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The Relationship between Capital Structure and Firm Performance Evaluation Measures: Evidence from the Tehran Stock Exchange Abbasali Pouraghajan Assistant Professor and member of the faculty, Department
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The Relationship between Capital Structure and Firm Performance Evaluation Measures: Evidence from the Tehran Stock Exchange Abbasali Pouraghajan Assistant Professor and member of the faculty, Department of Accounting, Qaemshahr Branch, Islamic Azad University, Qaemshahr, Iran, Esfandiar Malekian Member of the faculty, Department of Accounting, Mazandaran University, Babolsar, Iran, Milad Emamgholipour, Vida Lotfollahpour & Mohammad Mohammadpour Bagheri MA student, Department of Accounting, Babol Branch, Islamic Azad University, Babol, Iran, Abstract The main objective of this study is to investigate the impact of capital structure on the financial performance of companies listed in the Tehran Stock Exchange. For this purpose, we studied and tested a sample of 400 firm-years among Companies Listed in the Tehran Stock Exchange in the form of 12 industrial groups during the years 2006 to In this study, Variables of return on assets ratio (ROA) and return on equity ratio (ROE) used to measure the financial performance of companies. Results suggest that there is a significant negative relationship between debt ratio and financial performance of companies, and a significant positive relationship between asset turnover, firm size, asset tangibility ratio, and growth opportunities with financial performance measures. But the relationship between ROA and ROE measures with the firm age is not significant. Also, some of the studied industries have affect on firm performance. In addition, research results shows that by reducing debt ratio, management can increase the company s profitability and thus the amount of the company s financial performance measures and can also increase shareholder wealth. Keywords: capital structure, corporate financial performance, return on assets, return on equity. Published by Asian Society of Business and Commerce Research 166 1. Introduction Capital structure is one of the most important effective parameters on the valuation and direction of economic enterprises in the capital markets. Current changing and evolution environment cause that rating companies also in terms of the credit depends partly to their capital structure and strategic planning required them in order to select effective resources to achieve the goal of shareholders wealth maximization (Drobetz and Fix, 2003). So, one of the most important goals that financial managers should consider to maximize shareholders wealth is determination of the best combination of financial resources for the company. Moreover, financing decisions for the investment is the important duties of company in determination of the best combination of financial resources, and another purpose of financial manager from taking such decisions is maximization of corporate value and also in this regard, he should determine where invest their resources. On the other hand, how to finance the company s assets for interested individuals and institutions is noteworthy and also how much debt and stock the company used to finance its assets is important, Because this will impact on corporate financing decisions (Yahyazadehfar et al., 2010). Financial manager by taking accurate and timely decisions can reduce capital cost of company and thereby increase corporate value. Therefore, adequate and appropriate financing and investment will increase corporate value and thus will increase shareholders wealth. Since combination of various financial sources of every company is called capital structure (Ghalibafasl, 2005), then it can be noted that the best combination of financial resources for every company is optimal or desirable capital structure. Since the company s cost of capital is seen as a function of its capital structure, choice of optimal capital structure or adequate and appropriate financing and investment reduce company s cost of capital and increase its market value (Modarres and Abdoallahzadeh, 2008) and thus will increase shareholders wealth. Capital structure of a company is combination of debt and equity that make up the sources of corporate assets. The company which has no debt, its capital structure is only equity. Different companies have different capital structure (Ahmadpour and Yahyazadehfar, 2010). But the financing resources of companies based on their financial policies are divided in two part internal financial resources and external financial resources . On internal financial resources, the company fund from accumulated earning, i.e. instead of divide profit among shareholders, uses profit mainly in the company s operational activities to obtain more return. And in external financial resources, the company fund from debt and stock (Titman and Grinblatt, 1998). In fact, the present study seek to answer this question whether