The Impact of Capital Structure on Firm Performance: Empirical Evidence from Private Manufacturing Companies of Amhara Regional State of Ethiopia

Abstract

The financial performance of the business is crucial not only for maximizing its value but also for its survival. Existing theoretical and empirical evidences suggests that the capital structure choice is the major among the other factors that influence firm’s financial performance. Thus, the purpose of this study was to empirically examine the impact of capital structure on the financial performance of private manufacturing companies in Amhara regional state of Ethiopia. The study employed two of the most common profitability ratios: Return on Assets (ROA) and Return on Equity (ROE) as a proxy to measure financial performance (i.e. the dependent variable). Unlike other studies pertaining to Ethiopia on the issue under investigation, the current study employed four proxies: Total Debt Ratio (TDR), Short Term Debt Ratio (STDR), Long Term Debt Ratio (LTDR), and Debt-Equity Ratio (DER) to measure capital structure. Further, in the regression equation, natural logarithm of total assets was included as a control variable to check its effect on firm’s financial performance. Using a panel data for 16 private manufacturing companies for the period 2010 through 2014, the regression result reveal a significant positive relation of profitability measured by ROA with short term debts while a significant negative relationship is found with long term debt, total debts and debt equity ratio. Further, a significant positive relationship is found between short term debt and profitability measured by ROE. While long term debt is negatively and significantly related with ROE. The relationship of ROE with DER and TDR is statistically insignificant. Finally, the relationship of firm size is found to be statistically insignificant with the two measure of financial performance. In general, consistent to the pecking order theory the study concluded that capital structure (leverage) has a significant negative influence on the financial performance of private manufacturing companies of Amhara regional state of Ethiopia.

Keywords: financial performance, capital structure, manufacturing companies