Abstract:
Capital structure decision is one of the most crucial decisions of finance manager since it has
relation with the performance of the firm. This study examine the relationship between capital
structure and performance of commercial banks in Ethiopia based on the financial statement
of eight sample banks from 2000-2012. This study establish a model to measure the
association between capital structure which is proximate by total debt to total asset (TDTA)
and total debt to total capital (TDTC) and performance which is measured by return on asset
(ROA), return on equity (ROE) and net profit margin (NPM). In related with the regression
analysis various tests were conducted for the assumption of CLRM. The results of the
econometric analysis show that commercial banks in Ethiopia are highly levered institution.
The Regression analyses indicate that on average leverage has a positive effect on the
financial performance of commercial banks in Ethiopia when performance measured by
return on equity. In contrast, the similar analyses indicate that leverage has a significant
negative effect on performance of commercial banks in Ethiopia when performance is
measured by return on asset and net profit margin. Further, the size of the bank has
significant positive association with all performance measurement variables. The finding
implies that there are evidence which support both trade off theory and pecking order theory
of capital structure and capital structure has a significant positive or negative effect on
financial performance in the Ethiopian banking industry. Therefore, the finding suggest that
the bank makes its capital structure at optimal level by raising funds from equity finance by
participating in the secondary market in order to enhance its performance in related with
capital structure.
