1.

Introduction

Profitability, often perceived as an essential prerequisite for the prosperity of enterprises, is

considered as a fundamental indicator for financial robustness and operational sustainability.
For decades, the topic of what are the most important factors affecting the profitability of a
company has been at the centre of many strategy research. The factors explaining a firm's
profitability can be classified into three main categories: firm‐specific characteristics,
industry variables, and market‐related variables (Yazdanfar, 2013). Among those factors,
capital structure is undeniably crucial to evaluate how profitable a company or business is.
Nasimi (2016) states that debt and equity are two components of a firm’s capital structure
used to finance its assets. Shannon P Pratt and Roger J Grabowski (2014) also hold the idea
that a business's capital structure comprises debt capital, preferred equity capital, and
common equity capital. Debt is a financial obligation in which one party owes an amount of
money which is typically repaid with interest after a specific period of time. It entails a
written contract with terms on the principal amount, interest rate, payback period, and
collateral. According to La Rocca, M., La Rocca, T. & Cariola (2011), over the course of a
company's life cycle, the amount of debt in the capital structure is adjusted in response to the
company's upcoming financial needs. Meanwhile, equity is the term used to describe the
ownership interest in a company or property, including the asset’s value after deducting all
debts or liabilities. It represents one’s residual claim or interest in the firm’s assets, after
deducting liabilities (Inspired Economist, 2023). The capital structure plays a key role in
determining a company's financial health and ability to pursue long-term growth
opportunities, which directly link to profitability capacities. Effectively utilising debt allows a
company to leverage its own resources for funding large-scaled projects such as
infrastructure, research and development, or market expansion, while still maintaining
ownership and control. However, an overreliance on debt implies financial risks and restricts
flexibility, potentially curtailing growth prospects. Conversely, a conservative capital
structure, characterized by a high proportion of equity, provides stability and resilience,
empowering the company to survive through economic downturns and pursue strategic
investments with reduced financial constraints. Therefore, as pointed out by Velnampy, T. D.,
& Niresh, J. A (2012), capital structure decision is among the most important matters for a
firm since such decision directly affects the profitability.
Financial literature has given a lot of attention to the relationship between profitability and
capital structure. The research on how capital structure affects profitability will enable us to
identify existing correlation between capital structure and firm’s performance, therefore come
up with a winning strategy in these competitive business environments. In order to choose the
capital structure that would yield the highest level of profitability, these kinds of findings will
be definitely beneficial. In this context, this study will demonstrate the relevance of capital
structure on the firm’s profitability, which will help owners, managers, investors, and other
stakeholders make wise decisions about the level of debt and equity within the firm's capital.

2. Literature review
2.1 Modigliani & Miller theorem
One of the most significant theorems in the corporate finance world is developed by
Modigliani and Miller, which is widely known as M&M Theorem (1958). This popular
theory is the first study on the relationship between capital structure and business market
value, laying the foundation for many other later theories (Stern & Chew, 2003). Through
evaluating the market value of a firm, the profitability can be assessed since a high market
value implies a profitable business. The hypothesis of Modigliani Miller's theorem depends
on the leverage level of two enterprises. While the levered (L) implies that it depends entirely
on equity, the unlevered's capital (U) consists of both debt and equity. There are two versions
of M&M theory, which are based on different assumptions about the market’s condition.
The first version was developed in 1958 with the assumptions of a perfectly efficient market,
no taxes, no bankruptcy cost and symmetric information. Under this hypothesised market,
Modigliani & Miller concluded that the capital structure has no effect on the firm
performance, in other words, its market value is based on its earning potential and the risk of
underlying assets. Pan (2012) states that the M&M theory equation can be written as follows:

Where V represents the value of the levered firm, whereas V represents the value of the
L U

unlevered firm.
The assumption of a perfectly competitive market faces a number of objections from critics
since they see that the real world is differ from the ideal world developed in M&M
propositions (Gifford, 1998). Due to the limitations in the assumptions of the first theory
version, Modigliani & Miller introduced an updated version for their original theory, known
as M&M2 (1963) in which the existence of tax is taken into consideration. Due to the effect
of the tax shield, the cost of capital (WACC) decreases, therefore, the firm's value increases.
Under a market with imperfection, firms can benefit from the inclusion of debt in their capital
structure, therefore, they are likely to take on more leverage. In contrast to the conclusion of
the first M&M theory, in this version, Modigliani & Miller demonstrate that the value and
performance of the firm increase as the leverage increases, which implies that there is a
positive correlation between the capital structure and the firm performance.