capital structure of companies listed in stock exchange has impact on their financial performance? Which investigate by using major and index factors such as debt ratio (capital structure), asset turnover, asset tangibility ratio (assets structure), size, age and firm growth opportunities and industry type as determinant factors of capital structure and return on asset (ROA) and return on equity (ROE) as criteria to evaluate corporate performance. In this research, first we describe research literature, then indicate hypotheses, analysis methods, variables research models and finally provide research results. Published by Asian Society of Business and Commerce Research 167 2. Literature Review Decisions about capital structure is one of the most challenging and most difficult issues facing companies, at the same time, the most critical decision about the continued survival of companies. By reference to the conducted researches in this context, we can say that the most major reasons of firm failure is inefficient their inadequate and inappropriate financing and investment, the results of some conducted researches i.e. somewhat related to the topic of this research can be expressed as follows. Céspedes et al. (2010) investigated the relationship between capital structure and ownership in seven Latin American countries during 1996 to In this study, the numbers of 6766 firm-years were selected as a sample. They concluded that there is a positive relationship between leverage and ownership concentration. Also, the research results indicate a positive relationship between leverage and growth variable, and a negative relationship between leverage and profitability and larger firms have more tangible assets. Abor (2005) reviewed the impact of capital structure on profitability of the 22 companies listed in Ghana Stock Exchange during 1998 to Results showed that there is a significant positive relationship between capital structure (total debt to total assets ratio) and return on equity (ROE). Also he indicates that profitable companies have more dependence to financing through liability and high percent (%85) of liabilities of these companies are short term liabilities. San and Heng (2011) in their research studied the relationship between capital Structure and Corporate Performance of Malaysian Construction Sector during 2005 to In this study, 49 companies were selected as samples. Results showed that there is a significant relationship between capital structure and corporate performance. Aburub (2012) in his research investigated the impact of capital structure on the firm performance of companies listed in Palestine Stock Exchange during 2006 to 2010 which 28 companies were selected as samples. In this study, five measures of Return On Equity (ROE), return on assets (ROA), earnings per share (EPS), market value to book value of equity ratio (MVBR) and Tobin Q ratio as the measures of accounting and market of firm performance evaluation and also as dependent variables., and four measures of short-term debt to total assets ratio (SDTA), long-term debt to total assets ratio (LDTA), total debt to total assets ratio (TDTA) and total debt to total equity ratio (TDTQ) as the measures of capital structure and also as the independent variables were selected. Results indicate that the capital structure has a positive effect on firm performance evaluation measures. Zeitun and Tian (2007) in their study Surveyed the impact of capital structure on the firm performance for 167 Jordanian companies during 1989 to The results suggest that capital structure has significantly negative impact on accounting measures of firm performance evaluation. Also they indicate that shortterm debt to total assets ratio (SDTA) has significantly negative impact on market measure of Jordanian companies performance evaluation i.e. Tobin Q ratio. Sunder and Myers (1999) examined the effect of four factors: assets tangibility, growth opportunities, company s tax status and profitability on the capital structure (debt ratio) of 157 American companies in the period of 1979 to Research results indicate a significantly positive relationship between assets tangibility with debt ratio and a significantly negative relationship between debt ratios with firm profitability. Moreover, there is no significant relationship between two variables, growth opportunities and the tax status with the debt ratio. Published by Asian Society of Business and Commerce Research 168 Rajan and Zingales (1995) studied the determinant factors of capital structure of common company corporations in seven large countries around the world (America, Japan, Germany, France, Italy, Britain and Canada) during 1987 to In this study, they chose 4557 companies as samples of these seven countries. Research findings indicate that financial leverage has negative relationship with profitability and market value to book value ratio and positive relationship with the value of tangible fixed asset and firm size. Chen and Strange (2005) investigated the relationship between the