The impact of capital structure on performance: An empirical study of non-financial listed firms in Pakistan
International Journal of Commerce and Management
ISSN: 1056-9219
Article publication date: 25 November 2013
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.
Keywords
Acknowledgements
The authors are thankful to Dr Abbas J. Ali (the Editor) and two anonymous reviewers for their invaluable comments and suggestions. All these make this article more valuable and readable.
Citation
Ahmed Sheikh, N. and Wang, Z. (2013), "The impact of capital structure on performance: An empirical study of non-financial listed firms in Pakistan", International Journal of Commerce and Management, Vol. 23 No. 4, pp. 354-368. https://doi.org/10.1108/IJCoMA-11-2011-0034
Publisher
:Emerald Group Publishing Limited
Copyright © 2013, Emerald Group Publishing Limited