Macroeconomic Indicators Capital Structure Decisions And Profitability; A Panel Vector Autoregression Approach

ABSTRACT

The study sought to examine the impact of macroeconomic indicators on the capital structure decisions of firms and also the causal relationship between capital structure and profitability within the Ghanaian context. A panel data covering a period from 2000 to 2012 for 27 nonfinancial firms listed on the Ghana Stock Exchange were analysed using the Panel Vector Autoregression (PVAR) approach to mitigate endogeneity problems and more importantly to examine the causal relationship between capital structure and profitability. Empirical results from the study suggests that short-term debt is the most popular source of funding followed by equity and finally long-term debt. A significant positive relationship is observed between Real GDP and all the three measures of capital structure. For real effective exchange rates, a positive linear relationship is observed with all the capital structure measures. However, its relationship with long-term debt ratio is insignificant. In terms of the nexus between real Interest rates and capital structure, the study observes a negative relationship with all the three measures but statistically, only the relationship with total debt ratio is significant. Inflation is observed to have an insignificant positive association with all the measures of capital structure. We note that, the causal relationship between profitability and total debt ratio as well as with short-term debt ratio is bi-directional. The causal relationship between long-term debt ratio and profitability is uni-directional flowing form long-term debt ratio to return on equity. We suggest from the study that, in as much as corporate financial managers consider firm and industry fundamentals in deciding on their debt-equity mix, attention should be given to macroeconomic fundamentals. In addition, the fiscal and monetary policies of the government should be geared towards creating a conducive environment for firms to make informed financing decisions to optimize their capital structure.