CAPITAL STRUCTURE AND FIRM PERFORMANCE IN DIFFERENT ECONOMIC CONDITION

Abstract

Agency theory suggests that debt can mitigate agency problems between managers and shareholders while influencing firm value. This study investigates the relationship between capital structure and firm performance, with a particular focus on the moderating roles of economic growth and corporate social responsibility (CSR) disclosure.  The study adopts a conceptual-empirical design. First, a narrative synthesis of the capital-structure and stakeholder/CSR literatures is used to articulate testable propositions about the baseline leverage–performance link and moderating roles of GDP growth and CSR disclosure. Second, these propositions are empirically validated on a balanced panel of Bombay Stock Exchange–listed manufacturing firms (2011–2019), combining firm financials with macro indicators and hand-collected CSR disclosure. Estimation relies on firm- and year-fixed effects with robust errors, supplemented by robustness checks (alternative performance proxies) and endogeneity-sensitive specifications (e.g., dynamic panels). The empirical findings reveal that capital structure is negatively related to firm performance, consistent with agency theory predictions. However, this negative association is attenuated in periods of strong economic growth and among firms with higher levels of CSR disclosure, suggesting that favorable macroeconomic conditions and transparent stakeholder engagement can offset the costs associated with higher leverage. These results highlight the importance of contextual factors in shaping the capital structure–performance nexus. By incorporating data from India, this study contributes fresh evidence from a major emerging economy and provides new insights into how external conditions and voluntary disclosure practices moderate financial outcomes. For Indian manufacturing firms, higher leverage generally depresses profitability, but its impact is context-dependent: strong macro growth and credible CSR reporting mitigate the drag of debt. Managerially, prudent financing should be paired with operational discipline, high-quality CSR disclosure, and macro-aware debt timing. Future research should extend the framework across sectors and countries, incorporate market-based performance measures (e.g., Tobin’s Q), strengthen identification (e.g., instruments for leverage/CSR or system-GMM), and trace mechanisms - cost of capital, customer/employee responses - through which growth and disclosure temper leverage-related risks.