Although the Modigliani-Miller (M&M) theory started with perfect market assumptions, it
has inspired years of research in economics and finance. Scholars have delved into how real-
world factors such as transaction costs, information imperfection, taxes, and regulations
impact how businesses perform. This ongoing exploration shows a keen interest in
understanding how financial decisions intersect with real market complexities, aiming to
offer deeper insights into corporate behaviors and outcomes.

2.2 Trade-off theory

Trade-off theory’s original version came into being after the debate of Modigliani-Miller
theorem (Ahmadimousaabad, A., Bajuri, N., Jahanzeb, A., Karami, M., & Rehman, S., 2013).
The later version of M&M theory incorporates the effect of tax and demonstrates the benefits
of tax shield on the firm value. This theory might imply that a company should have a high
level of debt in its capital structure to take full advantage of tax shields. However, this theory
has a flaw that it does not count the cost of additional debts in relation to financial distress.
Later, as stated by Kraus and Litzenberger (1973), it is recognized that the costs of financial
distress are largely offset with the benefits from tax shields. Therefore, the trade-off theory is
developed to take into account the relationship between the cost of financial distress and the
tax shield benefits.
According to the trade-off theory, there is an optimal capital structure in which a well-
balanced benefit between debts and equity financing exists and that a company should aim to
achieve. In other words, the optimal capital structure is attained when the marginal cost of
borrowings is equal to its marginal benefit, balancing the potential tax benefits with the
financial risk. There are various factors affecting the trade-off model. Cost of bankruptcy and
financial distress might vary depending on the company's size, business model, and industry.
To illustrate, financial distress costs may be higher for organizations with high fixed costs or
asset-intensive operations than for those with service-oriented. In addition, depending on the
tax laws and regulations environment in which the company operates, interest payments from
debt may or may not be deductible. For that reason, based on variables including industry,
business risk, and tax rate, each company may have a different optimal capital structure.
The theory predicts that highly profitable firms will have higher debt levels in order to
maximize taxation benefits and increase the availability of capital (Çerkezi & Mr.Sc, 2013).
On the one hand, many studies, including those by Titman and Wessels (1988) and Fama &
French (2002), demonstrate that enterprises with high profitability typically have less
borrowings and this contradicts with the actual trade-off prediction. When evaluating the
costs and benefits of debt, Graham (2000) discovers that large and profitable companies with
a low level of financial distress take debt sparingly. On the other hand, several studies
validate the importance of target leverage and support the trade-off theory. Marsh’s research
(1982) provides evidence that businesses choose their funding source with target levels for
both the ratio of short-term and long-term debt ratio. Highly profitable firms have capacity
for greater levels of debt, taking substantial advantage of debt tax shields (MacKie-Mason,
1990).
There are some limitations around the trade-off theory related to overemphasis on tax
benefits and the lack of non-financial factors. According to McCall, J. (2022), the trade-off
model is based on the assumption that debt-financing is favorable since interest payments are
tax deductible. However, this is not always the case; in some situations, higher interest rates
or other expenses may cancel out the tax benefits of debt financing. Besides, the trade-off
theory overlooks non-financial aspects that can also affect a company's financing choices,
namely reputation or governance. Therefore, some other alternative theories come into
existence to provide more valuable insights into a company's financing decisions.

