What is it about?
The nature of the relationship between leverage and firm performance has been a subject of investigation in extant literature. We re-examine the nature of the association by using a sample of 78 non-financial firms listed in the Nifty 100 index during the 2013-2023 period by applying the quantile regression technique and comparing the result with the linear regression approach (system GMM technique).Our empirical analysis demonstrates that leverage negatively impacts the performance of firms. Further, results show that the association is non-homogeneous among firms of different quantiles: leverage withers the performance of highly profitable firms (upper quantile) than low profitable firms (lower quantile). The identified concave relationship highlights the prominence of optimal capital structure and the role of finance managers in designing a sound financial policy that matches firm characteristics and borrowing requirements. The findings of our study draw insightful implications for managers and policymakers while contributing to the ongoing leverage and firm performance debate reported in previous studies.
Featured Image
Photo by Austin Distel on Unsplash
Why is it important?
Since the pioneering work of Modigliani and Miller, the debate on the relationship between Capital Structure (CS) and Firm Performance (FP) has been a subject of discussion. Consequently, the CS and FP linkage has garnered the attention of several academic scholars. However, the majority of the empirical studies have demonstrated a linear link between CS and FP, whereas the studies on the nonlinear relationship are scant in the existing scholarly studies. Thus, to provide more insights, we used quantile regression techniques, and our results corroborate that the CS and FP relationship is non-homogeneous among Indian firms. To succinctly put, the magnitude of the negative impact of leverage is found to be more around highly profitable firms. Our regression result highlights the importance of maintaining the right capital mix and suggests that large firms should refrain from excessive borrowing. Further, we contend that policymakers must strengthen corporate governance mechanisms and restrict the earnings management activities of the management. Overall, our robust findings enhance the existing body of knowledge while drawing significant implications for management, policymakers, and other stakeholders.
Perspectives
The connection between financial borrowing and firm performance has posed a longstanding problem and has been debated in the academic fraternity. This hot topic has garnered the attention of several researchers around the world. To provide more insights into this topic, we employed the QR technique to investigate the conditional relationship between financial leverage and corporate performance in the Indian context. Initially, the system GMM technique is employed to check for the linear linkage between CS and FP among Indian firms. Using a balanced panel dataset of 515 firm-year observations of non-financial Nifty 100 public companies for the years 2011 to 2023, the study finds that leverage (SDA, LDA, and TDA) significantly deteriorates the performance of firms (ROA and ROE) in India. As borrowings bear periodic interest payments, the marginal return available to company owners is reduced. Besides, levered firms are prone to bankruptcy risk. As a result, the leverage withers the performance of Indian firms. The QR results reveal that the leverage-FP relationships significantly vary among firms across different levels of profitability distribution. In particular, the intense negative influence of leverage on the ROA and ROE is evident around the firms with upper quantiles (highly profitable firms) than the lower quantile firms (less profitable firms). The result implies that the highly profitable firms will likely have additional debt capacity, allowing them to borrow more than required. Thus, overinvestment in debt paves the way for bankruptcy and other costs. Moreover, firms end up investing in unfruitful avenues. As a result, highly profitable firms in India could not benefit from debt financing. Consequently, Indian firms must focus on optimal CS and strengthen their governance mechanisms to minimize the opportunistic behavior of managers, specifically among growing and matured firms.
Research Scholar and Teaching Assistant at Manipal Academy of Higher Education Nikhil M N
Manipal Academy of Higher Education
Read the Original
This page is a summary of: Is the nexus between capital structure and firm performance asymmetric? An emerging market perspective, Cogent Economics & Finance, January 2024, Taylor & Francis,
DOI: 10.1080/23322039.2023.2296195.
You can read the full text:
Contributors
The following have contributed to this page
