Capital Structure and Firm Performance; Evidence from Tehran Stock Exchange

Heydar Mohammadzadeh Salteh1, Elham Ghanavati2, Vahid Taghizadeh Khanqah* and Mohsen Akbari Khosroshahi
1

Department of Accounting, Marand branch, Islamic Azad University, Marand, Iran 2 Department of Accounting, Tabriz branch, Islamic Azad University, Tabriz, Iran

Abstract: This study is to investigate the impact of capital structure on firm performance. The study use
fifth performance measures (including return on equity, return on assets, earning per share, market value of equity to the book value of equity and Tobins Q) as dependent variable and four capital structure measures ( including short term debt, long- term debt and total debt to total assets, and total debt to total equity ) as independent variable. The sample of the present study consists of 28 Iranian companies listed in Tehran Stock Exchange (TSE). These companies belong to Vehicles and Parts Manufacturing economic sector. Companies were selected on the basis of availability of information necessary for conducting the study and the readiness of Annual Reports of the financial year 2005-2009. The results indicate that firm performance, which is measured by (ROE,MBVR & Tobins Q) is significantly and positively associated with capital structure, while report a negative relation between capital structure and (ROA, EPS). Altogether, our study provides evidence that indicates firm performance is positively or even negatively related to capital structure.

Keywords: Capital structure, Firm Performance, Accounting Measures, Market Measures, Tehran Stock
Exchange

1. Introduction
Since Modigliani and Miller published their seminal paper in 1958, capital structure has generated great interest among financial researchers. They argued that in efficient markets the debt-equity choice is irrelevant to the value of the firm and benefits of using debts will compensate with decrease of companies stock. Prior to MM theory, conventional perspective believed that using financial leverage increases companys value. In this respect, there is an optimized capital structure that minimizes capital costs. In a subsequent paper, Modigliani and Miller (1963) eased the conditions and showed that under capital market imperfection where interest expenses are tax deductible, firm value will increase with higher financial leverage. Models based on impact of tax, suggest that profitable companies should have more debts these firms have more need for tax management in corporations profit. However, increasing debt results in an increased probability of bankruptcy. Hence, the optimal capital structure represents a level of leverage that balances bankruptcy costs and benefits of debt finance. There are many variables in a capital structure choice and structure of debt maturity which will affect a companys performance. Debt maturity will influence a companys option in investing. The literature on the relationship between firm performance and capital structure has produced mixed results. Abor (2005) reports a positive relation between capital structure, which measured by STD and TD, and performance over the period 1998-2002 in the Ghanian firms. Arbiyan and Safari (2009) investigate the effects of capital structure on profitability using 100 Iranian listed firms from 2001 to 2007. The found short-term and total debts are positively related to profitability (ROE) which indicate a negative relation between long-term debts and ROE. Haung and song (2006), found a negative correlation between leverage and performance (earning before interest and tax to total assets is China firms). Chakraborty (2010) employed two performance measures, including ration of profit before interest, tax and depreciation to total assets and ratio of cash flows to total

* Corresponding author Tel: +98-9147344277

E-mail address: vahid_20t@yahoo.com 225

assets and two leverage measures, including ration of total borrowing to assets and ratio of liability and equity, and reported a negative relation between these ones. This study aims to examine the relation between financing choices; including short-term debt to total assets (SDTA), long-term debt to total assets (LDTT), total debt to total assets (TDTA) and total debt to total equity (TDTQ); and firm performance; such as earning per share (EPS), return on assets (ROA), return on equity (ROE), Market value of equity/ Book value of equity (MBVR) and Tobins Q, over the period 20052009 in the Tehran Stock Exchange using a pooling panel data procedure. The rest of the paper is organized as follows: Section two provides the literature review on capital structure and firm performance. Section three discusses the variable descriptions, expectation and methodology. The empirical results and discussion are presented in section four. Lastly, section five concludes the study.

2. Literature Review
The point of departure for all modern researches on firms capital structure is the Modigliani and Miller (1958) proposition which states that in a world of perfect capital market and no taxes, a firms financial structure will not influence its cost of capital. Consequently, the proposition submitted that firms in a given risk class would have the same applicable discount rate, differing based on scale factor only and would be unaffected by financial gearing (Weston and Copeland, 1998). However, Brigham and Gapenski (1996) argue that an optimal capital structure can be attained if there exist a tax sheltering benefits provided an increase in debt level is equal to the bankruptcy costs. They suggest that managers of the firm should be able to identify when the optimal capital structure is attained and try to maintain it at that level. This is the point at which the financing costs and the cost of capital (WACC) are minimized, thereby increasing firm value and performance. However, the results of examining the relationship between financing choices and performance are mixed and the question of capital structures impact on performance still holds well and empirical study continues. Moreover, empirical studies in this regard are mostly conducted in the mature capital markets and there are a few researches in the emerging market, especially in Iran. Therefore, it is important to explore the relationship between capital structure and firm performance in an emerging market, namely Iran.

