Capital Structure, Industry Pricing, and Firm Performance

29 Pages Posted: 4 Sep 2008

See all articles by Vishnu S. Ramachandra

Vishnu S. Ramachandra

Indian Institute of Technology (IIT), Bombay - Shailesh J. Mehta School of Management (SJM)

S.V.D. Nageswara Rao

Indian Institute of Technology (IIT), Bombay - Shailesh J. Mehta School of Management (SJM)

Date Written: September 4, 2008

Abstract

This paper provides empirical evidence on the link between industry pricing dynamics and industry capital structure. We find evidence of countercyclical mark-up behaviour as predicted by Chevelier and Scharfstein (1996). The mark-ups are more countercyclical for industries with higher debt ratio. Secondly, the paper analyzes growth in firm sales and profitability performance post an industry downturn under different financial structures. This methodology helps mitigate the endogenous nature of capital structure and firm performance, since it is assumed that the downturn was not anticipated by industry participants. Also, inclusion of lagged values of debt ratio (t-2) ensures that spurious relation between contemporaneous values of debt ratio and firm performance is not obtained. We find that firms which are over-levered compared to the industry median experience lower sales growth and lower profitability vis-a-vis a benchmark firm which assumes industry median characteristics. This lends support to the hypothesis that external financing induces financial fragility that leads to reduction in competitive spending at the time of distress.

Keywords: Capital structure, Product markets, Mark-ups, Business Cycles

JEL Classification: G 32

Suggested Citation

Ramachandra, Vishnu S. and Nageswara Rao, S. V. D., Capital Structure, Industry Pricing, and Firm Performance (September 4, 2008). 21st Australasian Finance and Banking Conference 2008 Paper. Available at SSRN: https://ssrn.com/abstract=1263245 or http://dx.doi.org/10.2139/ssrn.1263245

Vishnu S. Ramachandra

Indian Institute of Technology (IIT), Bombay - Shailesh J. Mehta School of Management (SJM) ( email )

Powai
Mumbai, Maharashtra 400076
India

S. V. D. Nageswara Rao (Contact Author)

Indian Institute of Technology (IIT), Bombay - Shailesh J. Mehta School of Management (SJM) ( email )

Powai
Mumbai 400076
India
91-22-25767789 (Phone)
91-22-25722872 (Fax)

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