CAPITAL STRUCTURE, PROFITABILITY, GROWTH AND FIRM VALUE: A CRITICAL LITERATURE REVIEW

Abstract

Future research preparations and development of in-depth exploration forms the key objective of the
independent study paper. The paper sought to answer this research question; what is the effect of
capital structure, profitability, and growth on firm value. Aim of this paper was to determine the effect
of capital structure on firm value, the effect of profitability and growth on the relationship between
capital structure and firm value and the joint effect of capital structure, profitability, and growth on
firm value. It discussed several empirical studies aimed at establishing research gaps. It discussed
major theories namely; pecking order theory, market-timing theory, trade off theory and Modigliani
and Miller theory. Trade off theory by Myers asserts that striking the balance of costs and the
associated advantages of leverage improves the firm’s value and profitability. Firms, which are more
profitable, can use debt financing which fosters growth and value. From empirical evidence,
association between capital structure, profitability, growth, and firm value is mixed. Capital structure
and value is still a puzzle due to differing theoretical perspective and conflicting opinions. The
conceptual framework consist the explanatory variable which is capital structure as parameterized by
debt to equity ratio, debt ratio and debt to capital ratio, moderating variable is growth as measured
by revenue growth, market share growth and assets growth. Intervening variable is profitability as
indicated by return on assets, net profit margin, and return on equity. Value is the response variable
as measured by Tobin’s Q. Synthesis of the review was by defining research objectives and literature
search. The key findings from the review was the empirical mixed evidence and the concepts of capital
structure of entities, profitability, growth, and firm value have not been widely studied. The review
concludes no conclusive findings due to inconsistencies in the outcomes, which calls for more research.
Further, critical review of existing theories is critical in contributing to the contemporary debate.
Additionally, more robust statistical tools and techniques are critical in the analysis of data with an aim
of solving the puzzle. This review will be of great benefit to industry practitioners engaged in
determining capital structure choices especially on the need by firms to decide and keep up optimal
financing structure important to shield them against risks. Further synthesis of literature is key in
confirming existing theoretical and empirical linkages.