Threshold regression study: effect of the company´s size on the leverage - rentability relationship

Abstract

This study uses the threshold methodology from Hansen(1999)to establish the relationship between company leverage and company profitability taking into account different regimes of the threshold variable: company size. This project aims at answering what is the company size for which leverage is less detrimental for profitability. Thus, this study uses panel data from 2008 to 2020 with 214listed companies from Brazil to establish if the kind of influence that leverage has on company profitability is determined depending on the company size. The findings suggest a adverse influence of leverage on company profitability that is higher for small-sized companies when profitability is Return on Assets (ROA)or Return on Equity (ROE), measures of accounting performance. However, the effect is beneficial and more positive for the small-sized companies when the profitability measure is Tobin’s Q, a variable that indicates market performance. The results are robust to different specifications and different debt ratios applied. Similar to other studies, the results show negative leverage –profitability nexus for measures of accounting performance. Nevertheless, the new finding of this study is proof that the leverage-profitability relationship changes depending on the size regime.