Debt and Profitability: Evidence from Indian Firms

Abstract

Capital structure has been a database issue in financial economics ever since Modigliani and Miller showed in 1958 that given frictionless markets and homogeneous expectations, the capital structure decision of the firm is irrelevant because it does not contribute towards the firm’s growth. The dilemma firms are faced with is making a decision on the capital structure choice to use. The purpose of this paper is to find out the effect of capital structure on financial performance of firms based on ROE, ROA, Tobin’s Q and EPS for the companies listed both at BSE and NSE over the period 2011-2016, measured through a simple regression model. Results indicate that Capital Structure is significantly and positively associated with firm Performance when measured by Tobin s Q, however they report a negative relationship between capital structure with firms’ performance when measured by ROA, and no significant relationship when measured by ROE as well as by EPS. Altogether, the study provides evidence which indicates firm performance is positively or even negatively related to capital structure. One important reason for this conflicting result can be the high cost of borrowing in developing countries like India. This study contributes to the empirical literature on the effect of capital structure on financial performance of Indian firms.

Keywords: Capital Structure, Performance of Firm, Panel Data, Regression

JEL Classification: D24, G31, C23, C31