2.3 Pecking order theory

Retained Debt
Equity
earnings

Pecking order theory is developed based on the foundation set by the M&M theory and the
trade-off theory. In 1984, Stewart Myers and Nicolas Majluf proposed the pecking order
theory based on the idea that when considering funding sources, managers adhere to a
hierarchy. As stated by Frank and Goyal (2009), the main underlying concept used to develop
the pecking order theory is asymmetric information between company managers and external
parties. The concept of information asymmetry implies that firm managers are better
informed about the company’s performance, future plan, prospects and risk compared to
shareholders or debt holders. As a result, external users require a larger return in order to
offset the risk they are facing and make up for information asymmetry.
Within the framework of the pecking order, companies should prioritise internal sources
since they have the lowest information asymmetry costs, followed by debt and equity.
Mentioned by Lemmon & Zender (2010), internal finance, or retained earnings financing, is
provided directly by the business which helps reduce information asymmetry between parties.
Therefore, internal financing is the most affordable and practical kind of funding. When a
business finances its own operations by an internal finance source, it might be a signal
indicating that the firm is doing well because its earnings are large enough to support both
ongoing operations and future expansion. Besides, managers do not expect to lose their
control over businesses, according to research by Hamilton and Fox (1998). This is also the
reason why managers typically prioritize financing their projects with available retained
earnings rather than accepting additional shareholders. When it is not possible to utilize the
retained earnings, the issuance of debt is taken into account. Managers who believe that their
firm is worth more than its current value and their stock price are cheap corresponding to
future prospects will choose debt over equity. In addition, since debt is less risky than equity,
to reduce the cost of capital, companies prioritize debt financing. External equity as predicted
by pecking order theory is chosen as a last option (Huang and Ritter, 2009; Bistrova, 2011).
In case businesses issue new shares to raise capital, it might be an indication that firms
believe their own stock is overpriced. External investors are always conscious about the level
of debt and equity within a firm. Explained by Myers and Majluf (1984), if a company
decides to issue equity, a rational investor will be alerted and re-value the stock price.
The theory put emphasis on the choice between three main financing resources. As can be
concluded from pecking order theory by Boadi et al (2015), high-performing companies are
likely to finance their operation and activities by retained earnings and fewer debts. Many
other scholars, such as Berger and Bonaccorsi di Patti (2006) and Fosu (2013), have further
verified the trade-off theory that there is a positive relationship between firm performance
and the level of leverage.

3. Hypothesis development
3.1 Conceptual Framework
The graph below demonstrates the variables used in the research and how these variables are
related to each other.
The figure above is designed based on the predictive validity framework by Libby et al
(2002) to construct careful research designs and hypotheses. This model provides a useful
description of the hypothesis testing process, and focuses our attention on the key
determinants of the internal and external validity of a research design ( Robert Libby, Robert
Bloomfield, Mark W Nelson, 2002)

3.2 Hypothesis
Many studies on the effect of funding structure have been carried out since the findings of
Modigliani and Miller (1958) were published. Despite decades of investigation, the
correlation between capital structure and business performance continues to spark
considerable debate and scrutiny, primarily due to the inconsistent nature of research
findings. This paper contributes to untangle this puzzle, hoping to shed more light on how
financial decisions shape the way companies operate and succeed in today's world. Hence,
three distinct hypotheses are formulated for this paper research.

3.2.1 Profitability and Capital Structure

Many researchers have explored the relationship between a company's capital structure and
its profitability. As stated by Huang & Song (2006), among these investigations, the pecking
order theory emerges as the most prevailing one in explaining firms' financing behaviour and
their prosperity. Most empirical studies supporting the pecking order notion conclude that
capital structure and profitability are negatively correlated (Friend & Lang, 1988). However,
in consistent with the pecking order theory, some studies have indicated that there exists a
positive correlation between corporate leverage and business profitability (Oyakhilome W.
Ibhagui & Felicia O. Olokoyo, 2017). Therefore, the following hypothesis will be
investigated in order to provide additional understanding about the relationship between
capital structure and profitability.
Hypothesis 1: There is a negative relationship between leverage and firm performance

