Capital Structure and Firm Efficiency

Authors

  • Dimitris Margaritis,

    1. The authors are respectively Professor in the Department of Finance, AUT, Auckland, New Zealand and Associate Professor, University of Nice-Sophia Antipolis and GREDEG-CNRS, Valbonne, France. They acknowledge financial support from the New Zealand Foundation for Research, Science and Technology.
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  • Maria Psillaki

    Corresponding author
    1. The authors are respectively Professor in the Department of Finance, AUT, Auckland, New Zealand and Associate Professor, University of Nice-Sophia Antipolis and GREDEG-CNRS, Valbonne, France. They acknowledge financial support from the New Zealand Foundation for Research, Science and Technology.
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  • They are grateful to the editor of this journal and an anonymous referee for their valuable comments. They would also like to thank Gary Feng and Boram Lee for excellent research assistance.

* Address for correspondence: Dimitris Margaritis, Department of Finance, Faculty of Business, AUT, Private Bag 92006, Auckland 1020, New Zealand.
e-mail: dmargaritis@aut.ac.nz

Abstract

Abstract:  This paper investigates the relationship between firm efficiency and leverage. We consider both the effect of leverage on firm performance as well as the reverse causality relationship. In particular, we address the following questions: Does higher leverage lead to better firm performance? Does efficiency exert a significant effect on leverage over and above that of traditional financial measures of capital structure? Is the effect of efficiency on leverage similar across different capital structures? What is the signalling role of efficiency to creditors or investors? Using a sample of 12,240 New Zealand firms we find evidence supporting the theoretical predictions of the Jensen and Meckling (1976) agency cost model. Efficiency measured as the distance from the industry's ‘best practice’ production frontier is positively related to leverage over the entire range of observed data. The frontier is constructed using the non-parametric Data Envelopment Analysis (DEA) method. Using quantile regression analysis we show that the reverse causality effect of efficiency on leverage is positive at low to mid-leverage levels and negative at high leverage ratios. Firm size also has a non-monotonic effect on leverage: negative at low debt ratios and positive at mid to high debt ratios. The effect of tangibles and profitability on leverage is positive while intangibles and other assets are negatively related to leverage.

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