The impact of capital structure on firm performance: evidence from Saudi-listed firms

The purpose of this study is to investigate the impact of capital structure on the performance of firms listed on the Saudi Stock Exchange (Tadawul). The study employs a panel of 350 firm-year observations for 70 Saudi non-financial listed firms over the period 2016 to 2020. A generalised method of moments (GMM) estimation is employed to estimate models to enable hypothesis testing, thereby addressing any autocorrelation, heteroscedasticity and endogeneity issues. The results indicate that short-term debt, long-term debt, total debt and debt-to-equity ratios all have a significant negative impact on firm operational performance (return on assets), while long-term debt, total debt and debt to equity have such an impact on firm financial performance (return on equity) and market performance (in terms of Tobin's Q). This suggests that firm agency issues that lead to a high-debt policy may result in diminished firm performance. The results also show that increases in sales growth, the degree of insider ownership, and firm size and age in general positively impact firm performance, while asset tangibility and liquidity have a more ambiguous impact. The findings of the study are limited to listed non-financial Saudi firms over the period 2016-2020; the key results may be relatable to other developing country settings. Future research may be extended to investigate the effect of capital structure on firm performance on the wider Tadawul and to other capital structure and performance measures. The findings have practical implications for firm managers, which will help them to identify the firm-specific factors affecting the capital structure and choose the values that enhance optimal capital structure. This study result suggests that as debt financing can have a significant adverse effect on firm profitability, managers should moderate leverage in order to maximise shareholder wealth. Indeed, as debt is more costly than equity, managers should keep debt levels lower and instead focus financing at the margin on internal sources such as retained earnings and new equity, using external funding only as a last resort. The study results should provide policymakers with a better understanding of the relationship between corporate capital structures and performance, thereby underpinning future policy formulation.