3.2.2 Profitability and Firm Size

Many studies consistently show a correlation between the size of a firm and its profitability.
Larger companies tend to enjoy greater profitability compared to smaller ones, thanks to
factors like economies of scale, increased market share, and stronger negotiating power with
suppliers and customers (Porter, 1979). Larger firms can spread fixed costs more effectively,
leading to improved efficiency and higher profit margins. Additionally, their established
presence in the market and brand recognition often gives them a competitive edge, allowing
them to charge premium prices and generate higher revenues. Moreover, larger firms usually
have access to greater resources and expertise, enabling them to pursue strategic initiatives
such as research and development, campaign expansion into new markets. Overall, the
positive association between firm size and profitability underscores the significance of scale
and market dominance in driving financial success in today's competitive business
environment. Thus, the following hypothesis is constructed in accordance with several
findings, including that of Papadogonas (2007).
Hypothesis 2: There is a positive relationship between profitability and firm size

3.2.3 Profitability and Industry

The influence of capital structure on company performance differs significantly across
industries due to sector-specific factors. Each industry possesses distinct characteristics,
market dynamics, and capital requirements that shape how decisions regarding capital
structure impact company performance. For example, industries with high capital intensity,
such as manufacturing or infrastructure, may find increased debt levels beneficial for
financing investments in equipment and facilities, potentially improving profitability through
cost efficiencies. Conversely, industries characterized by rapid technological advancements
or intense competition, like the technology sector, may prioritize equity financing to preserve
flexibility and adaptability in response to market changes. According to Akoto, R. K., &
Awunyo-Vitor, D., (2014), nonmanufacturing firms exhibit a negative correlation between
debt ratio and sales growth rates. Considering these insights and empirical findings, the
subsequent hypothesis is formulated.
Hypothesis 3: The effect of capital structure on firm performance varies among
industries

4. Methodology
4.1 Measurements
4.1.1. Dependent variables (ROA, ROIC)
The ability of a business to produce earnings higher than its costs is known as profitability. It
is an essential component of financial performance that shows how well a business is running
its operations and using its resources to produce profits for its investors and shareholders
(Van, 2005). Managers and shareholders put their focus on profitability metrics since it is a
key determinant of company's strategy and policies. Financial indicators such as net income,
gross profit margin, operational profit margin, return on invested capital (ROIC), return on
equity (ROE), and return on assets (ROA) can all be used to evaluate profitability
(Rutkowska-Ziarko, A., 2015). Among these financial ratio, ROA and ROIC are two
essential metrics for assessing profit capacity. While ROA is a valuable indicator of asset
efficiency and profitability, ROIC provides a deeper understanding by incorporating the cost
of capital.
4.1.1.1. Return on assets (ROA)
According to Jewell, J. J., & Mankin, J. A. (2011), return on assets (ROA) is one of the most
widely used and practical to evaluate a firm’s financial position, performance, and future
prospects. High level of profitability is shown by a high value of ROA, which shows that the
business is making more money per dollar of assets. Investors, analysts, and managers
frequently use return on assets (ROA) to assess a company's profitability in relation to its
asset base and compare it to other businesses in the same industry. It helps the evaluation
process of management's ability to deploy assets and create value for shareholders. However,
it is crucial to understand ROA in the context of industry standards, capital intensity, and
business models since variances in these elements might affect how ROA is interpreted and
what effect it has on profitability.

Return on Assets (ROA) = Net Income / Total Assets

4.1.1.2. Return on invested capital (ROIC)
Together with ROA, return on invested capital (ROIC) is also an useful measurement for
profitability, this ratio indicates the company's capacity to produce the anticipated return
based on the shareholders' invested resources (AL Matarneh, 2009). In other words, ROIC
provides a thorough assessment of an organization's capacity to allocate capital efficiently
and generate value for shareholders by taking into account both profitability and capital
structure. The ratio is computed by taking the company's operational income (EBIT, or
earnings before interest and taxes) and dividing it by the total amount of capital that was
invested (debt and equity financing combined). Strong profitability and effective capital
allocation are indicated by a greater ROIC, which shows that the business is creating value
(Bing Cao, Bin Jiang & Timothy Koller, 2006). ROIC is especially useful for comparing
businesses between industries and assessing how well management generates returns on
capital invested. It offers managers, analysts, and investors a useful indicator of financial
performance that takes operational profitability and capital costs into consideration. To obtain
a whole picture of a company's profitability and financial health, it's crucial to evaluate ROIC
in conjunction with other financial measures and take industry-specific aspects into account.

