The effect of capital structure on performance: empirical evidence from manufacturing companies in Ethiopia

Abstract

The aim of the study was to investigate the effect of capital structure as measured by total debt ratio (TOD) and long term debt ratio (LTD), on operating performance and financial performance as measured by Net Operating Profitability (NOP) and Return on Assets (ROA), respectively. Four hundred and twenty-five panel observations were obtained using the financial statements of a sample of 85 manufacturing enterprises for the years 2017 to 2021. In addition to descriptive statistics of mean, standard deviation, minimum, and maximum value, Pearson’s correlation analysis, robusted random effect, and two step system Generalized Moment Method (GMM) model were employed to analyse the data. The result revealed that each of TOD and LTD have negative and significant effects on NOP and ROA which supports the pecking order theory, whereas control variables of FATR and FS have positive and significant effect on NOP and ROA at conventional significance level. To improve performance and maintain profitability, financial managers are advised to implement sound capital structure policies and lower the level of debt.

PUBLIC INTEREST STATEMENT

The purpose of the study was to establish relationship and examine the effect of capital structure on the performance of Ethiopian Manufacturing Companies. This study is relevant and has contributed to four stakeholders. First, policymakers can use as an intervention mechanism for financing requirement. Second, financial managers of manufacturing companies can consider the debt equity mix while setting financing policy that enhances performance. Third, researchers can consider as special point of reference for further research. Finally, to the academia, the study has obtained evidence supporting the pecking order theory of capital structure that explains the arena of manufacturing companies in Ethiopia.

Keywords:

• Capital structure
• long term debt ratio
• total debt ratio
• performance
• Ethiopian manufacturing companies random effect
• two stem system GMM

REVIEWING EDITOR:

• David McMillan, University of Stirling, United Kingdom

SUBJECTS:

• Corporate finance
• economics
• economic theory and philosophy
• finance
• business
• management and accounting

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

Data available in [Mendely Data] at [https://data.mendeley.com/datasets/vctx8x86m2/draft?a=d0779d38-fa78-42a5-b724-fe9d3211ec24]. The excel set can also be resent via email.

Additional information

Funding

The author has neither received direct nor indirect funding for this research.

Notes on contributors

Tesfa Nega Tesema

Tesfa Nega Tesema has acquired his PhD from Punjabi University, Patiala, India. He has formerly served as Lecture of Debre Berhan University and Dire Dawa University; Lecturer, Dean, and Academic Vice President of Alpha University College. Currently, he is working for Ethiopian Civil Service University, Ethiopia, as an Assistant Professor, where he has served as PhD Coordinator of Public Financial Management, and being serving as Coordinator of Accounting and Finance undergraduate and postgraduate Programs. His research interests include accounting, auditing, finance, investment, taxation, project management, leadership, and corporate governance.