Effect of Capital Structure on the Financial Performance of Nifty 50

Companies

Seema Pandit

GLS University, Ahmedabad, India

Keywords: Capital Structure, Financial Performance, Nifty 50, Leverage, Debt Equity Ratio.

Abstract: Capital structure is a significant factor which affects the financial performance of the company. The aim of

this study is to understand how capital structure affects the financial performance of the companies included

in Nifty index. Data of Nifty 50 companies have been studied for a period of five years from 2017-18 to 2021-

22. The independent variable Debt-Equity ratio has been considered to measure the capital structure. While

return on assets (ROA), return on equity (ROE), return on capital employed (ROCE) and earnings per share

(EPS) have are the dependent variables hypothesized to measure the financial performance. Correlation and

Regression have been used to examine the effect of Debt Equity Ratio. The study also examines the return on

assets, return on capital employed, return on equity as well as earnings per share with a view to infer the

financial performance of the company’s.

1 INTRODUCTION

Capital Structure decision is one of the key decisions

that the management has to take. The companies use

equity shares, debentures, retained earnings, short

term loans to finance its capital requirements. These

funds are invested in assets – long term and short

term. The companies aim to maintain an optimum

capital structure. An optimum capital structure will

help to maximize the value of the firm and minimize

the cost of capital. The capital structure decisions

affect the financial performance of the company.

Various researchers in the past have reported

combined effect of leverage-capital structure on the

financial performance of the companies. The current

study aims to observe the relationship between the

leverage–capital structure and financial performance

of the Nifty 50 companies for a period of five years

from 2017-18 to 2021-22. Debt-Equity (D/E) ratio

has been applied to measure leverage and the ratios -

Return on Assets (ROA), Return on Capital

Employed (ROCE), Return on Equity (ROE) and

Earnings Per Share (EPS) has been applied to

measure financial performance.

2 LITERATURE REVIEW

A number of theoretical and empirical studies have

been done to examine the effect of capital structure

on the company’s performance. Modigliani and

Miller hypothesis points out that the capital structure

is irrelevant to value of company’s and cost of capital.

Under the assumptions of perfect capital markets,

value of the company’s is independent to capital

structure. Further, the M-M hypothesis propounded

that the return generated by debt financing is exactly

offset by the risk incurred regardless of the capital

structure mix. “According to the trade-off theory,

optimum capital structure is a trade-off between the

interest tax shield and the cost of financial distress.”

Agency cost theory explains the conflicts among

shareholders, debt holders and management. This

creates the agency problem which results into agency

costs. Agency costs have significant influence on the

company’s capital structure.

A number of empirical studies have been

conducted to examine the effect of capital structure

on the company’s performance. Ebrati, Emadi,

Balasang, & Safari (2013) concluded that “Return on

Capital Employed, Market value of equity/ Book

value of equity and Tobin’s Q are positively related

to capital structure and Return on Assets and EPS are

negatively related to capital structure. “Goyal (2013)

Pandit, S.

Effect of Capital Structure on the Financial Performance of Nifty 50 Companies.

DOI: 10.5220/0012514300003792

Paper published under CC license (CC BY-NC-ND 4.0)

In Proceedings of the 1st Pamir Transboundary Conference for Sustainable Societies (PAMIR 2023), pages 843-846

ISBN: 978-989-758-687-3

843

investigated the influence of capital structure on the

financial performance of banking companies listed on

the National Stock Exchange. The research

summarized that short term debt to capital ratio has a

positive effect on return on equity, return on assets

and earnings per share while the long-term debt to

capital ratio has a negative effect on Return on

Equity, Return on Assets and Earnings per Share.

Javed & Yoanus (2014) analyzed the influence of

capital structure on firm’s performance. The results

indicated a mixed relationship between the capital

structure and firm performance. The studies by

Vatavu (2015) indicated that performance of the

Romanian companies is higher when they do not use

the debt in their capital structure. Use of equity capital

in the capital structure results into favourable effect

on financial performance indicators while the use of

debt shows negative relationships with Return on

Equity and Return on Assets. Emin (2016) concluded

that both short term debt and long-term debt have a

significantly negative effect on Return on equity and

Return on Assets. Abubakar (2016) concluded that

there is a significant positive effect of short-term debt

ratio and long-term debt ratio on the return on equity

while total debt ratio has a significant negative effect

on return on equity. According the research done by

Sinha (2017), leverage has significantly negative

effect on Tobin’s Q ratio while it does not have

significant effect on ratio of Enterprise Value to Profit

before Interest, Depreciation and tax. Chandra

&Udhayakumar (2018) research indicated that ratio

of interest-bearing debt to fixed assets do not

significantly affect the EBIT margin and return on

assets The results of panel data model concluded that

leverage significantly does not affect the company’s

performance. Sudharika, De Silva, Madhusankha

&Siriwardhana (2018) examined the effect of capital

structure on the company’s financial structure on the

financial performance of 39 Hotels and Travel sectors

companies listed on the Columbo Stock Exchange

The company’s structure has been measured through

Debt-Equity Ratio and the company’s performance is

measured through Return on Capital Employed,

Earnings per share and Tobin’s Q. The debt equity

has significant negative effect on the company’s

performance. Pal (2022) studied that effect of

leverage on the company’s performance. The results

indicated that short term debt and long-term debt has

negative effect on the company’s performance across

all sectors. While the other independent variables had

a mixed effect on the company’s performance.

To summarize, some of the previous empirical

studies show the positive effect of leverage on

financial performance of the company’s whereas

some shows the negative effect of leverage on the

financial performance of the companies. The effect of

capital structure or leverage on the financial

performance of the company’s has always been

debatable. This has been the reason for which the

present study has been undertaken.

