The Effect of Capital Structure on Company Performance. The case of UK firm

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ACKNOWLEDGEMENT

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DECLARATION

I, [type your full first names and surname here], declare that the contents of this dissertation/thesis represent my own unaided work, and that the dissertation/thesis has not previously been submitted for academic examination towards any qualification. Furthermore, it represents my own opinions and not necessarily those of the University (Bardhan, 2001, 467).

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Abstract

This study seeks to investigate the impact of capital structure on firm performance by analyzing the relationship between operating performance of UK firms, measured by return on asset (ROA) and return on equity (ROE) with short-term debt (STD), long-term debt (LTD) and total debt (TD). Four variables found by most literature to have an influence on firm operating performance, namely, size, asset grow, sales grow and efficiency, are used as control variables. This study covers two major sectors in UK equity market which are the consumers and industrials sectors. 58 firms were identified as the sample firms and financial data from the year 2005 through 2010 are used as observations for this study, resulting in a total numbers of observations of 358. A series of regression analysis were executed for each model. Lag values for the proxies were also used to replace the non lag values in order to ensure that any extended effect of capital structure on firm performance is also examined. The study finds that only STD and TD have significant relationship with ROA while ROE has significant on each of debt level. However, the analysis with lagged values shows that non of lagged values for STD, TD and LTD has significant relationship with performance.TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION2

1.1 Background of the Study2

1.1.1 Modigliani and Miller's Capital-Structure Irrelevance Proposition4

1.1.2 Modigliani and Miller's Trade-off Theory of Leverage4

1.2 Significance of the Study5

1.3 Aim of the Study8

CHAPTER 2: LITERATURE REVIEW10

2.1 Theoretical Literature10

2.1.1 Firm performance, capital structure and ownership11

2.1.2 Firm performance and capital structure12

2.1.3 Ownership structure and firm performance13

2.1.4 Ownership structure and capital structure15

2.1.5 Theories of Capital Structure16

2.1.5.1 Static trade-off models16

2.1.5.2 Pecking order theories17

2.1.6 Return on Assets and Return on Equity19

2.1.7 WACC and its impact21

2.2 Empirical Literature24

CHAPTER 3: RESEARCH METHODOLOGY31

3.1 Variables of the Study31

3.2 Models33

3.2.1 Return on asset33

3.2.2 Return on equity33

CHAPTER 4: RESULT DISCUSSIONS34

4.1 Regression Analysis36

CHAPTER 5: CONCLUSION41

REFERENCES44

CHAPTER 1: INTRODUCTION

1.1 Background of the Study

The Modigliani-Miller (1958) analysis of the irrelevance of financing decisions began with the premise that financing decisions do not affect the cash flow stream itself. More specifically, they showed that capital structure decisions do not affect firm value when capital markets are perfect, corporate and personal taxes do not exist, and the firm's financing and investment decisions are independent. However, when one or more of the MM assumptions are relaxed, many economists have shown how firm value may vary with changes in the debt-equity mix. Empirical evidence indicates that capital structure changes really convey information to investors, but researchers ...