Capital structure and firm performance of listed companies in germany during & after covid 19 (from 2019 to 2024)

--- Page 1 --- CAPITAL STRUCTURE AND FIRM PERFORMANCE OF LISTED COMPANIES IN GERMANY DURING & AFTER COVID-19 (FROM 2019 TO 2022) HWR Berlin (Berlin School of Economics and Law) Master of International Finance WS 2022/2023 Supervisors: Prof. Dr. Axel Hellmann Prof. Dr. André Tomfort Submission: 19.07.2024 Author: Phuong Quynh Nguyen (Student ID No: 77211955141) Word count: 14078 words Abstract The correlation between capital structure and financial performance has always been one of the most interesting topics. The demanding in understanding about this connection of scholars, stakeholders is relatively high, especially when there are any macroeconomic events. Recently, the global pandemic – Covid-19 has caused several severe impacts on many aspects in society, specifically on global economy. Therefore, this study originally aimed at examining this relationship of capital structure and financial performance of listed firms from 2019 to 2022 in Germany. The research sample holds 988 observations from 247 German listed companies. Capital structure and firm size are two main independent variables while ROA, ROE, EPS, NPM are four metrics representing as financial performance in this research. The data were collected on Refinitive Eikon database. This study has found the fluctuation in the relationship between capital structure and financial indicators. Keywords: Capital structure, financial performance, Germany, Covid-19. --- Page 2 --- List of Abbreviation List of tables and figures Table 1: Number of observations by industry sectors Table 2: Descriptive statistics of financial performance and capital structure indicators: Period by period Table 3: Descriptive statistics of financial performance and capital structure indicators according to leverage ratio Table 4: Panel unit root tests of indicators Table 5: Multicollinearity tests on simple regressions of financial performance and capital structure indicators Table 6: Correlation matrix Table 7: Results of regression model in 2019 (before Covid-19) with robust standard errors Table 8: Results of panel data model in 2020 (during Covid-19) with robust standard errors Table 9: Results of panel data model in 2021-2022 (after Covid-19) with robust standard errors Figure 1: The European Central Bank fixed interest rate from 2008 to 2024 Introduction What would be an optimal capital structure to a firm? This question has been raised and investigated by a number of scholars since decades and it will remain its own attention and still keep discussions among economic researchers in the future who are keen on corporate finance. An optimal capital structure is the plausible proportion of liabilities and equity which could minimize the cost of capital but possibly create the highest profit with that structure (Khodavandloo, 2017). Therefore, the relationship between capital structure and financial performance has become one of the most attractive topics to economic researchers. There are various theories focusing on capital structure, for example, Modigliani-Miller theories pointed out their opinions about the capital structure relating to firm value or their suggestion about the leverage ratio with the advantage of tax shield; or Trade-Off theory encourages to maximize indebtedness level as long as they could manage their profit against the insolvency; or Pecking order theory where stated that firms managers should prioritize using internal funds in the case there is any demand in fund raising. A large number of relevant articles have been published to satisfy the curiosity about the relationship between capital structure and financial performance namely Khodavandloo, 2017; Chadha and Sharma, 2015; Chang et al., 2019, etc. This aforementioned relationship over a plenty of studies has shown different results over countries with different timelines and industrial sectors. --- Page 3 --- Recently, a global pandemic – Covid-19 has caused many tremendous and never-before impacts worldwide, directly influenced human civilization in many aspects, especially in economy. So, how was the impact of capital structure on financial performance indicators during and after Covid-19? What if there will be another global disaster happening in the future and how could humans react to these macroeconomic events? What could be the precaution that we can prepare to live with and get over these events? These questions have raised an urgence which encourages the study about the relationship between capital structure and financial performance during and post-Covid-19. The Covid-19 has begun in China in the end of 2019 and hence, the study includes four years, from 2019 to 2022. The news has released in late winter in 2019, which was a news influencing global economy, and from new year 2020, Covid-19 started spreading universally and then a global pandemic has begun. Therefore, this period has become a vulnerable period but worthy for testing. One of the biggest economies in the world is European economy and Germany is one of the most developed countries in Europe or even around the world. Consequently, the economy of Germany during this time is worth examining. Hence, the idea of studying the relationship between capital structure and financial performance in Germany’s economy within four years from 2019 to 2022 with a macroeconomic event has been a promising topic. The results will explain the changes of this above mentioned relationship between these two factors during Covid-19 period and bring out an overview which could be a useful materials and reference to whom interesting in this topic and to whom it may concern about the solution to any upcoming macroeconomic events. Research Background Overview Covid-19 The recent global pandemic, Covid-19, starting in Wuhan, China, in late 2019, has caused an alarming situation in most of countries in the world . This has been presumably the worst pandemic in the world since World War II (Naseer et al. 2023). The virus became the fear of billions of people on earth, affecting various aspects from health, international economy and society, which are linked together and brought to a spiral stagnation worldwide. Due to the unpredictable enlargement of Covid-19, governments have carried out full or partial lockdown, which began in China then spread to other countries from the East to the West, driving to the massive deceleration of global economy (Naseer et al. 2023). First and foremost, the pandemic spreading led to the increase in number of people infected by Covid-19. According to John Hopkins University data, there were approximately 270 million people being infected and nearly two hundred thousand cases recorded dead all over the world . The acceleration in number of suffering people caused the shortage in workforce, which caused the enclosing of numerous factories and then the discontinuity in manufacturing, contributed to the global economic recession . Consequently, business activities of most of companies have shrunk due to lacking in labor force as mentioned above, disruption in global supply chains and curtailing customers’ demand . According to IMF, the contraction would reach 3% in 2020, and this was recognized as the worst downturn since Great Depression . Besides that, international trade has suffered significantly because of the severe lockdown policies affecting export and import activities, which led to the dramatical increase in material costs . Agriculture industry was one of the most industries suffering Covid-19. The shortage in workforce and the disruption in both distribution and manufacture (due to the shrink in supply chain) have pushed agriculture industry into a tough situation in almost countries . Or in a different industry as energy industry, the world has witnessed a downturn in oil prices due to the strong decline in oil demand during Covid-19 as a consequence of lockdown and generally low requirement in transportation . In general, there were reverse trends in demand of essential commodities and energy, caused by the changes in consumption behaviors of humans all over the world . Furthermore, another problem, which many countries around the world were