhman, P. (2015). Debt financing and firm performance: an empirical study based on Swedish data. The Journal of Risk Finance, 16(1), 102-118.

Yolanda, K., & Soekarno, S. (2012, October). Capital structure determinants of Indonesian plantation firms: Empirical study on Indonesian Stock Exchange. In 2nd International Conference on Business, Economics, Management and Behavioral Sciences (pp. 61-65).