Impacts of Change in Capital Structure on the Profitability of Pharmaceutical Firms: A Study of Pharmaceutical Industry in Singapore

Abstract

An optimal capital structure can reduce the cost of capital and then contribute to corporate profitability. Debt financing usually plays a critical role since the proper use of debt is expected to increase revenues and profits. Some academicians find some positive effects of operating or financial leverage on profitability, while other studies on corporate leverage conclude that debt will impede profit growth in the pharmaceutical industry. This study aims to investigate the correlation between leverage and profitability in the Singaporean pharmaceutical industry. This study constructs a regression model with one dependent variable, Return on Equity (ROE), and four independent variables, including Debtto-Equity, Long-term Debt, Operating Leverage, and Interest Coverage ratios. The model is based on the secondary data collected from 30 SGX-listed pharmaceutical companies in the period from 2017 to 2021. Both correlation analysis and ordinary least squares (OLS) are adopted to explore the effects of leverage on profitability. The results show that Debtto-Equity and long-term Debt ratios are negatively correlated with ROE, and Operating Leverage and Interest Coverage ratios have a positive correlation with ROE. Based on these findings, this study suggests managers avoid taking unnecessary debt, and short-term debt is required to maintain high operating leverage that positively affects profitability. Also, managers should not rely on long-term debt but rather finance the business growth with equity.