3. Estimation Method 3.1. Data Sources

The sample of the present study consists of 28 Iranian companies listed in Tehran Stock Exchange (TSE). These companies belong to Vehicles and Parts Manufacturing economic sector. Companies were selected on the basis of availability of information necessary for conducting the study and the readiness of Annual Reports of the financial year 2005-2009.

3.2. Empirical Model and Proxies Variables

The purpose of this paper is to examine the relationship between capital structure choices and firm performance. The study used Accounting and market measures of performance the accounting Measures for measuring the performance, The study used more than one proxy for accounting and market to measure the performance, The researcher used the proxy ROA and, ROE as accounting performance measure while Tobins Q, EPS and MBVR are used to measure the market performance of firms. All these variables reflect the dependent variable as follow:

3.3. Dependent Variable

ROA; the return on assets: is calculated by dividing net income plus interest expenses with total assets ROE; return on equity: is another profitability ratio that is defined by dividing net income by equity ROA and ROE were chosen because they are important accounting-based and widely accepted measures of financial performance. ROA can also be viewed as a measure of managements efficiency in utilizing all the assets under its control, regardless of source of financing. Some writers such as Bettis and Hall (1982), Demsetz and Lehn (1985), Habib and Victor (1991), Gorton and Rosen (1995), Mehran (1995), Ang, Cole
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and Line (2000), Margaritis and Psillaki (2006), Rao et al (2007), Zeitun and Tian (2007) among others, made use of ROA and ROE as performance proxies in their studies. MBVR; Market value of equity/ Book value of equity; EPS; which indicates how much earning is created on per share, is calculated by dividing net income to the average number of common shares outstanding. Tobins Q introduced by Tobin as an appropriate performance measure in 1969 and is defined as follows: Tobins Q= Market value of equity+ book value of debt/ book value of assets

3.4. Independent Variable

Four different independent were used in the analysis. The independents variables used to test the hypotheses were firm- level leverage, which is computed as: SDTA: Short-term debt / total assets. LDTA: Long- term debt / total assets. TDTA: Total debt / total assets. TDTQ: Total debt / total equity. The study used multiple regression analysis to test the fifth dependent variable with the fourth independent variables, so the result of the study estimates the following regression models. YROE = 0 +1SDTA + 2LDTA + 3 TDTA + 4 TDTQ YROA = 0 + 1SDTA + 2LDTA + 3 TDTA +4 TDTQ YEPS= 0 + 1SDTA +2LDTA + 3 TDTA + 4 TDTQ YMBVR = 0 +B1SDTA + 2LDTA + 3 TDTA + 4 TDTQ YQ = 0 + 1SDTA + 2LDTA + 3 TDTA + 4 TDTQ (1) (2) (3) (4) (5)

3.5. Hypotheses
In order to investigate the effect of the debt on the firms performance the study used three hypotheses: H1: A firms capital structure does influence its performance. H2: Short- term debt decrease firm performance. H3: long- term debt decrease firm performance. H4: Total debt increase firm performance.

4. Empirical Results 4.1. Descriptive Statistics

Table1. Summary Statistics of the Explanatory Variables, 2005-2009 Mean .6208 .0544 .6750 3.6435 .2836 .0820 2.2839 1.2750 1.4737 Std. Deviation .1498 .0439 .1675 4.5145 .4122 .0728 1.2623 .8327 .8194 Skewness -.466 1.686 -.302 3.257 4.051 .057 -3.304 1.726 1.961 Kurtosis .344 3.236 .276 13.396 28.006 3.008 10.605 3.065 4.572 Minimum .1679 .0071 .1847 .2266 -2.3815 -1.0625 -1.976 .3457 .4324 Maximum .9855 .2364 1.0711 3.2151 3.1963 .3708 3.2735 3.7850 5.1852

SDTA LDTA TDTA TDTQ ROE ROA EPS MBVR Q

Table 1 shows the descriptive statistics of the variables. The table shows that all of the variables have a positive mean. Moreover, mean statistics provide some interesting evidence. First, the mean capital structures proxies (TDTA, SDTA and LDTA) are about 67.5, 62.08 and 5.44 percent respectively, which indicate Iranian companies in general, finance their assets by debts, especially by short-term debts. This means they operate in a risky manner. Second, the mean of the Tobins Q (1. 47) is greater than one which revealed the market value of listed companies in the TSE is greater than their book values. This suggests
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companies should invest more and more in capital. Also the mean of ROE (0.28) and ROA (0.08) show that Iranian companies, by considering inflation rate, have a poor performance over the period 2005-2009. Finally Table (1) shows the mean of MBVR (1.275) greater than one this indicates that the share price overvalued.

