The influence of capital structure on firm value and profitability during two opposite states of the economy - An empirical study of Swedish listed manufacturing companies

Abstract

This study investigates how changes in the capital structure of Swedish listed manufacturing companies influence equity value and return on assets during periods of economic recession and expansion. The purpose is to explain how Swedish manufacturing companies debt-to-equity ratios affect return on assets and equity value during two distinct economic phases. To achieve this, the study adopts a quantitative approach, analyzing data from 2008–2012 and 2015–2018, obtained from S&P Capital IQ. Four panel data regressions with fixed effects are conducted, two for each dependent variable (ROA and equity value), across both economic phases. The analysis is grounded in several theoretical perspectives, including the trade-off theory, dynamic trade-off theory, and the Modigliani & Miller theorem. Prior literature and empirical studies are also used to support the findings. The results reveal that a higher debt-to-equity ratio is positively associated with return on assets, especially during the recession period. This suggests that increased leverage can enhance operational performance in more uncertain environments. However, the study also finds that an increase in leverage negatively affects equity value across both economic phases, with a stronger negative effect observed during the expansion. These findings align with the dynamic trade-off theory, indicating that the optimal capital structure may vary depending on macroeconomic conditions. In summary, the analysis shows that while higher leverage can improve profitability during this economic recession, it may simultaneously lower equity value. The study underscores the importance of adapting capital structure decisions to the prevailing economic climate and brings evidence for more informed decision making aimed at stakeholders.