facing, was the rise of unemployment rate because of the full or partial lockdown . According to their research, even one of the most dynamic economies like the US also struggling with more than 26 million jobs were lost within 5 weeks . This situation got worse and widely spread to other continents such as Australia and South Korea, which were assumed as two the most developed countries with energetic economies . Due to the strict regulations of lockdown in many countries around the world, the behaviors in consumption, working, education, etc. have gradually changed. After Covid-19 occurring, the attitude towards healthcare and the awareness of healthy lifestyle became the priority to almost people. Besides, the quarantine measures have brought to a new trend in consumptions, where people paid more attention to essential commodities and nutritious food. The demand of eating-out reduced consequently . Moreover, people focused on the quality of time, where they agreed reducing working time and putting more effort in taking care for themselves and their families, or spending time with nature for finding the balance in life . Another aspect in human’s life witnessing a bundle of difficulties was education. Where the new norm was defined with various virtual classes from elementary to university students. Schools and universities were forced to be closed due to lockdowns though technology and internet access were unequal with a lot of difficulties among countries and regions . Another aspect that should be mentioned was the corruption of travel and tourism industry. It could be said that travel and tourism was obviously the industry suffering the most during this tough pandemic. In other words, travel and tourism companies have incurred significant loss after Covid-19 bursting with travel bans and harsh challenges from their governments . At the end, this event has caused enourmous consequences to the globe not only in a harmful direction but also bringing many changes which positively affect the human’s life. Germany economy in Covid-19 Similar to almost countries around the world, Germany significantly incurred a number of unfavorable damages caused by Covid-19. The first case was reported on January 28th, 2020 in Bavaria (Kropp and Schnabel, 2021). Consequently, the virus widely spread all over Germany with the most affected Länder including Bavaria, Baden-Württemberg, and North Rhine-Westphalia (Kropp and Schnabel, 2021). The country suffered two fierce waves of Covid-19, the first wave was in April 2020 and the second wave was from December 2020 to January 2021 with the peaking number of infected people up to 25,612. This second wave prolonged until February 2021, when Germany recorded the decline in infected cases (Kropp and Schnabel, 2021). The Covid-19 pandemic has brought a huge negative impact onto Germany society. Therefore, a number of strict policies against this unpleasant situation have been conducted as the solution to control the infection rate of the virus (Scholl, 2022). The efficient first measure applied here was lockdown (Bosen and Thurau, 2021). The lockdown occurred within seven weeks from 22nd March, 2020 (Bosen and Thurau, 2021). During this sensible period, all services such as restaurants, cinemas, or even day care centers and schools were forced to close, and only places providing essential commodities, which were supermarkets, banks, drug stores or gas stations, were allowed to operate. Besides, labor force experienced the upward trend “work-from-home”, companies are required to accept this new solution to operate their business amid the pandemic .Furthermore, in order to control the unemployment rate during this time, Germany encouraged companies to reduce the working hours of their employees instead of huge layoffs, estimating influencing 13% of labor force . Specifically, the hospitality was the most impacted with 45.2% labor force joining the short-timework, or in manufacturing sector, this number was only 20.1%, and also in other sectors such as transportation and warehousing with 17.3% and other services with 15.5% (Scholl, 2022). According to this policy, employees received their new monthly salary basing on their actual working hours during this tough time. Additionally, the gap between before and after salary was covered partially by the short-time allowance from Federal Employment Agency (Scholl, 2022). However, due to the Covid-19 lockdown, most of businesses could not run well as normal especially leading to the stagnation in supply chain industry in Germany (Herr and Nettekoven, 2022). The German GDP significantly depends on the manufacturing industry and global trading which were strongly impacted by the Covid-19 as almost all plants could not operate, for example, the exports and imports declined by 9.3% and 8% in 2020 sequentially due to social distancing. In 2020, the German GDP was reported dropping by 4.6 percent consequently (Herr and Nettekoven, 2022). Source: Statista, 2024 Figure 1: The European Central Bank fixed interest rate from 2008 to 2024 As a result, Germany government announced a “Stimulus Package” as a compensation to companies during lockdown period. This was the first time that Germany government used this method as the solution to calm the severe situation, which was Covid-19 (Scholl, 2022). In the “Stimulus Package”, the government used 130 billion euros in maintaining the economy and investing into technologies . This comprehensive idea from government was applied as the assistance to companies facing the problem of credit supply increase due to the pandemic (Scholl, 2022). Germany put a lot of efforts in maintaining the business of national companies, preventing the bankruptcy of firms, which suffered the difficulty in raising funds for their normal operations (Scholl, 2022). Or another measure implemented by their government was “Value-Added Tax Reduction”, introduced in July 2020. The VAT was considered as an aid to this emergency problem and it was contemporarily reduced by 3 percent from 19 percent to 16 percent to raise the national consumption level Covid-19 brought many enormous problems to Germany and those issues have been not faded completely after this pandemic . In his article, Fuest (2021) stated that there will be some challenges to German economy within next following years. These concerns would come from various social aspects, which accumulatively created a burden or challenges to German economy. For example, after the pandemic, German demography has changed with the decrease in the number of people at working age and the aging in population; or the downsizing of firms in every economic sector in Germany due to the deduction in employees or lower demand from national and international market (Fuest, 2021). According to Buch (2023), the difficulties coming from the markets have led to the fluctuation in macroeconomic index. As can be seen in figure 1, it demonstrates the interest rates of ECB applied on European commercial banks. After Covid-19, the shortage in outputs has led to the higher rate of inflation, which happened to any countries in Europe. The interest rates therefore have increased after Covid-19 as a consequence to adapt the changes in economy. Eventually, the credit risks and non-performing loans of firms gradually increased or financial covenants became stricter, which originated from the changes of inflation and interest rates (Buch, 2023). Research Objective The recent pandemic - Covid-19 - has created an awareness of the massive stagnation of global economy, which had no similar case recorded in the history and impacting many aspects of human’s life. This research paper was inspired by other empirical and theoretical studies to examine the relationship between capital structure and financial performance of companies in Germany during this period as a contribution to this noteworthy issue and how a macroeconomic factor becoming an influent factor to this relationship. Studying during this period can be a rational action in order to support other scholars in investigating and finding the solution against any upcoming events. This could be assumed as the precaution in case there will be another similar challenging factor impacting the wealthness of countries.

