Capital Structure, Industry Pricing, and Firm Performance

25 Pages Posted: 31 Aug 2009

See all articles by S.V.D. Nageswara Rao

S.V.D. Nageswara Rao

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

Date Written: August 31, 2009

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-à-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: G32

Suggested Citation

Nageswara Rao, S. V. D., Capital Structure, Industry Pricing, and Firm Performance (August 31, 2009). 22nd Australasian Finance and Banking Conference 2009. Available at SSRN: https://ssrn.com/abstract=1464588 or http://dx.doi.org/10.2139/ssrn.1464588

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)

Register to save articles to
your library

Register

Paper statistics

Downloads
276
Abstract Views
1,249
rank
39,050
PlumX Metrics