Earning Volatility and Capital Structure Decisions considering the Moderating Role of Financial Distress;A Structural Equations Modeling Approach

Abstract

Objective: The purpose of this study is to investigate the effect of financial distress on the relationship between earning volatility and capital structure decisions using Structural Equations Modeling (SEM) Approach. Methods: For this purpose, a sample of 82 companies were selected among the companies accepted by Tehran Stock Market between 2006 and 2017. To measure the moderating effect of financial distress, the sample companies were classified into two groups based on the KZ model. To measure the earning volatility, the researchers used observable variables such as coefficient of variation of ROE, coefficient of variation of OI divided by total assets and standard deviation of the percentage change in operating income. Also, we used three measures of total debt divided by total assets, total debt divided by book value of equity and total debt divided by market value of equity to measure the capital structure value. Results: After ensuring the acceptable process of the research measurement and structural models, the results indicated that earning volatility has a significantly negative impact on capital structure decisions and financial distress significantly affect the relationship between earning volatility and capital structure. Moreover,such a relationship is proved stronger in the unconstrained companies group. Conclusion: The effect of earning volatility on capital structure decisions is stronger in sound Companiescompared to financially distressed holding Companies.

Keywords

• capital structure
• earning volatility
• financial distress
• structural equations