Does Capital Structure Affect Profitability of Listed Ghanaian Firms?

Abstract

ABSTRACT: Capital structure is one of the crucial decisions managers must make that can affect a firm's short-term and long-term value maximization prospects. Though extant studies have shown capital structure significantly affects profits, researchers have struggled to find an optimal mix of capital structure ideal for value maximization due to the influence of macro and micro factors. There is therefore the need for this to be properly studied contextually. Building on the Pecking Order Theory, this study examines the capital structure effects on profitability from a short-term, long-term, and total debt financing perspective on listed Ghanaian firms between 2003 and 2013. An unbalanced panel data of 23 listed manufacturing and service firms that are listed on the Ghanaian Stock Exchange are subjected to robust maximum likelihood heteroskedastic linear estimation models. Three main regressions that are run explain the short-term debt, long-term debt and total debt effect on firm profitability. The results show that short-term debt exhibits a positive effect on return on equity (ROE), whilst the relationship reverses for long-term debt, indicating that short-term financing was beneficial to firms rather than long-term financing. Also, total debt exhibited a negative and non-significant effect on return on equity. The author also found that firm liquidity exhibited a more pronounced positive effect on profitability for firms with short-term debt than long-term debt. Financial risk negatively affected the returns of only firms with short-term debt. Market share had a pronounced positive effect on ROE across firms whilst firm age exhibited a less pronounced positive effect on firm profits. Firm size and growth had increasing profit effects but was not significant in the dataset. Financial risk also negatively affected profits, but this was only significant in firms with short-term debt structures. This study finds that managers need to adopt more short-term debt financing rather than long-term financing as the former leads to more profits. There is a need for policymakers to develop long-term debt financing structures to compete in the Ghanaian debt market. It is also recommended that managers exercise due care when supplementing equity capital with debt.