The Relationship between Capital Structure and Product Markets: Evidence from New Zealand

Abstract

We investigate whether the capital structure of New Zealand firms influences their product-market performance in the period from 1984 to 2008. Our main findings are that the use of leverage by publicly listed New Zealand companies leads to an increase in relative-to-industry sales growth, but a decrease in relative-to-industry return on assets (ROA). We also conduct a reverse causality test by examining whether sales growth and ROA influence leverage. We find no evidence that sales growth has an impact on the use of debt, but significant evidence that ROA is negatively correlated with its use. Our results suggest that New Zealand firms use debt to compete more aggressively in their product markets, even though this strategy comes at a cost of lower relative-to-industry profitability. A possible explanation for this behaviour is the more competitive trading environment that has developed in New Zealand over the last 25 years.

Keywords: Capital structure, product markets, imperfect markets

JEL Classification: G31, G32, L11, L13