CAPITAL STRUCTURE AND FIRM PERFORMANCE

OF LISTED COMPANIES IN GERMANY DURING &

AFTER COVID-19 (FROM 2019 TO 2022)

HWR Berlin (Berlin School of Economics and Law)

Master of International Finance WS 2022/2023

Supervisors: Prof Dr Axel Hellmann

Prof Dr André Tomfort

The correlation between capital structure and financial performance has always been one of the most interesting topics The demanding in understanding about this connection of scholars, stakeholders is relatively high, especially when there are any macroeconomic events Recently, the global pandemic – Covid-19 has caused several severe impacts on many aspects in society, specifically on global economy Therefore, this study originally aimed at examining this relationship of capital structure and financial performance of listed firms from

2019 to 2022 in Germany The research sample holds 988 observations from 247 German listed companies Capital structure and firm size are two main independent variables while ROA, ROE, EPS, NPM are four metrics representing as financial performance in this research The data were collected on Refinitive Eikon database This study has found the fluctuation in the relationship between capital structure and financial indicators

Keywords: Capital structure, financial performance, Germany, Covid-19.

Table of Content

List of Abbreviation iii

List of tables and figures iv

1 Introduction 1

2 Research Background 2

2.1 Overview Covid-19 2

2.2 Germany economy in Covid-19 3

2.3 Research Objective 5

2.4 Research Structure 5

3 Literature Review 7

3.1 Theoretical Review 7

3.2 Empirical studies 10

4 The economic model and data analysis 14

4.1 Data Collection 14

4.2 Variables 14

4.3 Data descriptive 17

4.4 The econometric model and method 21

4.5 Panel unit root test 22

4.6 Multicollinearity test 22

4.7 Correlation matrix 23

4.8 Regression analysis 24

5 Findings and discussion 28

6 Limitations 31

7 Conclusion 32

References 33

STATUTORY DECLARATION 37

List of Abbreviation

ADF Augmented Dicker-Fuller

ECB European Central Bank

EPS Earnings per Share

GDP Gross Domestic Product

GMM Generalized method of moments

GPM Gross Profit Margin

IMF International Monetary Fund

IFRS International Financial Reporting StandardsISIC International Standard Industrial ClassificationLAR Long-term Asset ratio

logTA Natural logarithm of Total Assets

NPM Net profit margin

OLS Ordinary Least Squares

The US The United States

VIF Variance Inflation Factor

List of tables and figures

Table 1: Number of observations by industry sectors

Table 2: Descriptive statistics of financial performance and capital structure indicators: Period by

period

Table 3: Descriptive statistics of financial performance and capital structure indicators according to leverage ratio

Table 4: Panel unit root tests of indicators

Table 5: Multicollinearity tests on simple regressions of financial performance and capital structure indicators

Table 6: Correlation matrix

Table 7: Results of regression model in 2019 (before Covid-19) with robust standard errors Table 8: Results of panel data model in 2020 (during Covid-19) with robust standard errors Table 9: Results of panel data model in 2021-2022 (after Covid-19) with robust standard errors

Figure 1: The European Central Bank fixed interest rate from 2008 to 2024

2 Introduction

What would be an optimal capital structure to a firm? This question has been raised andinvestigated by a number of scholars since decades and it will remain its own attention andstill keep discussions among economic researchers in the future who are keen on corporatefinance An optimal capital structure is the plausible proportion of liabilities and equity whichcould minimize the cost of capital but possibly create the highest profit with that structure(Khodavandloo, 2017) Therefore, the relationship between capital structure and financialperformance has become one of the most attractive topics to economic researchers There arevarious theories focusing on capital structure, for example, Modigliani-Miller theories pointedout their opinions about the capital structure relating to firm value or their suggestion aboutthe leverage ratio with the advantage of tax shield; or Trade-Off theory encourages tomaximize indebtedness level as long as they could manage their profit against the insolvency;

or Pecking order theory where Myers and Majluf (1984) stated that firms managers shouldprioritize using internal funds in the case there is any demand in fund raising A large number

of relevant articles have been published to satisfy the curiosity about the relationship betweencapital structure and financial performance namely Khodavandloo, 2017; Chadha andSharma, 2015; Chang et al., 2019, etc This aforementioned relationship over a plenty ofstudies has shown different results over countries with different timelines and industrialsectors

Recently, a global pandemic – Covid-19 has caused many tremendous and never-beforeimpacts worldwide, directly influenced human civilization in many aspects, especially ineconomy So, how was the impact of capital structure on financial performance indicatorsduring and after Covid-19? What if there will be another global disaster happening in thefuture and how could humans react to these macroeconomic events? What could be theprecaution that we can prepare to live with and get over these events? These questions haveraised an urgence which encourages the study about the relationship between capital structureand financial performance during and post-Covid-19 The Covid-19 has begun in China in theend of 2019 and hence, the study includes four years, from 2019 to 2022 The news hasreleased in late winter in 2019, which was a news influencing global economy, and from newyear 2020, Covid-19 started spreading universally and then a global pandemic has begun.Therefore, this period has become a vulnerable period but worthy for testing

One of the biggest economies in the world is European economy and Germany is one of themost developed countries in Europe or even around the world Consequently, the economy ofGermany during this time is worth examining Hence, the idea of studying the relationshipbetween capital structure and financial performance in Germany’s economy within four yearsfrom 2019 to 2022 with a macroeconomic event has been a promising topic The results will

Covid-19 period and bring out an overview which could be a useful materials and reference towhom interesting in this topic and to whom it may concern about the solution to anyupcoming macroeconomic events.

