Is the nexus between capital structure and firm performance asymmetric? An emerging market perspective

The nature of the relationship between leverage and firm performance has been a subject of investigation in extant literature. We re-examine the nature of the association by using a sample of 78 non-financial firms listed in the Nifty 100 index during the 2013-2023 period by applying the quantile regression technique and comparing the result with the linear regression approach (system GMM technique). Our empirical analysis demonstrates that leverage negatively impacts the performance of firms. Further, results show that the association is non-homogeneous among firms of different quantiles: leverage withers the performance of highly profitable firms (upper quantile) than low profitable firms (lower quantile). The identified concave relationship highlights the prominence of optimal capital structure and the role of finance managers in designing a sound financial policy that matches firm characteristics and borrowing requirements. The findings of our study draw insightful implications for managers and policymakers while contributing to the ongoing leverage and firm performance debate reported in previous studies. Since the pioneering work of Modigliani and Miller, the debate on the relationship between Capital Structure (CS) and Firm Performance (FP) has been a subject of discussion. Consequently, the CS and FP linkage has garnered the attention of several academic scholars. However, the majority of the empirical studies have demonstrated a linear link between CS and FP, whereas the studies on the nonlinear relationship are scant in the existing scholarly studies. Thus, to provide more insights, we used quantile regression techniques, and our results corroborate that the CS and FP relationship is non-homogeneous among Indian firms. To succinctly put, the magnitude of the negative impact of leverage is found to be more around highly profitable firms. Our regression result highlights the importance of maintaining the right capital mix and suggests that large firms should refrain from excessive borrowing. Further, we contend that policymakers must strengthen corporate governance mechanisms and restrict the earnings management activities of the management. Overall, our robust findings enhance the existing body of knowledge while drawing significant implications for management, policymakers, and other stakeholders.