The Relation Between Profitability and Leverage for Polish Companies During a Financial Crisis
The paper refers to the problem of the relationship between profitability and leverage. This is a major part of any capital structure decision. The aim of the paper is to identify whether the relationship between profitability and leverage is positive or negative. It must be noted that the trade-off theory assumes a positive relation, while pecking order theory assumes a negative relation. We also assume that because of financial crisis specificities, declining profitability will be accompanied by declining leverage. In our work, to identify the relation, we employed correlation coefficient techniques. Moreover, to model the relation, we utilized univariate regression analysis. Furthermore, we conducted three levels of analysis: for aggregated data of the companies of the whole Polish economy, for firm-level data of companies listed on WSE and for firm-level data of panel companies listed on WSE. Our analysis covers the period of 2005-2016. We found positive relationships between ROE and leverage and negative relationships between leverage and ROA. We think that these relations might be explained by the effects of financial leverage and the fact that the owners' rate of return (ROE) is higher than the cost of debt. The originality of our research lies in including different measures of profitability (esp. ROA and ROE) and the effects of financial leverage (EFL) as the explanation for the inconsistency in research on the relation between profitability and leverage. Our results are an important contribution to a debate on the relationship between profitability and leverage, and might explain both positive and negative interaction by connecting this relation with the effects of financial leverage and the relation between cost of capital and the rate of return. (original abstract)
- Abeywardhana, D. Y. (2015). Capital structure and profitability: An empirical analysis of SMEs in the UK. Journal of Emerging Issues in Economics, Finance and Banking, 4(2), 1661-1675.
- Artola, C., & Genre, V. (2011). Euro area SMEs under financial constraints: Belief or reality? CESifo Working Paper Series No. 3650. Retrieved from SSRN: https://ssrn.com/abstract=1966955
- Bris, A., Koskinen, Y., & Pons, V. (2004). Corporate financial policies and performance around currency crises. The Journal of Business, 77(4), 749-796.
- Brun, M., Chai, F., Elgg, D., Esteban, A., Gastel, G., Körting, T., Momo, R., Nigro, V., Poiares, R., Servant, F., Solera, I., & Vivet, D. (2013). Profitability, equity capitalization and net worth at risk. How resilient are non-financial corporations in a crisis environment? European Committee of Central Balance Sheet Data Offices, Working Paper 2013. Retrieved from https://www.bde.es/f/webbde/SES/cenbal/colabora /ficheros/en /WP_Study_Group_ECCBSO_2013.pdf
- Campello, M., Graham, J. R., & Harvey, C. R. (2010). The real effects of financial constraints: Evidence from a financial crisis. Journal of Financial Economics, 97, 470-487.
- Casey, E., & O'Toole, C. M. (2013). Bank-lending constraints and alternative financing during the financial crisis: Evidence from European SMEs. ESRI, Working Paper No. 450.
- Claessens, S., Tong, H., & Wei, S-J. (2011). From the financial crisis to the real economy: Using firm-level data to identify transmission channels. Journal of International Economics 88(2), 375-387.
- Demirguc-Kunt, A., Martinez-Peria, M. S., & Tressel, T. (2015). The impact of the global financial crisis on firms' capital structure: The role of financial markets and institutions. Policy Research Working Paper; No. 7522. World Bank, Washington, DC. Retrieved from https://openknowledge. worldbank.org/handle/10986/23623
- Donaldson, G. (1961). Corporate Debt Capacity: A Study of Corporate Debt Policy and the Determination of Corporate Debt Capacity. Boston: Division of Research, Harvard School of Business Administration.
- ECB Occasional Paper (2013). Corporate indebtedness ratios only started falling in the later stages of the recession in the euro area. Corporate finance and economic activity in the euro area. Structural issues report No. 151. Retrieved from https://www.ecb.europa.eu/pub/pdf/scpops/ecbocp151.pdf
- European Investment Bank (2014). unlocking lending in europe. Retrieved from www.eib.org/.../economic_report_unlocking_lending_in_europe_
- Fama, E. F., & French, K. R. (2002). Testing Trade-Off and Pecking Order Predictions about Dividends and Debt. The Review of Financial Studies, 15(1), 1-33.
- Ferrando, A., & Griesshaber, N. (2011). Financing obstacles among Euro area firms who suffers the most? Working Paper Series No 1293 by European Central Bank.
- Gaud, P., Hoesli, M., & Bender, A. (2007). Debt-equity choice in Europe. International Review of Financial Analysis, 16, 201-222.
