The IUP Journal of Accounting Research and Audit Practices:
Determinants of Profitability of Capital-Intensive Firms in the Indian Capital Market: A Static and Dynamic Panel Approach

Article Details
Pub. Date : Oct, 2019
Product Name : The IUP Journal of Accounting Research and Audit Practices
Product Type : Article
Product Code : IJARAP21910
Author Name : Ravi Vaidya and Pooja Patel
Availability : YES
Subject/Domain : Finance
Download Format : PDF Format
No. of Pages : 19

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Abstract

Capital structure of a firm is a crucial determinant of its financial health and ability to grow and generate healthy returns for all its stakeholders. Ample research has been undertaken to identify the determinants of capital structure of a firm. The present study, using annual data of 214 listed firms from the automobile, cement and steel industry in the Indian capital market for the period 2011-2018, makes an attempt to explore the relationship of the capital structure of these asset-heavy businesses with their profitability performances. The study employs a balanced panel-regression approach: Fixed Effect Model (FEM), Random Effect Model (REM), and Generalized Method of Moment (GMM). The study also implements panel unit root tests to find the stationarity of data. The considered variables of all the three models under pooled regression explain the profitability in terms of performance of companies. All the three relationships depict heterogeneity in time and homogeneity in cross-section. Hence, it is a one-way variable intercept model estimated using FEM by deploying an OLS procedure. The leverage has a negative impact on profitability. However, cash flow, net block and ratio of total liabilities to net block affect profitability positively. The results of Hausman tests for all the three relationships reject the null hypothesis which states that REM is inappropriate; hence, the significance of FEM rather than REM is validated. The OLS model under fixed effect with time is considered to be the preferred model as compared to GMM estimation as the J-statistic reveals some of the misspecification by independent variables. Hence, the dynamic specifications of all the three models are apt to prove invalid. This study attempts to broaden the discussion on the effect of crucial financial variables on the profitability performance.


Description

The capital structure of a firm is one of the most important capital financing decisions according to Modigliani and Miller (1958), and has been proven to be a determinant of profitability as stated by Jaisinghani and Kanjilal (2017). A higher need for capital results in higher long term as well as current debt, which leads to unfavorable debt-to-equity equilibrium. Preliminary studies by Friend and Lang (1988), Barton et al. (1989), Petersen and Rajan (1994), Mollik (2005), Berger and Di Patti (2006) and Kyereboah-Coleman (2007) endorsed a mixed relationship between leverage of the firm and its value. A high debt also leads to higher interest servicing, resulting in poor interest coverage ratio, thus affecting profitability.


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