3 Research Background

3.1 Overview Covid-19

The recent global pandemic, Covid-19, starting in Wuhan, China, in late 2019, has caused analarming situation in most of countries in the world (Wang et al 2020) This has beenpresumably the worst pandemic in the world since World War II (Naseer et al 2023) Thevirus became the fear of billions of people on earth, affecting various aspects from health,international economy and society, which are linked together and brought to a spiralstagnation worldwide Due to the unpredictable enlargement of Covid-19, governments havecarried out full or partial lockdown, which began in China then spread to other countries fromthe East to the West, driving to the massive deceleration of global economy (Naseer et al.2023)

First and foremost, the pandemic spreading led to the increase in number of people infected

by Covid-19 According to John Hopkins University data, there were approximately 270million people being infected and nearly two hundred thousand cases recorded dead all overthe world (Gopinath 2020) The acceleration in number of suffering people caused theshortage in workforce, which caused the enclosing of numerous factories and then thediscontinuity in manufacturing, contributed to the global economic recession (Naseer et al.2023) Consequently, business activities of most of companies have shrunk due to lacking inlabor force as mentioned above, disruption in global supply chains and curtailing customers’demand (Naseer et al 2023) According to IMF, the contraction would reach 3% in 2020, andthis was recognized as the worst downturn since Great Depression (Gopinath 2020) Besidesthat, international trade has suffered significantly because of the severe lockdown policiesaffecting export and import activities, which led to the dramatical increase in material costs(Naseer et al 2023)

Agriculture industry was one of the most industries suffering Covid-19 The shortage inworkforce and the disruption in both distribution and manufacture (due to the shrink in supplychain) have pushed agriculture industry into a tough situation in almost countries (Naseer et

al 2023) Or in a different industry as energy industry, the world has witnessed a downturn inoil prices due to the strong decline in oil demand during Covid-19 as a consequence oflockdown and generally low requirement in transportation (Priya et al 2021) In general, therewere reverse trends in demand of essential commodities and energy, caused by the changes inconsumption behaviors of humans all over the world (Priya et al 2021)

Furthermore, another problem, which many countries around the world were facing, was therise of unemployment rate because of the full or partial lockdown (Naseer et al 2023)

According to their research, even one of the most dynamic economies like the US alsostruggling with more than 26 million jobs were lost within 5 weeks (Naseer et al 2023) Thissituation got worse and widely spread to other continents such as Australia and South Korea,which were assumed as two the most developed countries with energetic economies (Naseer

et al 2023)

Due to the strict regulations of lockdown in many countries around the world, the behaviors inconsumption, working, education, etc have gradually changed After Covid-19 occurring, theattitude towards healthcare and the awareness of healthy lifestyle became the priority toalmost people Besides, the quarantine measures have brought to a new trend inconsumptions, where people paid more attention to essential commodities and nutritious food.The demand of eating-out reduced consequently (Naseer et al 2023) Moreover, peoplefocused on the quality of time, where they agreed reducing working time and putting moreeffort in taking care for themselves and their families, or spending time with nature forfinding the balance in life (Naseer et al 2023)

Another aspect in human’s life witnessing a bundle of difficulties was education Where thenew norm was defined with various virtual classes from elementary to university students.Schools and universities were forced to be closed due to lockdowns though technology andinternet access were unequal with a lot of difficulties among countries and regions (Naseer et

al 2023) Another aspect that should be mentioned was the corruption of travel and tourismindustry It could be said that travel and tourism was obviously the industry suffering the mostduring this tough pandemic In other words, travel and tourism companies have incurredsignificant loss after Covid-19 bursting with travel bans and harsh challenges from theirgovernments (Naseer et al 2023)

At the end, this event has caused enourmous consequences to the globe not only in a harmfuldirection but also bringing many changes which positively affect the human’s life

3.2 Germany economy in Covid-19

Similar to almost countries around the world, Germany significantly incurred a number ofunfavorable damages caused by Covid-19 The first case was reported on January 28th, 2020

in Bavaria (Kropp and Schnabel, 2021) Consequently, the virus widely spread all overGermany with the most affected Länder including Bavaria, Baden-Württemberg, and NorthRhine-Westphalia (Kropp and Schnabel, 2021) The country suffered two fierce waves ofCovid-19, the first wave was in April 2020 and the second wave was from December 2020 toJanuary 2021 with the peaking number of infected people up to 25,612 This second waveprolonged until February 2021, when Germany recorded the decline in infected cases (Kroppand Schnabel, 2021)

The Covid-19 pandemic has brought a huge negative impact onto Germany society

the solution to control the infection rate of the virus (Scholl, 2022) The efficient first measureapplied here was lockdown (Bosen and Thurau, 2021) The lockdown occurred within sevenweeks from 22nd March, 2020 (Bosen and Thurau, 2021) During this sensible period, allservices such as restaurants, cinemas, or even day care centers and schools were forced toclose, and only places providing essential commodities, which were supermarkets, banks,drug stores or gas stations, were allowed to operate Besides, labor force experienced theupward trend “work-from-home”, companies are required to accept this new solution tooperate their business amid the pandemic (Bosen and Thurau 2021) Furthermore, in order tocontrol the unemployment rate during this time, Germany encouraged companies to reducethe working hours of their employees instead of huge layoffs, estimating influencing 13% oflabor force (Pusch and Seifert 2020) Specifically, the hospitality was the most impacted with45.2% labor force joining the short-timework, or in manufacturing sector, this number wasonly 20.1%, and also in other sectors such as transportation and warehousing with 17.3% andother services with 15.5% (Scholl, 2022) According to this policy, employees received theirnew monthly salary basing on their actual working hours during this tough time Additionally,the gap between before and after salary was covered partially by the short-time allowancefrom Federal Employment Agency (Scholl, 2022) However, due to the Covid-19 lockdown,most of businesses could not run well as normal especially leading to the stagnation in supply

chain industry in Germany (Herr and Nettekoven, 2022) The German GDP significantlydepends on the manufacturing industry and global trading which were strongly impacted bythe Covid-19 as almost all plants could not operate, for example, the exports and importsdeclined by 9.3% and 8% in 2020 sequentially due to social distancing In 2020, the GermanGDP was reported dropping by 4.6 percent consequently (Herr and Nettekoven, 2022)

Source: Statista, 20241

Figure 1: The European Central Bank fixed interest rate from 2008 to 2024

As a result, Germany government announced a “Stimulus Package” as a compensation tocompanies during lockdown period This was the first time that Germany government usedthis method as the solution to calm the severe situation, which was Covid-19 (Scholl, 2022)

