The Effects of Capital Structure on Firm Performance in the Taiwan 50 and Taiwan Mid-Cap 100

Abstract

This paper tries to explore an optimal capital structure for the purpose of maximizing firm performance and analyzes the relationship between optimal capital structure and the value of the firm. We investigate the relation between ROE and the capital structure by testing data of firms in Taiwan 50 and Mid-Cap 100. This research probes the MM and trade-off theories by taking financial distress costs into consideration and examines financial decision behavior of firms under the trade-off theory. In this paper, we have several findings as follows: first, there is evidence supporting the existence of optimal capital structure and firm’s debt ratios consistently adjusted gradually toward target over time. In addition, because of agency costs, firms in Mid-Cap 100 have smaller target ratio then those in Taiwan 50. Moreover, findings provide further evidence on the relation between the distribution of debt ratio and corporate performance. Finally, firm’s performance is a significantly quadratic function of debt ratio. These empirical results indicate that the financing behavior of non-financial firms in the Taiwan 50 and the Taiwan Mid-Cap 100 is consistent with the trade-off theory; besides, corporate performance is a nonlinear function of the capital structure when financial distress cost is considered.