The Effect of Debt on Corporate Profitability: Evidence from French Service Sector

Outline

• Abstract
• Keywords
• 1. Introduction
• 2. Data
• 2.1 Data Description
• 2.2 Variables
• 3. Methodology
• 4. Results
• 4.1 Descriptive Analysis
• 4.2 Correlation Between the Variables
• 4.3 Econometric Analysis
• 5. Conclusion
• References

Conclusions

In this paper, we are interested in the effect of debt on profitability of French service companies. In other words, this article expands the empirical literature regarding the influence of debt on profitability.

There are three essential theories which highlight the influence of debt on corporate profitability, namely: signaling theory, tax theory and the agency costs theory. Furthermore, the disagreement between researchers observed not only theoretically but also empirically.

Lack of studies on French firms and the concentration of studies on listed companies and industrial companies have motivated our study. To do this, we examined empirically the impact of debt on profitability by using the generalized method of moments (GMM) on an unbalanced panel of 2240 French companies of service sector observed over the period 1999-2006. Our sample is composed of unlisted companies like Limited Companies and Limited Liability Companies. In addition, in order to improve the precision of the estimation by reducing heterogeneousness between different sizes of companies, we studied the behavior of these firms according to their size (VSEs, SMEs and LEs). Moreover, we analyzed not only the linear effect of debt on profitability, but also the non-linear effect by estimating a quadratic model which takes into account the squared of debt variable in the regression equation.

According to this study, we can underline that debt has no influence on profitability either in a linear way, or in a non-linear way. This finding is consistent with that of Baum et al. (2007) on American industrial companies. In addition, when we present the analysis using different size classes, we also find that there is no impact regardless the size of enterprise.

For potential research, it would be interesting to take into account some reflections. First, it will be interesting to extend this analysis across different components of corporate debt (long term and short-term); because, according to most of the studies, contradictory effects have been found. Secondly, we ideally would add new specific variables for companies and sectors, for example, the ownership structure of the corporate capital and the environment in which companies operate. Finally, considering the fact that the relationship between debt and profitability can be non-linear, we can deepen our analysis by using econometric methods that can evaluate the effects of non-linearity as quantile regression and threshold models.