variables of firm size, firm age, business risk, sale growth rate, tax, profitability and intangible assets with debt ratio (capital structure) in 2003 in 972 stock companies in China and concluded that the relationship between these variables and debt ratio depend on the basis of calculation of dependent variable (market value or book value). Sogorb (2005) Surveyed the impact of small and medium companies features on their capital structure in Spain during 1994 to In this study, he used from data of 6482 nonfinancial companies in 8 industry order. Results show that tax reserves and profitability of these companies have negative relationship with capital structure while size, growth opportunities and assets structure in these companies have positive relationship with capital structure. Daskalakis and Psillaki (2005) in their research reviewed the determinants of Capital Structure of the SMEs in the Greek and the French companies. This study was performed on the1252 Greek companies and 2006 French companies during a six-year period from 1997 to In this study, they used from assets structure (tangible assets to total assets ratio), size, growth opportunities and profitability of company as determinants of capital structure. Results showed that assets structure and profitability have negative relationship with debt ratio (Capital Structure) in both countries, but firm size and growth opportunities have positive relationship with Capital Structure. Harris and Raviv (1991), Chevalier (1995) and Kovenock and Phillips (1995) Surveyed the effect of various industries on capital structure decisions and concluded that the type of industry can affect the use of debts and firms performance. Onaolapo and Kajola (2010) investigated the effect of capital structure on financial performance of companies listed on Nigeria Stock Exchange. This study was performed on 30 nonfinancial companies in 15 industry sectors in a 7-year period from 2001 to The results showed that the capital structure (debt ratio) has a significant negative effect on financial measures (ROA and ROE) of these companies. Fosberg and Ghosh (2006) in the research conducted on the 1022 companies in the New York Stock Exchange (NYSE) and 244 companies in the America Stock Exchange (AMEX) concluded that the relationship between capital structure and ROA is negative. Houang and Song (2006) in the research conducted on the 1200 Chinese companies during 1994 to 2003 concluded that financial leverages has negative relationship with return on assets and growth opportunities. Andersen (2005) reviewed the relationship between capital structure and firms performance for 1323 companies from various industries and concluded that there is a significant relationship between capital structure and ROA. Elsayed Ebaid (2009) studied the effect of capital structure on the performance of 64 Egyptian companies during 1997 to The results suggest that there is a significant negative relationship between ROA and total debt to total assets ratio. But there is no significant relationship between ROE and total debt to total assets ratio. And also Mramor and Crnigoj (2009) concluded that there is a significant negative relationship between financial leverage (total debt to total assets ratio) and return on assets ratio (ROA). Published by Asian Society of Business and Commerce Research 169 3. Research Hypotheses In order to investigation the effect of capital structure on corporate financial performance, we designed the following hypotheses for testing: H 1 : there is a negative and significant relationship between debt ratio and firm performance. H 2 : there is a positive and significant relationship between asset turnover ratio and firm performance. H 3 : there is a positive and significant relationship between firm size and firm performance. H 4 : there is a positive and significant relationship between firm age and firm performance. H 5 : there is a positive and significant relationship between assets structure (assets tangibility) and firm performance. H 6 : there is a positive and significant relationship between growth opportunities and firm performance. H 7 : type of industry has effect on firm performance. Intentions of firm performance in above hypotheses are accounting measures of firm performance evaluation i.e. the return on assets (ROA) and return on equity (ROE). 4. Research Design 4.1 Statistical Society and Sample Statistical society of this study includes all companies listed in Tehran Stock Exchange during 5-years period from 2006 to 2010 which have following features: 1) Companies must be listed before the research period. 2) They should be nonfinancial companies. 3) The end of financial period of companies lead up to December 31 of each year. 4) Financial period have not changed in the course of study. Thus, by considering the above constraints, the investigated sample size was about 80 companies. These companies have been selected among 12 investigated industries in this study. In Table 1, the number of selected companies for each industry is presented. (Table 1) 4.2 Methods of data collection and information Data used in this study are actual and historical information which have been collected using documents analysis method and through the site of Tehran Stock Exchange (Note 1) and CDs of financial data in companies listed in Tehran Stock Exchange. 