The Relationship between Capital Structure and Profitability (Case Study in Tehran Stock Exchange)

We examine whether there is a relation between profitability and capital structure. The typical capital structure theory exposition has become known since that time as a trade off theory. Trade off theory provides an exposition of the benefits of prudent debt use and the dangers of excessive debt use. According to the static trade-off theory of capital structure, firms balance the benefits of interest tax shields against the costs of financial distress. Using data from 252non-financial companies that were in continual existence from 1999 to 2008 in Tehran Stock Exchange, consistent with earlier theories, we find that there is a positive association between the return on equity (ROE) and short-term debt. This suggests increasing short-term debts with low interest rate will lead to increase in profitability. Furthermore, the results have been shown a negative association between ROE and long-term debt. So, when firms increase long-term debts, this results to decrease in profitability. Finally, our results also indicate there is a positive relationship between ROE and total debt.