THE NEXUS BETWEEN CAPITAL STRUCTURE AND FIRMS’ PROFITABILITY: EVIDENCE FROM OIL & GAS SECTOR OF PAKISTAN

Abstract

The optimal capital structure is conceptualized as a basic framework pertinent to acquiring, utilizing, and contributing financial resources of the organization. The estimation and maintenance of the capital structure of a firm are the integral managerial decisions that could ultimately affect the future of the organizations. No doubt, the potential of profitability is the first thing for its future growth and to inculcate a sense of confidence among investors to invest in the firms. This study aims at examining the nexus between capital structure and profitability of firms in the context of the Oil & Gas sector of Pakistan. The sample of this research is comprised of the top five top performing firms of the Oil & Gas sector for a period of ten years(2006-2015). Keeping in view the explanatory orientation of this research, quantitative research approach was employed. In order to achieve study objectives, the secondary data were extracted from the financial statements of the firms under study and data were analyzed through descriptive statistics and correlation coefficients. During data analysis, the profitability of the firm was measured in terms of Gross Profit Ratio (GPR), Return on Capital Employed(ROCE) and Return on Equity (ROE). Whereas, the capital structure was measured in terms of Debt to Equity (D/E) ratio and Debt to Total Funds (D/TF)ratio. The findings drawn from this study revealed a negative linkage among various dimensions of capital structure of firms and their profitability potential in the context of the Oil & Gas sector of Pakistan. Primarily, this study findings corroborated that sample firms under study brought sudden changes in the composition of their debt and equity mix (capital structure) that significantly threatened the profitability of firms. This study suggests that selected firms understudy need to adopt consistent capital structure policies with a clear understanding of future profitability. Financial managers need to focus on developing prudent optimal capital structure and avoid making abrupt changes in the debt and equity mix of the firms.