Capital Structure Decisions and Corporate Performance: Does Firm’s Profitability Matter?

Abstract

This study aims to investigate the relationship between financing decisions and firm performance. It particularly investigates the heterogeneous effects of capital structure ratios on financial profitability. The study employs the Quantile regression methodology on a sample of 120 non-financial companies listed on Tadawul stock exchange during the period 2017–2020. Financial performance was measured using return on assets, return on equities and Tobin’s Q variables in order to assess accounting and market performance. Data on the various variables is obtained from the companies’ annual reports. Quantile regression results show that debts to equity ratio hamper firms’ performance where as equity financing ratio increases business profitability. Additionally, findings demonstrate that this relationship is nonlinear. Particularly, a debt to equity ratio has a greater negative effect on performance of high-profitable firms. However, the positive effect of the equity financing ratio seems to be higher in high profitable companies than low ones. These results would help managers of non financial firms regarding optimal capital structure decisions. Indeed, managers of non-financial firms could use results of this study as a benchmark to make efficient decisions related to the structure of the capital such as reducing the proportion of debts in the capital and increasing the weight of equity financing. Particularly, enterprises in the early stages of development, with lower profits reflected in return on assets, return on equities, and Tobin’s Q should carefully avoid debt, whereas firms with big earnings are encouraged to raise their capital by issuing new shares in the financial market.