Effect of Firm Size on the Association between Capital Structure and Profitability

Abstract

This paper examines the association between capital structure and firm profitability through the moderating effect of firm size. The analysis of financing choice and firm profitability in developing countries is interesting because of the differences between the characteristics of their firms and those of companies in advanced economies. This research utilized secondary data obtained from the published annual financial statements of 156 manufacturing companies listed on the Tehran Stock Exchange (TSE) over the period 2011–2019. The given description was evaluated using a panel econometric approach, namely, the fixed-effects regression method. The results displayed that profitability is negatively affected by capital structure decisions. However, firm size is positively related to profitability. The robust findings also illustrate that the size of a firm plays a significant role in improving the influence of capital structure choice on the firm’s profitability. Similar to other emerging economies, in Iran, when internal finances are inadequate, long-term debt is used as an alternative for financing. These results provide evidence to support the hypothesis of the trade-off theory, which explains the relationship between firm size, capital structure, and profitability. These findings provide significant information from a developing country, Iran, that confirms the argument of the trade-off theory and provides substantial guidance for sector management.