Return on Invested Capital (ROIC) = Net Income / Invested Capital

4.1.2. Independent variables ( Debt/Equity, Interest coverage, Debt /Tangible Assets)

The combination of securities and funding sources that firms utilize to fund actual
investments is known as their capital structure (Stewart C. Myers, 2001). The funding
structure represents how a company chooses to raise financial resources to support its
activities and strike the balance between ownership and debt obligations. A business can
optimize its capital structure to minimize expenses, reduce risks to the finances, and
maximize shareholder value. To assess a company's capital structure and financial health,
debt-to-equity (D/E) ratio, interest coverage ratio, and debt-to-tangible assets ratio are three
key financial metrics.

4.1.2.1. Debt to equity

A mixture of equity and debt that a company uses to fund its operations is known as its
capital structure (Shubita & Alsawalhah, 2012). The most vital ratio used to evaluate
financial leverage is the debt-to-equity ratio (D/E). It calculates the percentage of debt
funding a business receives in comparison to its equity (Nissim & Penman, 2001).. Given the
company's increased reliance on debt financing, a high D/E ratio is indicative of rising
financial leverage. Higher leverage can enhance equity returns, but it also raises financial risk
because of debt commitments and interest payments. On the other hand, a low debt-to-equity
ratio (D/E) indicates a more conservative capital structure. The D/E ratio is a tool used by
analysts and investors to evaluate a company's capacity to pay off debt, control financial risk,
and produce profits for owners.

Total Debt to Equity (TDE) = Total Debt / Equity

4.1.2.2. Interest coverage

Trade-off theory suggests that the increase of debt in capital structure leads to the rise of
bankruptcy’s cost as a company takes on more debt, the likelihood of bankruptcy may
increase due to the burden of servicing debt obligations. An essential financial indicator for
assessing a company's capacity to pay interest on outstanding debt is the interest coverage
ratio. The relation between capital structure and interest coverage is studied by many
researchers, such as Thompson (1972); and Eriotis, Vasiliou and Ventoura-Neokosmidi
(2007). A high interest coverage ratio suggests less financial risk because the business makes
excessive operational income to comfortably pay its interest. On the other hand, a lower
interest coverage ratio could be a warning of increased financial risk and issues for paying
interest. The interest coverage ratio is a common tool used by investors and lenders to
evaluate a company's solvency, liquidity, and debt servicing capacity. A strong interest
coverage ratio not only reflects the company's ability to manage its debt obligations
effectively but also provides assurance to stakeholders regarding its financial stability and
resilience.

Coverage ratio ( CR) = EBIT / Interest expenses

4.1.2.3. Debt to tangible assets

The debt-to-tangible asset ratio is also an important financial metric that provides valuable
insights into a company's capital structure, leverage, and financial risk. It is founded that
debt/tangible assets ratio is associated with capital structure and overall business performance
(Xu, 2020). Tangible assets are physical assets such as property, plant, and equipment. Unlike
intangible assets, such as goodwill, patent and brand recognition, tangible assets are easy to
measure and monitor. As stated by Hall (2012), fixed assets are used to attract more debts
since this type of assets are liquid and play a role as collaterals for creditors in the event of
bankruptcy. Therefore, it is crucial to investigate the relationship between capital structure
and tangible assets. According to Booth, Aivazian, Demirgüç-Kunt, and Maksimovic (2001),
there exists an inverse relationship between the ratio of tangible assets and the creditor's
financial risk. The risk of default would be lower when the proportion of physical assets was
higher, and vice versa. Total Debt to Tangible Assets (TDTA), which is calculated by total
debt over tangible assets, is utilized in this study to reflect the capital structure.

