Capital structure and performance of commercial banks in Ethiopia

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.