Capital Structure and Firm Profitability: An Indian Empirical evidence
Our findings connote information asymmetries are less severe such that the cost of capital are lower as long-term borrowings demonstrate the existence of pecking-order theory of financing hierarchy followed by Indian firms When firms are highly profitable, they utilize investment opportunities for their future growth and avoid using debt and issue equity. Faster recovery of accounts receivables, tax shelters, and carry forward of losses entices Indian firms to enjoy tax benefits and mitigate interest costs and default risks. The study envisages capital structure using market-to-book ratio and promoters’ shareholding as useful instruments to explain the firm profitability by simultaneous equation models on the non-financial listed firms. An unbalanced panel data of 638 listed firms with 8,750 firm-year observations were analysed during 20012016. As a solution, 2SLS portrays market-to-book ratio (mtbr) and Indian promoters’ shareholding (pro) as useful instrumental variables that affect firm profitability with accountingbased measures such as return on capital employed (roce) [positive], return on assets (roa), return on networth (ronw), return on equity (roe), and tobin’s Q (tobinsq) reports negative relationship. This paper attempts to fill the gap of capital structure rudiments emphasizing the strength of robust instruments to investigate capital structure.