Total Debt to Tangible Assets (TDTA) = Total Debt / Tangible Assets

4.1.3. Control and dummy variables

4.1.3.1. Control variable

According to Gill, Biger & Mathur (2011), control variables such as firm size and sales
growth should be included as these factors play as determinants of firm’s profitability. This
research incorporates firm size as control variable since it is recognized to have an impact on
the firm's performance, therefore support the investigation. As stated by Negasa (2016), a
significant positive correlation exists between firm’s size and profitability. Large companies
are typically more profitable than smaller firms due to economies of scale, larger market
shares, and better brand recognition. In fact, large companies can boost their operational
efficiency and profit margins by spreading fixed costs over a wider revenue base. In addition,
owing to their scale and creditworthiness, larger businesses are able to obtain debt financing
more easily and at lower interest rates, which lowers the cost of debt and boosts profitability
even more. Conversely, due to smaller operational scope and limited access to financial
resources, smaller firms frequently struggle to realize economies of scale, which makes it
difficult for them to negotiate favorable borrowing terms. All of these factors can seriously
impede their ability to increase profitability and competitiveness in the market. Therefore, in
this study, the natural logarithm of revenue is used as a proxy for firm size (Gill et al., 2011)

Firm Size (FS) = LN (Revenue)

4.1.3.2. Dummy variables

In order to have better understanding about the capital structure and profitability among
industries, this research includes industry dummy variable (INDUM) in the regression. The
incorporation of a dummy variable that represents different industries into the regression
analysis allows us to account for industry-specific factors that could potentially confound the
correlation between capital structure and profitability. Mentioned by Jay et al., (2014), firm
returns are different among industry. For instance, manufacturing companies often encounter
unique challenges and opportunities, namely fluctuations in inputs, complexities in supply
chain or regulation, which have an immediate impact on their bottom line. The effects of
manufacturing-related factors on capital structure and profitability can be isolated and
analyzed by adding a dummy variable to the regression analysis that represents the
manufacturing industry.

Table 1: Summary of variables

Variables Category Measurement

ROA Dependent variable Net Income / Total Assets

ROIC Dependent variable Net Income / Invested Capital

TDE Independent variable Total Debt / Equity

Interest coverage Independent variable EBIT / Interest expenses

TDTA Independent variable Total Debt / Tangible Assets

Firm size Control variable LN (Revenue)

INDUM Dummy variable N/a

4.2. Method

4.2.1. Panel data

To investigate the relationship between capital structure and profitability, in this study,
empirical regression models are constructed using panel data analysis. In econometrics
analysis, panel data is advantageous by offering improvements in the control over individual-
specific features, capturing dynamics over time, taking into account correlation within the
data, and allowing model specification flexibility (Moffatt, 2018). This type of data allows
researchers to better understand how variables change over time, conduct more accurate and
efficient analyses, and tackle challenging research issues that require incorporating together
individual and time effects. Panel data regression model is given as follows:

Yit = α+ β Xit + εit

Where:

Yit = dependent variables belonging to firm i at time t

Xit = independent variables belonging to firm i at time t

i = individual cross-sectional dimension

t = time dimension

α = constant number

β = coefficients between Xit and Yit

εit = residual error of firm i observed at time t

4.2.2. Fixed and random effects

Before investigating the correlation of capital structure ans profitability, it is better to

determine the most appropriate model between random effects model and fixed effects
model. The primary difference between these two models is that whereas the fixed model
account for time-invariant unobserved variables that may be associated with the observed
independent variables, the random model presumes no correlation. The following represents
the Hausman Test hypothesis (Hausman, Abrevaya & ScottMorton, 1998):

The null hypothesis (H0): The random effects model is preferred

The alternative hypothesis (H1): The fixed effects model is preferred

A significance level of 0.05 is used to assess the P-value of the Hausman Test in order to
determine which model—the fixed effects model or the random effects model—is superior. If
the P-value is more than 0.05, the random effects model is accepted. In other words, the fixed
effects model should be used and the null hypothesis rejected when the P-value is less than
0.05.
4.2.3. Stationary

