Investigating the dynamics of capital structure affecting firm performance: evidence from nonfinancial listed companies from KSE Pakistan

Abstract

Capital structure is considered amongst the most important elements in developing the financial structures of any firm. The present study focuses on testing the existence of capital structure irrelevance, presented by Modgiliani and Miller (1958), in nonfinancial sector of Pakistan. Agency Cost, corporate Taxes and Cost of Financial Distress are taken as control variables. The sample of the study comprises of 100 nonfinancial companies listed at Karachi Stock Exchange, Pakistan for the period of 2005 to 2012. Fixed Effects Model is applied for the analysis. The study concludes that capital structure show no significant effects on EPS, Tobin’s Q and ROCE without considering Tax effect and only Net profit shows to be positively influenced by capital structure. Measures of capital structure show no significant effects on EPS and Tobin’s Q after incorporating agency cost and cost of financial distress separately, whereas Net profit and ROCE are significantly influenced by capital structure. In short, the capital structure irrelevance theorem by Modgiliani and Miller is fully supported by the results of the study considering Tax as a government intervention to create an imperfect market situation. For agency cost and cost of financial distress, the capital structure irrelevance theorem is partially supported in nonfinancial sector of Pakistan.