In the “Stimulus Package”, the government used 130 billion euros in maintaining theeconomy and investing into technologies (Dorn et al 2020) This comprehensive idea fromgovernment was applied as the assistance to companies facing the problem of credit supplyincrease due to the pandemic (Scholl, 2022) Germany put a lot of efforts in maintaining thebusiness of national companies, preventing the bankruptcy of firms, which suffered thedifficulty in raising funds for their normal operations (Scholl, 2022) Or another measureimplemented by their government was “Value-Added Tax Reduction”, introduced in July

2020 The VAT was considered as an aid to this emergency problem and it wascontemporarily reduced by 3 percent from 19 percent to 16 percent to raise the nationalconsumption level (Dorn et al 2020)

Covid-19 brought many enormous problems to Germany and those issues have been not fadedcompletely after this pandemic (Fuest 2021) In his article, Fuest (2021) stated that there will

be some challenges to German economy within next following years These concerns wouldcome from various social aspects, which accumulatively created a burden or challenges toGerman economy For example, after the pandemic, German demography has changed withthe decrease in the number of people at working age and the aging in population; or thedownsizing of firms in every economic sector in Germany due to the deduction in employees

or lower demand from national and international market (Fuest, 2021) According to Buch(2023), the difficulties coming from the markets have led to the fluctuation in macroeconomicindex As can be seen in figure 1, it demonstrates the interest rates of ECB applied onEuropean commercial banks After Covid-19, the shortage in outputs has led to the higher rate

of inflation, which happened to any countries in Europe The interest rates therefore haveincreased after Covid-19 as a consequence to adapt the changes in economy Eventually, thecredit risks and non-performing loans of firms gradually increased or financial covenantsbecame stricter, which originated from the changes of inflation and interest rates (Buch,2023)

3.3 Research Objective

The recent pandemic - Covid-19 - has created an awareness of the massive stagnation ofglobal economy, which had no similar case recorded in the history and impacting manyaspects of human’s life This research paper was inspired by other empirical and theoreticalstudies to examine the relationship between capital structure and financial performance ofcompanies in Germany during this period as a contribution to this noteworthy issue and how a

period can be a rational action in order to support other scholars in investigating and findingthe solution against any upcoming events This could be assumed as the precaution in casethere will be another similar challenging factor impacting the wealthness of countries.

3.4 Research Structure

This research paper is basically a review of the well-known topic between capital structureand financial performance in a context where a global pandemic (Covid-19) influenceddramatically to all aspects of humanity, especially in economy The introduction andbackground bring an overview of the impact of Covid-19 to the world generally and toGermany specifically It continues with the theoretical review, where the theories to bedevelopped are illustrated, and the empirical studies have been conducted by other scholars.Then, the definition of variables are introduced, and the scope of work will be explainedfollowing Then the testing hypotheses will be announced clearly according to the purpose ofthe paper before discussing part of key findings The last section is conclusion summarizingthe whole work

The MM theory can be illustrated into two different parts I & II According to the MM-I,which was announced in 1958, it stated that the market value of a company completely has norelevance to the debt to capital ratio As a state in their work, the market value of an entity has

no relevance to its capital structure The concern of optimization between debts and equity isconsidered as an irrelevant concern if firms managers manage to maximize the firm marketvalue In which, the funding strategy based on debts, re-investing from profit or retainedearnings or issuing new shares has no impact on its market value (Franco Modigliani andMerton H Miller 1958) However, this theory was built under many unrealistic assumptions,for examples: taxes and other operating costs are not taken into account, or the fictionallyperfect transparency in information between the insiders and outsiders (Franco Modiglianiand Merton H Miller 1958; Stoiljković et al 2023)

Acknowledging the incorrection within their own theory, which is applied with confinedstandards in a perfect market condition, Modigliani and Miller has published another workwith the aim of amending the controversy points in the MM-I With its new version,Modigliani-Miller theory II has attempted to correct their original model by adding taxesfactor (Modigliani and Miller 1963; Stoiljković et al 2023) With an additional factor, theMM-II has stated that a company can take advantage of tax shield and increase the debt level

in their capital structure The two authors have realized that tax could become a burden to thefirms and it could enhance the personal income tax of shareholders With that reason, firms’managers might choose to increase the reasonable level of debts However, a firm could not

be funded by debts in a large portion without any constraints This solution has become riskywhen the debt amount stays at significantly higher level than equity This would presumablylead to the problem of the fulfillment of debt obligation or even the bankruptcy in thatcompany because of the huge gap between debt and equity Furthermore, the extreme level ofdebts might lead to the domination issue in management and decision making in operation Itcould be explained that with high level of debts, any investments or decisions would be thenbinding with the covenants between firms and related financial institutions (Stoiljković et al.2023)

Trade-Off Theory

Unlike the original model enduring tremendous criticism from other economists, thecorrection model has achieved more agreements and has been used as a basis knowledge forother theories to be developed and trade-off theory of Kraus and Litzenberger (1973) is one ofthem

Once again in their research, they claimed that the perfect capital market and the ignorance ofbankruptcy penalties in MM theorem are probably the imaginary conditions Hence, whichmeans that in the real imperfect capital market which includes taxes and bankruptcy penalties,the market value of a company might be influenced by the capital structure (Kraus andLitzenberger 1973) They stated that company should evaluate correctly about the cases inwhich the firm is solvent or even insolvent (to avoid it) in order to maximize the firm marketvalue through its debt level And the question was to discover the optimal capital structurewhere the firm can maximize debt level for the tax shield purpose with the constraint ofremaining the solvency (Abdullah and Tursoy 2021; Kraus and Litzenberger 1973)

The most common indicator well-explained for the market value of a company is its stockprice Hence, the issue could be narrowed down to maximizing the stock price of a company,which is not an easy question to answer properly (Priska and Tri 2012) Or another suggestion

is to decrease the weighted cost of capital (WACC) to the possible lowest level (Priska andTri 2012) Or firms can refer to the debt-to-value ratio with a certain target and progressivelyachieve it Although this idea was given as a promising solution to firms who pursue trade-offtheory, it remains various within problems and cost of adjustment is one of all (Myers 1984)

