The impact of capital structure on company profitability of industrial companies listed on the Johannesburg Stock Exchange

Abstract

This study empirically examines the impact of capital structure on the profitability of the industrial firms listed on the JSE over a period 2006-2015. The sample consists of 52 industrial companies with a complete data set of at least 8 consecutive years. The effects of capital structure on profitability are estimated on the whole sample, then on large firms and small firms, and lastly on different sub-sectors. This study contributes to literature by providing an in-depth assessment of the impact of capital structure on a more homogeneous sample of industrial firms in South Africa. It also uses different measures of profitability and debt to asset ratios in an integrated framework in order to provide a comprehensive analysis of the problem. The fixed (within) effects regression model is used to estimate the effects of capital structure on profitability. The study also applies the pooled ordinary least squares model (pooled OLS) for robustness checks on the full sample. The empirical findings of this study reveal that total debt and long-term debt negatively and significantly affect the profitability (NPR, ROA and EPS) of the whole sample. In the case of small and large firms, the results present a statistically significant negative relationship between ROA and debt ratios in small firms while exhibiting a strong negative impact on profitability (ROA, EPS and NPR) for large firms. The results are generally robust to a number of sensitivity tests, including estimations on different sub-sectors and an alternative estimation method (pooled OLS). Total debt and long-term debt have a negative influence on the profitability of all sectors and especially on ROA where the influence is significant. However, short-term debt positively influences the ROA and NPR of the construction and materials sub-sectors, but affects other sectors differently. From the estimations of the pooled OLS regression as an alternative model, the results mostly concur with the findings from the fixed (within) effects where debt negatively affects firm profitability. Based on the findings of the study, debt appears to be a costly source of financing for industrial firms in South Africa as its increase results in the decline of profits. Firm managers should consider using internally generated funds which are a cheaper source of financing or issuing equity which is less risky since it does not have the fixed monthly interest and principal payments that debt has.