The Relationship Between Capital Structure and Financial Performance of Listed Companies in Pakistan

Abstract

For companies in emerging markets, a financial issue that is crucial is the decision between debt and equity financing and between short-term and long-term financing, the interest rates and macroeconomic conditions in which these companies operate, can change rapidly. The study design adopted for this study was quantitative longitudinal research design that was based on secondary financial data to examine the relationship between capital structure and financial performance of companies listed on Pakistan Stock Exchange (PSX). 280 firm-year observations were generated by a balanced panel of 40 non-financial companies selected using purposive sampling based on full annual financial statements for the period 2019-2025. Capital structure was calculated using debt-to-equity ratio and short-term debt ratio and long-term debt ratio was used as a control variable, while performance was determined by return on assets (ROA) and return on equity (ROE), and firm size, asset tangibility, sales growth and liquidity were used as controls. The ordinary least squares, fixed-effects, and random-effects models were estimated using robust standard errors; the Hausman test indicated the fixed-effects model for ROA and the random-effects model for ROE. Leverage showed negative correlation with ROA with debt-equity ratio (β = −1.80) and short-term debt ratio (β = −18.34) being significant, while the long term debt ratio was not. The short-term debt (β = −47.35) and long-term debt (β = −30.60) showed negative association and the debt to equity ratio showed positive association (β = 3.31) with ROE. The results suggest that debt maturity mix has a significant impact on firm performance and that firms need to carefully manage short-term debt.