An Empirical Analysis of Relationships between Capital Structure, Market Power, Profitability and Expenditure

Abstract

This paper analyzes the important determinants of capital structure in the Indonesian Companies. Objectives: This study extends the empirical works on the determinants of capital structure, taking all the relevant independent variables as determinants; it sheds new light on the relationship between business risk and leverage. Approach: This paper using Generalized Methods of Moment to analyze capital structure and market power, and profitability in relationships. Capital structure and market power, as measured by Tobin's Q, are shown to have a cubic relationship, due to the complex interaction of market conditions, agency problems and bankruptcy costs. Result: The study finds a saucer-shaped relation between capital structure and profitability. The negative relationship between debt ratio and the size of shareholding means that more diffused ownership results in lower leverage, which supports the agency hypothesis. The current results indicate a significant positive relationship of tangibility (FA/A ratio) with debt ratio, which vindicates the trade-off theory that postulates a positive correlation between debt ratio and tangibility since fixed assets act as collateral in debt issues. Implication: this study implying for academics can develop capital structure theory, for practitioner as the reference for business decision-making, especially market structure.

Keywords: Capital structure; market structure; profitability; and expenditure