A typical assumption in many time series statistical models is the stationarity of the data
(Gozgor, 2011). Stationarity refers to the property of a time series variable where its
statistical properties, such as mean and variance, remain constant over time. Spurious
regression findings can arise when time series data are subjected to non-stationary, which can
result in inaccurate inference and unreliable parameter values. For accurate and insightful
findings, it is crucial to guarantee that all of the variables employed in the regression model—
both the independent and dependent variables—are stationary. Prior to performing regression
analysis, methods such as first differencing or unit root tests - the Augmented Dickey-Fuller
(ADF) test are frequently used to evaluate stationarity. Researchers can get more reliable
estimates and provide more accurate interpretations of the relationships between variables
across time by guaranteeing stationarity in regression models.

4.2.4. Performance Measures

Profitability stands as the cornerstone indicator of a company's performance, as emphasized

by Keramidou et al., (2014) and corroborated in various studies across the field of finance
and economics. In this study, profitability is meticulously assessed through the utilization of
return on assets (ROA) and return on invested capital (ROIC) as robust proxies. Besides
profitability, capital structure is also the central of this study and it is measured through total
debt-to-equity ratio, interest coverage and total debt-to-tangible assets ratio. To rigorously
assess the hypotheses previously mentioned in this study and delve deeper into the
relationship between profitability and capital structure, the following regression models have
been formulated.

Model 1:

ROAit = β0 + β1*TDE + β2*CR + β3*TDTA + β4 LN(Revenue) + β5*INDUM + ℇit

Model 2:

ROICit = β0 + β1*TDE + β2*CR + β3*TDTA + β4 LN(Revenue) + β5*INDUM + ℇit

In these two models, β0 is the intercept of regression line with the y-axis, whereas β1 to β3 are
the coefficient of independent variables. The control variable’s coefficient is β 4 and that of
dummy variable is β5.
5. Data

In this study, the main purpose is to examine the correlation between capital structure and
firm’s performance of listed companies on London Stock Exchange (LSE) market. The data
is collected from audited reports which ensures the reliability and credibility of the financial
information. Besides, the companies are classified between non-manufacturing and
manufacturing depends on their main activities and operation. The reason for this
classification lies behind the fact that manufacturing companies have represented a
significant portion of the companies listed on the LSE. In addition, firms operating in
industrial sectors are likely to have a higher level of debt compared to other sectors.

5.1. Data collection

The sample comprises 118 companies that are listed on the London Stock Exchange (LSE)
over the period from 2017 to 2022. These companies span across 11 diverse sectors,
encompassing healthcare, energy, financials, consumer staples, materials, industrials, utilities,
consumer discretionary, communication services, technology, and real estate. To delineate
between manufacturing and non-manufacturing entities, the sectors are analyzed based on
their predominant characteristics. Specifically, sectors such as financials, healthcare, utilities,
communication services, technology, and real estate are categorized as non-manufacturing,
while the remaining sectors were classified as manufacturing. Of the total sample, 47
companies are identified as belonging to non-manufacturing fields, highlighting the
significant representation of diverse industries within the dataset.

Table 2: Summary of classification

Sector Classification

Financials Non-manufacturing

Healthcare Non-manufacturing

Utilities Non-manufacturing

Communication services Non-manufacturing

Technology Non-manufacturing

Real Estate Manufacturing

 Energy Manufacturing

Materials Manufacturing

Industrials Manufacturing

Consumer discretionary Manufacturing

Consumer staples Manufacturing

5.2.2. Data descriptive

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relationship between efficiency and profitability", Benchmarking: An International Journal,
Vol. 20 No. 5, pp. 647-660. https://doi.org/10.1108/BIJ-12-2011-0090

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Hausman, J.A., Abrevaya, J., & Scott_Morton, F. M. (1998). Misclassification of the

dependent variable in a discrete-response setting. Journal of Econometrics, 87(2), 239-269.

Jay Bourgeois III, L., Ganz, A., Gonce, A., & Nedell, K. (2014). Profitability of industries
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Negasa, T. (2016). The effect of capital structure on firms’ profitability

evidenced from

Ethiopian. Wollega Universty Ethiopia.

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