The Effects of Profitability and Debt-To-Equity Ratio on Operating Leverage

Abstract

The aim of this study was to analyze the effects of profitability and debt-to-equity ratio on operating leverage in the case of companies listed on the Korea Exchange from 2000 to 2021. The analysis showed that the profitability and debt-to-equity ratio of companies in Korea rose with increasing operating leverage (fixed costs), and it is worth noting that a company’s cost structure affects its capital structure. There was a positive correlation between profitability and debt-to-equity ratio for Korean firms, which means that their capital structure can be explained by the pecking order theory. That is, the more profitable a company is, the more it prefers to raise funds through debt issuance rather than equity issuance. In the case of Korean companies with a relatively high dependence on debt, the increase in operating leverage for facility investment among other business activities mostly expands debt, and the higher the profitability, the higher the debt-to-equity ratio is.