- Gjorgieva-Trajkovska, O., & Jovanova, B. (2012). The impact of the global financial crisis on small and medium enterprises financing. Retrieved from http://tinyurl.com/cfcd8ha
- González, V. M., & González, F. (2012). Firm size and capital structure: Evidence using dynamic panel data. Applied Economics, 44(36), 4745-4754.
- Gritta, R. D., Adams, B., & Adrangi, B. (2006). An analysis of the effects of operating and financial leverage on the major U.S. air carriers' rates of return: 1990-2003. Conference Paper/Presentation Transportation Research Forum, New York. Retrieved from http://ageconsearch.umn.edu/bitstream/208042/2/2006_8A_FinLeverage_paper.pdf.
- Haan, L., & Hinloopen, J. (2003). Preference hierarchies for internal finance, bank loans, bond, and share issues: Evidence for Dutch firms. Journal of Empirical Finance, 10(5), 661-681.
- Holton, S., Lawless, M., & McCann, F. (2012). Credit demand, supply and conditions: A tale of three crises. Central Bank of Ireland Working Paper.
- Ivashina, V., & Scharfstein, D. (2010). Bank lending during the financial crisis of 2008. Journal of Financial Economics, 97, 319-338.
- Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
- Kayo, E. K., & Kimura, H. (2011). Hierarchical determinants of capital structure. Journal of Banking & Finance, 35(2), 358-371.
- Lucas, D. J., & McDonald, R. L. (1990). Equity issues and stock price dynamics. The Journal of Finance, 45(4), 1019-1043.
- Majluf, N. S., & Myers, S. C. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187-221.
- Marsh, P. (1982). The choice between equity and debt: An empirical study. Journal of Finance, 37(1), 121-144.
- Mazur, K. (2007). The determinants of capital structure choice: Evidence from Polish companies. International Advances in Economic Research, 13(4), 495-514.
- Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporate finance and the theory of investment. American Economic Review, 48, 261-297.
- Modigliani, F., & Miller, M. H. (1963). Corporate income taxes and the cost of capital: A correction. American Economic Review, 53, 433-443.
- Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 39, 575-592..
- Opler, T. C., & Titman, S. (1994). Financial distress and corporate performance. Journal of Finance, 49(3), 1015-1040.
- Prasad, D., Puri, Y. R., & Jain, R. (2015). Return to profitability after a financial crisis. The International Journal of Business and Finance Research, 9(1), 89-101.
- Psillaki, M., & Daskalakis, N. (2009). Are the determinants of capital structure country or firm specific? Small Business Economics, 33(3), 319-333.
- Rajan, R. G., & Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. Journal of Finance, 50(5), 1421-1460.
- Ramalho, J., & Silva, J. V. (2009). A two-part fractional regression model for the financial leverage decisions of micro, small, medium and large firms. Quantitative Finance, 9(5), 621-636.
- Režňáková, M., Svoboda, P., & Polednáková, A. (2010). Determinants of capital structure: Empirical evidence from Slovakia. Ekonomický časopis, 58(3), 237-250.
- Schwartz, E., & Aronson, J. R. (1967). Some surrogate evidence in support of the concept of optimal financial structure. Journal of Finance, 22(1), 10-18.
- Seifert, B., & Gonenc, H. (2008). The international evidence on the pecking order hypothesis. Journal of Multinational Financial Management, 18, 244-260.
- Sen, M., & Eda, O. (2008). Testing of pecking-order theory in Istanbul stock exchange market. International Research Journal of Finance and Economics, 21, 1450-2887.
- Shubita, M. F., & Alsawalhah, J. M. (2012). The relationship between capital structure and profitability. International Journal of Business and Social Science, 3(16), 104-112.
- Shyam-Sunder, L., & Myers, S. C. (1999). Testing static trade-off against pecking order models of capital structure. Journal of Financial Economics, 51, 219-244.
- Singh, D. (2016). A panel data analysis of capital structure determinants: An empirical study of non-financial firms in Oman. International Journal of Economics and Financial Issues, 6(4), 1650-1656.
- Sogorb-Mira, F. (2005). How SME uniqueness affects capital structure: Evidence from a 1994-1998 Spanish data panel. Small Business Economics, 25(5), 447-457.
- Taggart, R. A. (1977). A model of corporate financing decisions. Journal of Finance, 32(5), 1467-1484.
- Titman, S., & Wessels, R. (1988). The determinants of capital structure choice. Journal of Finance, 43(1), 1-19.
- Velnampy, T., & Niresh, J. A. (2012). The relationship between capital structure and profitability. Global Journal of Management and Business Research, 12(13), 67-74.
- Warner, J. B. (1977). Bankruptcy costs: Some evidence. The Journal of Finance, 32(2), 337-347.