Abstract
The purpose of this study is to empirically examine the effect of capital structure and profitability on firm’s value. The study sample included (41) manufacturing companies Out of a total of (63) companies listed on Amman Stock Exchange (ASE) over the five years period (2014-2018). To test the study hypotheses and to achieve its objectives, data was obtained from (ASE) database and annual reports issued by Jordanian manufacturing public shareholding companies. Thus, capital structure (which have been measured by leverage and debt to equity ratio) and profitability (which have been measured by ROA and ROE) are presented as independent variables, while the firm’s value is articulated as the dependent variable using market value and Tobin’s Q as firm’s value measure. Multiple regression analysis is undertaken to analyse the potential effect of capital structure and profitability on firm’s value.The study reveals different results by using different firm’s value measures. When using the first model (market value) the results found that DER has significant effect on market value and the direction of the relationship is positive, while ROA has significant effect on market value and the direction of the relationship is negative. However, when the second model (Tobin’s Q ) used the results found that there is no significant effect between all of the independent variables (capital structure and profitability variables) and Tobin’s Q . Keywords : capital structure, profitability, firm’s value, manufacturing companies, Jordan DOI : 10.7176/RJFA/10-20-07 Publication date :October 31 st 2019
Highlights
The interaction between capital structure, profitability and firm’s value is an important issue that has received considerable attention in corporate finance literature
Building upon the above issues, this study provides empirical evidence from Amman stock exchange (ASE) to address the effect of capital structure and profitability on the firm value of Jordanian manufacturing companies listed on the Amman stock exchange (ASE)
The total number of companies analysed is (41), representing (65.08%) of the original population and the total number of observations added up to (205)
Summary
The interaction between capital structure, profitability and firm’s value is an important issue that has received considerable attention in corporate finance literature. The main proposition of Modigliani and Miller’s theory is that, under a number of restrictive assumptions, the value of the firm is independent from its financial structure These assumptions include the absence of taxes, bankruptcy costs, equality of borrowing and lending rates, and the independence of the companies productive activates from its financing decisions. Modigliani and Miller in 1963 argue that, when there are corporate taxes, and when interest payment are tax deductible, 100 per cent debt financing is optimal, which means that the firm’s value increases as debt increases (Mouna, et al, 2017) They gave a cautionary warning that the firm will not necessary maximize their value by using 100 per cent debt due to bankruptcy costs (Al-Nsour and Jresat, 2018). Pecking-Order Theory posits that it is difficult to determine the optimal capital structure because firms make use of first equity capital, debt and lastly equity in financing new investments. Effective capital structure can lower the cost of capital, increasing the NPVs of projects, thereby increasing the firm’s value (Gitman, 2003)
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