Capital Structure and Firm Profitability: A Systematic Literature Review

Abstract

ABSTRACT This paper presents a systematic literature review of the relationship between capital structure and firm profitability. Drawing on foundational theory, including the Modigliani-Miller irrelevance and tax-adjusted propositions, trade-off theory, pecking order theory and agency cost theory, alongside empirical studies from developed markets (the United States, France, the G7 economies), emerging markets (Ghana, Jordan, Egypt, Vietnam) and cross-country panels, the review synthesises evidence on how leverage relates to profitability measures such as return on assets, return on equity and Tobin's Q. The findings show no single, generalisable relationship: some studies report a positive association consistent with the disciplining role of debt under agency theory (Margaritis & Psillaki, 2010; Abor, 2005), others report a negative association consistent with financial distress and pecking order behaviour (Zeitun & Tian, 2007) and still others find no statistically significant relationship at all (Ebaid, 2009). The review further identifies firm size, asset tangibility, ownership structure, industry classification and macroeconomic conditions as key moderating factors and highlights recurring methodological gaps, including short panel windows, unresolved endogeneity between capital structure and performance and limited sector-level disaggregation. The review concludes that future systematic work should treat the capital structure-profitability relationship as context-dependent rather than search for a single universal effect and should prioritise longer panels, causal identification strategies and industry-specific analysis.