Abstract
This study investigates whether the channels through which capital structure affects firm performance vary between South Africa's financial and non-financial industries, a topic that has been less explored in developing countries. Using return on assets (ROA) as a performance metric and the total debt-to-asset ratio to represent capital structure, we employed a dynamic panel model with the generalized method of moments (GMM) to address endogeneity problems. Our dataset comprises 42 financial and 115 non-financial firms listed on the Johannesburg Stock Exchange from 2015 to 2023, with missing data handled to maintain a balanced panel. Firms with more than three years of missing financial data were excluded, and average values were inferred for firms with less than three years of missing financial data to ensure sufficient data. Findings reveal a consistent negative association between capital structure and firm value across both industries, indicating that increasing leverage tends to reduce firm value. However, this relationship is mediated by different factors: firm size, product competition, liquidity risk, and growth opportunities mediate the link in the non-financial industry, whereas dividend yield, innovation, and investment decisions do not mediate the link. In contrast, only dividend yield partially mediates within the financial industry. The robust analysis performed using alternative measures of firm performance (Tobin’s Q) and capital structure (long-term debt ratio) produced results that are consistent with our main estimates, demonstrating the stability of our findings. This research provides valuable information for developing economies like South Africa and shows that when assessing the linkage between capital structure and firm value, there is an indirect relationship, and potential mediators should be considered. The findings warrant distinct policy measures across both industries under study. For the non-financial industry, optimising capital structure through liquidity risk frameworks, competitive market incentives, and growth-oriented financing is critical, whereas the financial industry requires dividend regulation aligned with capital adequacy rules and stability focused tax adjustments. Industry specific regulatory oversight is recommended to protect firms from the negative effects of high leverage.