4.2. Regression Analysis

YROE: The result of the MLR analysis shows that the correlation between ROE and independent variables (SDTA, LDTA, TDTA) not significant, while it is significant with TDTQ. The independent variables are barely related with ROE based on the Adjusted R-square value (17%). The results are not consistent with Ebaid (2009) and Saeedi & Mahmoodi, (2011) who found that none of capital structure has a significant relationship with firm performance when measured by ROE.
Table2. MLR between ROE & ROA with Independent Variables Dependent Variables Independent Variable Constant SDTA LDTA TDTA TDTQ Adjusted R- Square Durbin Watson F-value Prob(statistic) Coefficient .582 7.904 7.346 -8.615 .058 ROE t-statistic 3.508 .630 .583 -.687 5.440 .175 1.798 8.390 .000 Sig .001 .530 .561 .493 .000 Coefficient .288 2.759 2.915 -3.063 -.003 ROA t-statistic 14.635 1.853 1.952 -2.059 -2.159 .628 1.544 59.669 .000 Sig .000 .066 .053 .041 .033

YROA: The result of the MLR analysis shows that the correlation between ROA & (SDTA, LDTA) is not significant, while it is significant with (TDTA & TDTQ). The independent variables are extremely related with ROA based on the Adjusted R-square value (62.8%). These finding are consistent with Karadeniz et al. (2009), Chakraborty (2010), Saeedi & Mahmoodi (2011) reports a negative relationship between performance and capital structure.
Table3. MLR between EPS, MBVR & Tobin's Q with Independent Variables Dependent Variables Independent Variable Constant SDTA LDTA TDTA TDTQ Coefficien t 2.512 13.054 15.578 -12.374 -.277 EPS tstatistic 6.297 .433 .515 -.411 -8.929 Sig .000 .666 .607 .682 .000 MBVR Coefficien tt statistic .251 .984 36.902 2.016 36.960 1.910 -37.589 -1.950 .024 1.469 Sig .32 7 .04 6 .05 8 .05 3 .14 4 Tobin's Q Coefficien tt statistic 1.288 3.811 34.341 1.344 32.986 1.287 -34.321 -1.344 .065 3.035 Sig .00 0 .18 1 .20 0 .18 1 .00 3

Adjusted Rsquare Durbin-Watson stat F-value Prob(statistic)

.492 1.679 34.680 .000

.176 1.942 8.439 .000

.098 1.545 4.795 .001

YEPS: This model tests the relationship between EPS & independent variables. The result of the MLR analysis shows that the correlation between EPS & (SDTA, LDTA, TDTA) independent variables are not
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significant. The independent variables are reasonable related with EPS based on the Adjusted R-square value (49.2%).These finding are not consistent with Frank & Goyal (2003), Berger & Bonaccors di Patti (2006) who indicates a positive relationship between capital structure and performance. YMBVR: The result of the MLR analysis shows that the correlation between MBVR & (LDTA, TDTA, TDTQ) are not significant, while it is significant with SDTA. The independent variables are barely related with MBVR based on the Adjusted R-square value (17%). These findings are consistent with Hadlock and James (2002) who indicate a positive relationship between capital structure and performance. YQ: The result of the MLR analysis shows that the correlation between Tobins Q & (SDTA, LDTA &TDTA) is not significant, while it was significant with TDTQ. The independent variables are barely related with Tobins Q based on the Adjusted R-square value (10%). These finding are consistent with Saeedi & Mahmoodi (2011) who report a positive relationship between Tobins Q and capital structure.

5. Summary and Conclusions

This study examines the relationship between firm performance and capital structure. The sample of the present study consists of 28 Iranian companies listed in Tehran Stock Exchange (TSE). These companies belong to Vehicles and Parts Manufacturing economic sector. Companies were selected on the basis of availability of information necessary for conducting the study and the readiness of Annual Reports of the financial year 2005-2009. Analysis is conducted using MLR regression analysis, the study interprets accounting and market measures as a proxy for the performance, the analysis determines the impact of leverage level on each of these measures. Our results indicate that firm performance which is measured by (EPS & ROA) are negatively related to capital structure. These findings are not consistent with Champion (1999), Gosh et al. (2000), Hadlock and James (2002), Frank and Goyal (2003) and Berger and Bonaccors di Patti (2006) who revealed a positive relation between firm performance and capital structure, while are consistent to Rajan and Zingales (1995), Zeitun and Tian (2007) and Abor (2007) who indicate firm performance is negatively related to capital structure. The study results indicate that (ROE & Tobin's Q) are positively related to TDTQ. while MBVR Statistically significant related to SDTA. Moreover the independent variables are extremely related with ROA based on the Adjusted R-square value (62.8%).

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