Furthermore, this theory can be explained more detail by considering the optimal capitalstructure as a perquisite, and other practical elements are added in, namely taxes, bankruptcypenalties, industry, market conditions, and rational investors, etc Then, the managers shouldsupervise to assure of the bankruptcy ability while maximizing debt financing (Abdullah andTursoy 2021) In other words, firms perhaps would like to enhance the debt level as much aspossible with an aim of increase their market value However, it is impossible for them toraise a giant debt level, which might cause the problem of insolvency or so-called financialdistress (Priska and Tri 2012) In the case the level of debt is outstanding comparing to firm’sequity, this might lead to an inverse effect when the shareholders become afraid of firm’s debtobligations and which could lead to the falling market value of companies (Priska and Tri2012)

Besides, insolvency is not the sole issue in maximizing debt level and some considerableproblems might be faced For example, the borrowers (particularly here are financialinstitutions and banks) would incur the losses if the firm’s managers agree to shareholder’sinterest and decide to invest into higher risk projects, or they even use the loan to pay out totheir stockholders (banks would set up covenants and trace the payments of the borrowers tomake sure they use the fund correctly) (Mostafa and Boregowda 2014) More than that, firmswould probably get difficulties in approaching new loan for their new investments while their

debt level is high and financial institutions being afraid of granting new loan lines to them(Mostafa and Boregowda 2014)

Pecking Order Theory

Moreover, another relating idea is pecking order theory by Myers and Majluf (1984) Thebasic concept of pecking order theory is that firms presumably prefer internal to externalfunding (Myers 1984) And, if the requirement could not be fulfilled by internal finance, theywould prioritize financing with debts, then convertible bonds, and equity might be the lastsolution for funding (Myers 1984) Besides, cost of obtaining internal fund is comparativelycheaper than raising external fund (Shahar et al 2015) In general, this theory could be failed

in explaining everything in capital structure decision making In some cases, firms decided toraise fund from issuing new stock even though they are capable of debt funding (Myers1984) However, in aggregation, internal funding and debt financing seem to be more popularabove all (Myers 1984)

One of the main obstacles raised by the Myers and Majluf (1984) is asymmetric information

It is found out that firms might choose not to fund with stock issuing if their valuableinvestment projects are valuated wrongly, both under- and overvalue due to asymmetricinformation (Myers 1984) The outsiders have lack of information about the NPV of projectsand truth with the managers of stock issuing firm, then they would adjust the stock priceinappropriately, which leads to unmatching amount of valuation between the required andactual-received amount (Myers 1984) If the actual amount received by firm through issuing

is less than the expectation, they would pass by the projects (Myers 1984) Otherwise, theinvestment is much higher than the need and even higher than the assumable NPV, theshareholders would not satisfy with their income (Myers 1984) Therefore, the cost of externalreliance is passing by positive NPV projects due to discussed problem can be eliminated bydebt financing method (Myers 1984)

Additionally, another point of view has been discovered by the economic scholars is that debtfunding creates a positive impact on the share price of firms In their scientific work, Kim andStulz (1988) confirmed the increase in share price is positively related to the announcement ofdebt issue Secondly, the negative impact had occurred when stock issue news was beingpublic by firms The stock price went down after the news as evidence of unhappyshareholders with the equity funding news (Myers and Majluf 1984) Hence, this leads to aconclusion that managers are unwilling to make equity funding and try to avoid it (Luigi andSorin 2009)

Nevertheless, this theory does not support firms raising fund by debt as much as they can.Myers (1984) has revealed in his research that even though firms acquire fund to cover theirexpenditure of new projects, they would put a huge effort to remain an acceptable level ofdebt (Myers 1984) The purpose of this action is to manage their risk level at a lowest rate,close to risk free rate if it is possible (Myers 1984) Secondly, firms would like to get a

“Reserve borrowing power”, where they might have an advantage in debt borrowing in thefuture and avoid the debt overhang situation (Myers 1984)

Furthermore, according to Myers (1984), the dividend payout ratios to the shareholders are set

at normal rates which can be achieved with internal funding for their projects (Myers 1984)

4.2 Empirical studies

Those introduced theories about capital structure are evidence spreading the idea howimportant of capital structure impacting on other aspects in firms, especially their financialperformance Therefore, a large number of researches have been conducted by scholars fromworldwide with different periods, which varied from cases in normal economic conditions toglobal financial crises or even global pandemic This paper particularly focused on the impact

of capital structure on financial performance of firms Hence, I would like to focus on relatingresearches which study on this relationship in different contexts

Abdullah and Tursoy (2021) published their work about the relationship between capitalstructure after International Financial Reporting Standards (IFRS) adoption in Germany Theresearch was studied during period 1993-2016 with an aim of observing the change in debtlevel and whether the positive impact of capital structure on financial performance still remain

the same or not Germany was assumed as “the most financial competitive country in the Europe”, according to Schwab and Sala-i-Martin, 2016, and soon adopted IFRS in 2005

(Abdullah and Tursoy 2021) As introduced in their study, 2448 firm-years observations werecollected for testing during this examining period Those companies were non-financial firmsand were listed on the Frankfurt Stock Exchange as following the requirement as listedcompanies in Germany while other non-listed firms optionally chose between IFRS and HGB(Handelsgezetzbuch) In their research, Abdullah and Tursoy used ROE, ROA and stock price

as indicators of financial performance, also as the dependent variables While independentvariable was the leverage ratio, representing the capital structure of firms Besides, they alsoused growth rates, dividend to price ratio and firm size as controlling variables with thedummy variables were IFRS adoption and stock return Then, they agreed to pick up GMMtechnique as the best solution to solve the problem of endogeneity issue Moreover, Hansen J-statistic and Arellano-Bond test were chosen for autocorrelation errors

Within the group of firms being tested, the research has shown that capital structure hadpositive impact on the financial performance, supporting the research hypothesis.Nevertheless, it also revealed the negative correlation of capital structure and stock price due

to gambling thought among investors As a result, this article was probably evidencesupporting the positive correlation as other previous researches, illustrating the benefits of taxshield, lower cost of issuing debt and profitability orientation of managers Moreover, theadoption of IFRS has revealed the increase of ROE during the second half period of testingpool, which means the previous strong relationship of capital structure and financialperformance has been reduced Moreover, they have found that German larger firmsperformed better than smaller ones while dividend plays as a negative factor in its relationshipwith financial performance of the tested firms To sum up, two authors have given thelimitations in their research The first one was about the sample size, which did not cover alllisted non-financial companies in Germany due to lack of financial data And the secondlimitation was the scope only in Germany, hence the adoption IFRS was not clear andacquiring more researches in other countries for comparing purpose (Abdullah and Tursoy2021).

