MM Model with Taxes and Its Verification: Suitable Methodology to Avoid “Automatic” Negative Relations Between Leverage and Profitability

Juraj Medzihorský (), Hussam Musa (), Peter Krištofík () and Yaroslav Lysenko ()
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Juraj Medzihorský: Faculty of Economics, Matej Bel University in Banská Bystrica, Department of Finance and Accounting
Hussam Musa: Faculty of Economics, Matej Bel University in Banská Bystrica, Department of Finance and Accounting
Peter Krištofík: Faculty of Economics, Matej Bel University in Banská Bystrica, Department of Finance and Accounting
Yaroslav Lysenko: Faculty of Economics, Matej Bel University in Banská Bystrica, Department of Finance and Accounting

Chapter Chapter 52 in Advances in Empirical Economic Research, 2023, pp 849-856 from Springer

Abstract: Abstract Calculation of leverage affects its relationship with profitability, as retained earnings are included in equity. In majority of empirical studies, the negative relationship between leverage and profitability is confirmed. Such results are against MM model with taxes (and trade-off theory that partially follows this model). The aim of our contribution is to point to and empirically confirm the methodology, which may be suitable for the verification of MM model with taxes, with an emphasis on profitability as capital structure determinant. Applying an adjusted leverage—with the exclusion of retained earnings—on the sample of 416 European listed non-financial firms from the index STOXX, we confirmed the positive correlation between leverage and profitability, while the negative correlation was confirmed when we applied several traditional measures for leverage. According to the background of the pecking-order and life-cycle theories, non-adjusted leverage should be applied to their analysis. As a result, all mentioned theories seem to be confirmed when a suitable measure for leverage is individually applicated.

Keywords: MM model with taxes; Methodology; Capital structure (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/978-3-031-22749-3_52

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