Capital Structure, Firm Performance and Risk Exposure: New Evidence from OECD Countries

Abstract

Optimal capital structure is a key tool to take advantage of the trade-off between firm performance and risk. Based on this, we examine how optimal capital structure influences corporate performance and risk exposure. We use a strong-balanced panel of 3,344 firm-year observations from 10 different OECDcountries for 2006–2016. Results reveal that firms having short-term debt normally experience high accounting-based performance while lowering market-based performance, firms using long-term and total debt are largely exposed to decreased accounting and market-based performance. The higher the long-term and total debt, the greater the chances that firms become vulnerable to insolvency risk. Findings are robust across alternative indicators of capital structure, firm performance and risk, alternative model development and the two-step system GMM estimator to control endogeneity issues. This research will be of importance to firm managers and policymakers in designing an appropriate capital structure for maximizing firm performance while minimizing debt-taking risks.

Keywords

• capital structure
• performance
• risk
• OECD