Impact of Capital Structure on Firm Value and Profitability with the Moderation of Audit Quality: Evidence from N-11 Countries

Abstract

Purpose: This study seeks to test the moderating effect between the relationship of capital structure and two firm outcomes which are market based firm value (FV) and accounting based profitability (return on equity, ROE) in the Next-Eleven (N-11) emerging economies. This analysis builds on a gap in the literature – there is limited evidence of the link between financing decisions and value and profitability in non-developed capital markets.

Methodology/Design/Approach: The study uses a panel data based on 3,124 based collected from 2014 to 2024 from Thomson Reuters Data stream. computes four complementary specifications: A pooled OLS, a cross-sectional GMM, firm fixed-effects with cluster-robust standard errors, and a static panel GMM estimator based on a within-firm de-meaning transformation, to evaluate the robustness of the capital structure–performance relationship across estimation methods.

Findings: The results show that there is no significant multicollinearity with any specification (average VIF = 1.07). The capital structure, the audit quality and their interaction are not statistically significant in the pooled OLS estimation, cross-sectional GMM estimation and cluster-robust fixed-effects (CFE) estimation. The capital structure is positive and significant in the firm value and ROE regressions of the static panel GMM, however, after de-meaning. Audit quality does not provide any evidence of a moderating effect in any of the regressions. There is a negative and statistically significant correlation with firm size.

Practical Implications: In markets with external auditors, managers, auditors, and regulators evaluating the leverage–value relationship should not be swayed by simply switching to a pooled or cluster-robust estimate, because the negative or positive relationship between leverage and value can be masked by the estimator. Policymakers who wish to improve the role of external audit in these markets should consider / enable other forms of governance – not auditor identity.

Originality/Value:  The study is one of the first to analyze market-based and accounting-based performance measures in a single study, to explore the three-way interaction between capital structure, audit quality and firm performance, utilizing the former level of aggregation (full N-11) and to explicitly compare the cluster-robust fixed-effects regression approach with static panel GMM approach on an identical de-meaned specification.

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