The Relationship between Capital Structure Measures and Financial Performance: Evidence from Ghana

Kwame Mireku,Emmanuel Ogoe,Samuel Mensah

doi:10.5539/ijbm.v9n6p151

Abstract

One of the areas that has been a focus of intense debate when it comes to capital structure research is whether touse the book value or market value of capital structure as the accurate measure of financial leverage (Salehi &Biglar, 2009). Various arguments have been raised in favour of which of the measures researcher should use incapital structure studies. However, much has not been done to determine which of the measures has a moresignificant relationship with financial performance. Therefore the thrust of this paper was to establish therelationship between capital structure measures and financial performance so to determine which of the capitalstructure measures has a stronger association with financial performance. Two definitions of capital structuremeasures (book value & market value) and six financial performance measures were used. For this study, fifteencompanies on the Ghana Stock Exchange (GSE) were selected over a 6-year time period (2002–2007). Theoutcome of the study established that the capital structure of firms influences their performance. Many measuresof firm performance were negatively correlated with financial leverage. Meaning, companies with less debt inGhana have high profit margins and good financial performance. The study established that the market value ofcapital structure has a stronger relation with financial performance as compared to the book value. Researchersshould therefore consider first, the use of market value in any studies on capital structure.

Highlights

1.1 Background of the StudyAccording to Rajan and Zingales (2003), recently, a number of research works have probe into business financing decisions in the past to gain more understanding of present-day corporate governance and corporate financing
This study empirically examined the relationship between capital structure measures and financial performance using Pearson’s coefficient of correlation and significant level instead of student’s T test
Findings of this study may help stakeholders to recognize the link between capital structure and financial performance and choosing appropriate measures to evaluate and analyze the companies’ financial status

Summary

Introduction

1.1 Background of the StudyAccording to Rajan and Zingales (2003), recently, a number of research works have probe into business financing decisions in the past to gain more understanding of present-day corporate governance and corporate financing (see). In addition to the above, financial economists have worked over the past decades to move corporate financing into a more scientific task, with a body of recognized theories that can be tested and explained by empirical studies. Capital structure which refers to an organization's financing structure is a subject that continues to engage the attention of researchers in the field of accounting and finance. It is seen as one of the most perplexing issues in corporate finance literature (Brounen & Eichholtz, 2001). Capital structure studies have persistently increase over time and still continue to engage the attention of researchers with the main purpose of determining whether optimal equity and debt combination exist. How organizations select the amount of equity and debt in their capital structure mix still remain a mystery

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