2.1 Objectives of the Study

To investigate how the capital structure of a company

affects the financial performance of company

2.2 Research Methodology

Sample Selection: The sample of the study consists of

the Nifty 50 companies. Since the financial

performance analysis of the banking and financial

services sector is different from the other companies,

these companies have been excluded. The study

covers the data of 39 companies for a period of five

years from the year 2017-18 to 2021-22. The relevant

financial data have been collected from the annual

reports and websites of companies and various

websites.

Variables for the Study: The measurement of

company’s performance is debatable as there are

various dimensions of performance measurements,

both financial and non-financial. The present study

considers the financial performance. The financial

performance measures the performance in terms of

profitability, return on investment and return on

assets.

Dependent Variables: Return on Assets (ROA),

Return on Equity (ROE), Return on Capital

Employed (ROCE) and Earnings per Share (EPS)

Independent variable: Debt Equity (D/E) ratio

2.3 Research Hypothesis

Following hypothesis has been developed to study the

effect of capital structure on company’s performance.

1. H

0 –

D/E Ratio does not significantly

affect ROA

2. H

0 –

D/E Ratio does not significantly

affect ROE

3. H

0 –

D/E Ratio does not significantly

affect ROCE

4. H

0 –

D/E Ratio does not significantly

affect EPS

2.4 Methodology

In order to study the relationship between capital

structure and company’s performance, Correlation

PAMIR 2023 - The First Pamir Transboundary Conference for Sustainable Societies- | PAMIR

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analysis has been employed. Further, to study the

effect of D/E ratio on the ROA, ROE, ROCE and

EPS, Regression Analysis has been employed.

2.5 Analysis and Discussion

Correlation Analysis: The results in Table-1 show the

results of the Correlation Analysis. The results

indicate that there is a negative relationship between

the D/E ratio and all the financial performance

parameters – EPS, ROE, ROCE and ROA.

Table 1: Correlation Matrix.

Table 2: Regression of ROA on D/E.

Table 3: Regression of ROE on D/E.

Independent

Variable

Dependent Variable: Return on Equity

Coefficient P-Value R-Square

D/E Ratio

13.1995055

*0.035864863 0.11663115

Table 4: Regression of ROCE on D/E.

Table 5: Regression of EPS on D/E.

The above correlation matrix indicates that there is a

moderate negative relationship between D/E ratio and

EPS and ROE whereas there is a strong negative

relationship between D/E ratio and ROCE and ROA.

Regression Analysis

The regression analysis is run to find the effect of the

independent variable - D/E ratio on the dependent

variables – ROA, ROE, ROCE and EPS. According

to the regression results in Table II, we fail to accept

the null hypothesis and conclude that D/Eratio

significantly affects ROA. R-square of 0.2655

explains that around 26.55% changes in ROA are

explained by D/Eratio. When D/Eratio decreases by I

unit, ROA will increase by 11.11. According to the

regression results in Table III, we fail to accept the

null hypothesis and conclude that D/E ratio

significantly affects ROE. R-square of 0.1166

explains that around 11.66% changes in ROE are

explained by D/E ratio.

When D/Equity ratio decreases by I unit, ROA will

increase by 13.20

According to the regression results in table IV, we

fail to accept the null hypothesis and conclude that

D/E equity ratio significantly affects ROCE. R-square

of 0.1904 explains that around 19.04% changes in

ROCE are explained by D/E ratio. When D/E ratio

decreases by 1 unit, ROCE will increase by 13.96.

According to the regression results in Table V, we

accept the null hypothesis and conclude that D/E

Ratio does not significantly affect the EPS.

3 DISCUSSIONS

The study examined the relationship between the

(D/E ratio and the various dependent variables –

ROA, ROE, ROCE and EPS. The results of

correlation analysis suggest a negative relationship

between the capital structure and the financial

indicators measured by ROA, ROE, ROCE and EPS.

The regression analysis results point out a significant

effect of D/E ratio on ROA, ROE and ROCE.These

results are in line with the previous studies conducted

by Ebrati, Emadi, Balsang and Safari (2013), Vatavu

(2015), Emin (2016), Sudhrika, De Silva, Madhu

Sankha and Siriwardhana (2018). The results of the

study are in contradiction to the study done by

Chandra and Udaykumar (2018) which concluded

that leverage significantly do not affect the

company’s performance.

Total D/E (X)

EPS

ROE

ROCE

ROA

Total

D/E

(X)

EPS

-0.290730893

ROE

-0.341513031

0.267032692

ROCE

-0.436361331

0.268791632

0.905769

ROA

-0.515362046

0.244134577

0.870973

0.89004

Independent

Variable

Dependent Variable: Return on Assets

Co-efficient

P-Value

R-Square

D/E Ratio

11.1120011

*0.000929062 0.265598038

Independent Variable

Dependent Variable: Return on

Capital Employed

Coefficient P-Value R-Square

D/E Ratio -13.96707688 *0.006165708 0.190411211

Independent Variable

Dependent Variable: Earnings

Per Share

Coefficient P-Value R-Square

D/E Ratio - 52.68350626 0.076595581 0.084524452

Effect of Capital Structure on the Financial Performance of Nifty 50 Companies

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4 CONCLUSIONS

The study has been conducted to study the effect of

capital structure on the financial performance of the

Nifty 50 companies. Out of Nifty 50companies, the

data of 39 companies have been analysed for a period

of 5 years from 2017-18 to 2021-22. The banking and

financial services companies have been excluded

from the study. The results of correlation show

negative relationship between capital structure and

financial performance. The regression results suggest

significant effect of capital structure on the financial

performance of the Nifty 50 companies.

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