Earning Volatility, Capital Structure Decisions and Financial Distress by SEM

ABSTRACT

The article investigates the relationship between earning volatility and capital structure and in particular, aims to contribute to prior research by examining the moderating role of financial distress on the relationship between earning volatility and capital structure. Thus, we employ a MIMIC model of Structural Equations Modeling (SEM) approach to examine the associations, which enables us to measure the earning volatility and capital structure by a few best indicators. Using 902 firm-year observations listed in the Tehran Stock Exchange (TSE) from 2006 to 2017, we find that earning volatility has a significant and negative impact on capital structure. In addition, the results indicate that financial distress significantly affects the relationship between earning volatility and capital structure. In short, when financial distress acts as a moderating variable, the relationship between earning volatility and capital structure is weaker than the time when there is no such variable.

KEY WORDS:

• Capital structure
• earning volatility
• financial distress
• MIMIC
• structural equations

JEL:

• G32
• M41
• G33
• C39
• C39