Capital structuring in MLEs and its implications on company profitability

Abstract

Purpose: This study seeks to elicit significant variables affecting financing decisions within the Maltese environment. In addition, this study will assess the impact of capital structure on firm profitability for a five-year period of observation. Lastly, this research also aims to identify how firms can reduce the cost of debt by improving their disclosure policies or alternatively through the selection of a reputable audit firm. Design: The GLM regression analysis is used to establish the relationship as well as the degree of impact between leverage and the independent variables. It is also used to determine the impact of debt maturity on firm profitability. Non-parametric tests (Mann-Whitney and Kruskal Wallis tests) were also used to determine whether any preferential treatment is given by banks to MLEs who have an association with Big4 firms and also to compare the interest rates charged for each respective audit firm. Findings: The results of the empirical tests have shown that leverage in the Maltese environment is significantly influenced by company-specific characteristics, namely tangibility, profitability, business risk, dividend pay-out, asset utilization, size, NDTS, Liquidity, Age, Tax-shield, Profit Margin and Gross Margin. Contradictory to M&M’s irrelevance theory, this study provides evidence that capital structure has significant influence on firm profitability. This study revealed a significantly negative relationship between short-term debt and ROE. However, a positive relationship was established between long-term debt, total debt and ROE. This study concluded that no preferential treatment is given by banks to MLEs who have appointed a Big4 audit firm. Conclusion: It can be concluded that “capital structure matters. It always has and always will” (Milken 2009). Value: This research will serve as a contribution to the literature on capital structure and will aid firms to make sound capital structure decisions and to deliver added value to the providers of capital.