In a similar study in Malaysia, (Khodavandloo, Zakaria, and Nassir 2017) examined thisrelationship among 45 listed companies in the field of trading and services sector on BursaMalaysia from 2004 to 2013 The main reason for choosing trading and services companies asthis was reckoned as the primary industry in Malaysia economy (Khoon and Lim 2010) Theperiod was chosen with an aim of studying how this relationship varied during globalfinancial crisis To make it clear, authors had divided the period into 3 parts: pre-crisis (2004-2006), crisis (2007-2009) and post-crisis (2010-2013) and introduced three main hypotheses

in his work The first hypothesis claimed about the negative relationship of leverage ratio tofinancial indicators; the second one discussed about the stronger negative correlation betweenthe mentioned proxy during crisis; and in the last hypothesis, they aimed to test whether thisnegative impact remained strongly post-crisis Then in the conclusion, they summarized thatthe leverage ratio influenced severely negative on the financial performance of theseexamined companies The impact of capital structure on financial performance indicators such

as ROA, ROE, GPM and market indicators (EPS, PE) throughout those years wereconsistently negative To sum up, they stated that it was rational with debt as externalfunding, however, it created a contradictory profit outcome if companies took advantage ofthis method as the case of trading and services companies in Malaysia

In normal economic conditions, Dinh and Pham (2020) have researched the same concern thatwas mentioned through this paper The scope of work was stated to be based onpharmaceutical enterprises, which were listed on Vietnam’s stock market The research tookplace in 2020, before the global pandemic with a hope of supporting firms in improving theirperformance and assisting the government to gain a better environment for national firmsdeveloping They chose return on equity (ROE) as the principal indicator of financialperformance The primary advantage of choosing ROE over the other ones available was theconcept of maximizing stakeholders’ wealth There were some leverage ratios wereindependent variables, including self-financing (E/C), leverage ratio (LR = A/E), long-term

rate) Generally, the paper demonstrated two main hypotheses for testing, the null hypothesis

mentioned that “there is no relationship between capital structure and financial performance”, while the alternative one claimed the relationship between these indicators At

the end of their research, they concluded rejecting the null hypothesis and a mixed signalwhere not all independent variables having same effect on ROE Self-financing was the onlyindex giving a negative impact on financial performance and others stayed stronglysupportive to the increase of return on equity Hence, some recommendations were given inorder to improve those pharmaceutical firms’ financial performance, namely: enhancingborrowing capital with sensible interest rates, efficiently balancing long-term and short-termdebts, reasonable capital structure where they could manage the cost of capital and risks, andlast but not least, diversifying loan channels not only loans with banks or financial institutionsbut also issuing bonds

Or recent case reported by Vuong, Vu, and Mitra (2017) also investigated about therelationship between capital structure and financial performance In their research, theypicked up ROE, ROA and EPS similar to above papers and new indicator – Tobin’s Q whichwas mentioned as the fraction of market value of firm and total assets The key independentvariables of capital structure were listed as following: short-term debt over total assets, long-term debt over total assets and growth rate of total assets; and firm size was added into themodel as the control variable This study agreed to test 729 large and super large entities listed

on London Stock Exchange in UK from 2005 to 2017 And thus, this sample size was to besufficient to detect the introduced relationship as UK economy was ranked at the fifth in theworld and the second in Europe Over the research, authors have examined the influence ofindependent variables on dependent ones not only in general context but also with dividedsamples according to the industrial sectors for having a better view of this impact on thesefinancial indicators In conclusion, they described that the long-term loans brought a negativeimpact to ROA and ROE proxy which was assumed as the issue of agency conflict probably.However, short-term and long-term liabilities turned out to be the positive supports for theincrease of Tobin’s Q Whereas the leverage ratios were irrelevant to the movement of EPS

In contrary, growth rate of firms seemed to have a negative impact on financial performancewhile the size of entities did have firmly positive correlation with it

Chang et al (2019) measured the impact of leverage and profitability of 5,112 firms of “Four Asian Tiger economies” within 14 years (2003-2016), including 46,301 firm-year

observations totally According to Chang et al (2019) recently, Hong Kong, South Korea(Korea), Taiwan and Singapore were countries in the group of the fastest growth rateeconomies in the world in the early 1960s and 1990s While Hong Kong and Singapore werewell-known of being two main international finance hubs in Asia, Korea and Taiwan were thepioneer and leading countries of information technology These four countries together wereleading economies and became wealthy with higher level of education and skilled workforce

in region Chang et al (2019) have found the interest in examining the relationship betweenleverage and financial performance of companies in these four Asian countries They

conducted working with leverage ratio which was computed by division of total liabilitiesover total assets as their primary dependent variable Then they used ROA as profitability,tangibility, growth rate, firm size as the explanatory variables The regression analysis wasrun during the research and scholars concluded that there was a considerably inverserelationship between firms’ capital structure and profitability It means that the increase ofleverage ratio led to the decrease of profit in each country Nevertheless, leverage and growthrate turned out to be a strongly positive correlation for cases in Hong Kong, Taiwan andKorea Moreover, size of firm was steadily positive increase with the enhancement of debts incapital structure in all four countries Finally, the last dependent variable – tangibility has asignificantly negative connection with those enterprises’ capital structure This conclusion,from the point of view of Chang et al (2019), was an advantageous information to investors

where “Four Asian Tigers” were promising countries for investments.

