Moderating effects of firm size and leverage on the working capital finance-profitability relationship: Evidence from China

Abstract

We evaluated the moderating effects of firm size and leverage on the working capital finance (WCF)-profitability relationship among Chinese companies during 2000-2017. Applying the generalized method of moments (GMM) technique on panel data, we observed that firm size and leverage have strong moderating roles in the WCF-profitability relationship. We observed that small or low-leverage firms have an inverted U-shaped WCF-profitability relationship. However, this relationship is U-shaped for large or high-leverage firms. We report break-even points in these relationships that show the portion of short-term debt in working capital financing. The results reveal that the break-even point for all subgroups (small, large, low-leverage, and high-leverage firms) decreases compared to the break-even point of the full sample. This study shows how the break-even point of the WCF-profitability relationship shifts when a company expands or its leverage level changes. Managers can use this information for profit maximization.