4.3 Methods of Data Analysis and Hypotheses Testing In this research, for indication of type and intensity of relationship between dependent and independent quantitative variables, we use Pearson correlation and estimation of multiple regression models for hypotheses testing. And analyzed the results based on statistical significance or insignificant coefficients. For this purpose, after determining the method that shows the most accurate estimation, by using the t statistic, we test the estimation coefficients of independent variables in regression models used to hypotheses. Published by Asian Society of Business and Commerce Research 170 The following general hypothesis used for this test: H 0 : β = 0 H 1 : β 0 H 0 hypothesis means that the independent variable coefficient is zero and in other words, there is no relationship between the changes in the tested dependent variable and independent variables. H 1 is also indicating the relationship between changes in independent variables and dependent variable. Here, the hypotheses are tested in a 5% error level. If the pvalue 5%, the correlation is confirmed at 95% confidence level and otherwise is rejected. After doing t test, general significant of regression model is examined using the F statistic (Fisher s test). In order to identify the presence or absence of significant auto regression among components of intervals from Durbin Watson test (DW), and also to final analyses and statistical tests, we use from SPSS.18 and EXCEL software. 4.4 Operational Research Models and Variables In order to test the hypotheses presented in this research, we used from research models of Onaolapo and Kajola (2010). Where is used the dependent variables, return on assets (ROA) and return on equity (ROE) as accounting measures for evaluating the firms performance, and independent variable, the debt ratio (DR) as capital structure. Also is used from variables of asset turnover (TURN), firm size (SIZE), firm age (AGE), assets tangibility (TANG) and growth opportunities (GROW) as control variables. Models 1a and 1b investigate the total sample of companies, while in models 2a and 2b type of industry (IND) as dummy variable add to model 1 and investigate the effect of each industry on firm performance. Research models and variables are as follows and how to calculate each of the variables is shown in Table (2). Model (1): ROA i,t = DR i,t + TURN i,t + SIZE i,t + AGE i,t + TANG i,t + GROW i,t + (1a) ROE i,t = DR i,t + TURN i,t + SIZE i,t + AGE i,t + TANG i,t + GROW i,t + (1b) Model (2): (by adding variable of industry sector) ROA i,t = DR i,t + TURN i,t + SIZE i,t + AGE i,t + TANG i,t + GROW i,t + IND + (2a) ROE i,t = DR i,t + TURN i,t + SIZE i,t + AGE i,t + TANG i,t + GROW i,t + IND + (2b) In these models: ROA i, t = return on assets of firm i in year t ROE i, t = return on equity of firm i in year t DR i, t = debt ratio of firm i in year t TURN i, t = asset turnover ratio of firm i in year t SIZE i, t = size of firm i in year t AGE i, t = age or number of activity years of firm i in year t TANG i, t = assets tangibility ratio or assets structure of firm i in year t GROW i, t = growth opportunities of firm i in year t Published by Asian Society of Business and Commerce Research 171 IND = industry types that company works in it. =The error of model (Table 2) 5. Research Findings 5.1 Descriptive Statistics Descriptive statistics table i.e. shown in the following indicates the descriptive parameters amount for each variable separately and for all years. Information about descriptive statistics is shown in (Table 3). As it is clear from the observation of information in descriptive statistics table, the ROA mean for sample firms is 10%. ROA represents the profit i.e. obtained from the use of corporate assets (Rahnamayroodposhti, 2008). Thus, the mean value of 10% for ROA indicates poor performance of management in obtaining profit from firm assets. The ROE mean for the total sample is ROE represents the firm power to obtaining profit from resources which shareholders given to company (Rahnamayroodposhti, 2008). The mean value of ROE indicates good performance of management in obtaining profit from firm equity. Given the above, can be noted that the cost of financing is less than asset returns and therefore, the excess amount is belong to equity, as a result the return on equity is more than return on assets. On the other hand, application of debit ratio (DR) in the capital structure of sample companies is in a range between 0.01 and 2.36 which its mean is equal to and this means that on average more than 65 percent of financial resources needed for companies are supplied from debt, that this case show the importanc
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