Chadha and Sharma (2015) published an article of their study about how leverage ratioimpacted on firm performance of 422 listed manufacturing companies on Bombay StockExchange (BSE) in India The study period was chosen from 2003-2004 to 2012-2013 Theglobal financial crisis took place in 2008-2009, within this study period, henceforth, theoutcome of this study would bring an overview of how the impact of capital structure on firmperformance before, during and after crisis Indian economy is a growing economy withpotential development in many industries, thus, the research is important for helping firmsachieving optimal capital structure and firms’ goals (Chadha and Sharma 2015) In theirresearch, they collected data of ROA, ROE and Tobin’s Q as their dependent variablesrepresenting as firm performance indicators Besides, they used leverage ratio (Debt overequity) as explanatory variable while choosing firm size, age, tangibility, sales growth rate,asset turnover and ownership structure as control variables The results showed that leverageratio obviously had no impact on ROA of those Indian firms Nevertheless, ROA waspositively influenced by size, age, growth, asset turnover and ownership Therefore, anyincrease in these control variables would lead to the increase of ROA Inversely, they foundthere was a significantly negative correlation between ROE and leverage ratio While firmsize, age, asset turnover and ownership structure could not explain well for the up and down

of ROE, the increase tangibility and sales growth did explain well for the upward trend ofROE Similar to the relationship of ROA, Tobin’s Q also had an uncertain relationship toleverage ratio and sales growth rate Even so, Tobin’s Q still could be explained well withstrong positive connection with the rise of other mentioned independent variables: age,tangibility and ownership In conclusion, Chadha and Sharma (2015) stated that leverage wasnot a crucial element for explaining the effectiveness of firm performance, however, othercontrol variables such as age, size, tangibility, sales growth rate, ownership structureassumably did it better

However, almost those theories and empirical studies are conducted with normal assumptions,where there is no outstanding disaster happening The aim of this research is to examine

performance during and after the pandemic and how these impacts change or whether theyconstantly have the same influence on financial performance of firms

5 The economic model and data analysis

5.1 Data Collection

This study dataset is primary data downloaded specifically from Refinitiv Eikon database.According to the main purpose of examining the relationship between leverage ratio andfinancial performance of listed companies in Germany from 2019 to 2022 (during and afterCovid-19), dataset collection has been conducted carefully by applying some obviouscategories Those required criteria applied into this action include choosing Germany as thecountry for getting data; the time range limits from 2019 to 2022; those companies are thelisted companies in Germany; and those companies are non-financial or insurance companies Due to the testing concern which has been explained previously, the primary dataset wascollected including these information: Name of companies, Country of exchange, Industryname, Year of collection, Net income after Tax, Total assets, Total liabilities, Revenue andEarnings per share These chosen index are later used and designed for creating the requiredvaribles for the testing model, which will be explained in below parts

The using material was collected and reconciled into an Excel file for further steps of dataanalysis by R-Studio software

(2021) Another version of leverage ratio was the figure used in research paper of Dinh andPham (2020), inheriting from the measurement of Chu, Nguyen and Ngo in 2015 (Dinh andPham, 2020), where the leverage ratio was calculated by total assets to total liabilities.Relying on previous researchers’ usage, I design the leverage ratio will be the total liabilities

to the total assets

logTA=log ⁡(Total Assets) (6)

Dependent variables

In general, financial performance represents the profitability and other relating criteria ofenterprises In my research, I decide to pick up four major dependent variables with an aim ofdemonstrating the efficiency in operation of those observations in this study (Dinh and Pham,2020)

Return on Assets (ROA)

The first dependent variable taken into account is the return on assets (ROA) It can be saidthat ROA has become one of the most important figure in measuring the profitability of anycompanies (Chang et al., 2019) Therefore, this proxy can be assumed as the firstrepresentative number in interpreting the financial performance of any entities According toBerk and DeMazro (2013), ROA is calculated by total sum of net income and interest expensedivided by book value of total assets In comparision, one of the essential characteristics thatshould be noticed in using ROA is that this measurement is not as strongly impacted by theleverage ratio as return on equity (ROE), which will be introduced later (Berk and DeMazro,2013) Nevertheless, in reality, the definition in the book of Berk and DeMazro (2013) hasslightly amended But , the core meaning of this index still remains as a figure showing firm’sprofitability For example, Abdullah and Tursoy (2021) has utilized ROA formula as the

fraction between the numerator - net income and the total assets as the denominator Or thiscould be constructed by using earnings before tax divided by total assets (Chang et al., 2019),

or simply ROA was the division between net income and total assets (Vuong, Vu, and Mitra,2017; Chadha and Sharma, 2015; Bauwhede, 2009) Therefore, among wide variety of return

on assets measurements, I conclude to use the simple method in calculating it, which is:

ROA= Net Income

Return on Equity (ROE)

The second dependent variable that is used to represent the financial performance ofcompanies is return on equity (ROE) Similar to ROA, ROE is presumed as a fundamentalindex in illustrating the profitability of any companies Although one of the particulardisadvantages in using ROE is that it could not reflect the indebtedness situation of firms, thisfigure still shows a positive correlation of firms in acquiring the investment opportunities,which significantly relating to the capital structure of any enterprises (Berk and DeMarzo2013) Accordingly, in other empirical studies, scholars commonly examined this proxy withexplanatory variables in order to test the relationship of capital structure and firmperformance Normally, the return on equity equals company’s net income divided by its totalequity (Khodavandloo et al., 2017; Chadha and Sharma, 2015; Vuong, Vu and Mitra, 2017;Abdullah and Tursoy, 2021) In my study, I accept and repeatedly utilize ROE formular asfollowing:

ROE= Net Income

Total Equity (3)

Net Profit Margin (NPM)

Thirdly, another widely-used indicator demonstrating firms’ financial performance that Ifound it interesting to study is the net profit margin (NPM) This figure illustrates how well afirm manages its operating and other relating expenses to obtain the profit from its revenue(Berk and DeMazro, 2013) Therefore, testing how net profit margin fluctuating under theimpact from leverage ratio could help to understand more about the relationship betweencapital structure and financial performance of any companies It was not exactly used by otherscholars, net profit margin could be replaced by other similar indicator, usually gross profitmargin (GPM) The gap between gross profit margin and net profit margin is the differenceprimarily caused by interest expenses and taxes (Berk and DeMazro, 2013) To give anillustration of what I have explained, in the research of Khodavandloo et al (2017), theychose GPM as an indicator for testing the firm’s performance correlating with its capitalstructure As mentioned above, in their study, the GPM showed a negative relationship resultunder the movements of leverage ratio (Khodavandloo et al., 2017) A question has come