Journal of Economic & Administrative Sciences

Vol. 22, No. 1, June 2006 (41 -59)

An Empirical Study of Firm Structure and Profitability Relationship: The Case of Jordan Dr. Abdussalam Mahmoud Abu-Tapanjeh Mutah University
Abstract The present study examines the relationship of firm structure and profitability, taking into consideration major characteristics such as firm size, firm age, debt ratio and ownership structure of 48 Jordanian industrial companies for a period of one decade, that is from 1995 to 2004, listed in Amman Stock Exchange. Hypotheses are developed taking into account both previous research and the particular idiosyncrasies of the national context. The study employed two model specifications in order to test the hypotheses, using the profitability measurement of Rate of Return on Equity (ROE) and Rate of Return on Investment (ROI). The empirical findings suggest that firm structure emerges as an important factor affecting profitability. The results indicate that a weak relationship existed between some of the independent variable and profitability, except for debt ratio. Introduction Firm structure plays a determinant role in firm profitability. A considerable research was undertaken examining the relationship between firm structure and profitability. This relationship is viewed from two competing hypotheses. On the one hand, the traditional market structureconduct-performance or collusion hypothesis and on the other hand, the efficient market hypothesis. The traditional hypothesis postulates that firm structure determines profitability, i.e., highprofit firms are found in highprofit industries with favorable competitive structure. Whereas, the efficient market hypothesis advances the notion that more subtle firm qualities related to organizational and managerial capabilities are those that underline the firms competitive advantage, which leads to profitability. (Demsetz, 1973) and (Peltzman, 1977) postulated that market concentration is a result of firms superior efficiency that leads to larger market share and profitability. In other words, market-concentration lowers the cost of collusion between firms and this results in higher than normal profits. Many studies are found testing these competing hypotheses and the results concludes with general mixed opinions. (Bain, 1956) and (Mason, 1993) suggest that firm structure involving mainly industry concentration and entry barriers are important determinants of firm profitability. Whereas,

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studies like (Porter, 1991) view that market environment partly exogenous and partly subject to influences by firm actions. Despite the influence, either negative or positive, on the firms profitability, specific strategic responses might strengthen in prevailing serious impediments to firm success. Other firm specific factors such as capital intensity, firm size, debt ratio, firm age and market share also affect profitability. Most prior studies were built on western data. Very rare research was done in Jordan as well as in the Arab countries. Thus, this study will add to our understanding of the extent to which the result in Arab countries will be similar to past studies. The remainder of this paper is organized as follows. The next section gives the relevant theoretical background on firm concentration and profitability as well as the development of the hypotheses. The third section describes the methodology and the sample selection. Section four portrays the analysis of the data and the statistical results. The last and final section presents summary, conclusions and directions for future research. Theoretical Background and the Development of Hypotheses This study attempts to investigate the relationship between firm structure and profitability at Jordan Industrial Companies (JIC), taking into consideration the major firm characteristics such as, firm size, firm age, debt ratio, and ownership structure. This prevailing view can be traced from the two basic paradigm notions, i.e., collusion hypothesis and the efficient market hypothesis. The traditional notion or the collusion hypothesis follows the structure-conduct-performance paradigm. According to this hypothesis, firm profitability depends to monopolistic conduct, and this conduct depends on industry structure. This conduct enables firms to set prices above the costs, thus, making abnormal profit. The pioneering work of (Bain, 1951), and (Barney, 1991) lays two assumptions of this paradigm notion. First, the firm is considered homogeneous in terms of strategically relevant resources, and secondly, an attempt to develop resource heterogeneity has no long-term viability due to high mobility of strategic resources among firms. On the other hand, efficient market hypothesis argued the traditional theory (efficient market theory) postulating that firms profitability depends on a proxy relationship between superior efficiency, market share, and concentration. (Porter, 1991) has noted that firm profitability can be decomposed into effects steaming from industry structural characteristics and the firms strategic positioning within its industry. Extending the argument, this study is a logical approach to add to this literature, in studying the impact of firm structure to profitability by
41

Dr. Abdulsalam Abu-Tabanjeh

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examining the major factors such as firm size, firm age, debt ratio, and ownership structure. The following is a separate discussion for each factor leading to the development of the hypotheses: Firm Size and Profitability A good number of researchers had investigated the relationship between firm size and profitability. Most of the results come out with varying opinions. Some studies postulate negative results while some studies have evidence supporting the positive notion. (Amato & Wilder, 1985) conveyed that the relationship between firm size and profitability may be positive for some firm size ranges and negative for others. Again, if the size reached a threshold, additional expansion of firm size may further separate ownership from control. This suggests that the relationship between firm size and profitability can become negative beyond the threshold firm size. (Fama & French, 1993) captured much of the cross-section of average stock returns. If stocks are priced rationally, systematic differences in average returns are due to differences in risk. Thus, with rational pricing, size and book equity to market equity must proxy for sensitivity to common risk factors in returns. (Fama & French, 1993) also attributed this predictive power of size to its ability to capture risk. Again from the companys perspective, small firms apparently faced higher capital costs than larger firms. Here, we can mention (Baumol, 1959) proposition that large firms have all of the options of small firms, and in addition, they can invest in lines requiring such scale that small firms are excluded. (Michaelas et al., 1999) indicated that larger firms use higher gearing ratios than smaller firms, and they suggest this is a result of smaller firms facing higher financial barriers. This view is also supported by (Chittenden et. al., 1996), (Hall et. al., 2000) and (Cassar & Holmes, 2001, 2003), who provided evidence suggesting that size is positively related to long term debt and negatively related to short-term debt. (Romano et. al., 2001) and (Gibson, 2002), also found an important relationship between size and capital structure. (Lopez Garacia & AybarArias, 2000) suggest that size significantly influences the self-financing of smaller companies. Contrary to these studies, (Berk, 1997) suggests that investor returns are positively correlated with size when size is measured with non-market measures such as employees, assets and sales. (Leledakis, Davidson & Smith, 2004) found that there is little correlation between firm size and profitability, while (Hecht, 2001) conveyed that there is no correlation between non-market measures of size and investor returns. (Jordan et. al., 1998) also found that there is no relationship between financial structure and enterprise size. Critical resource theories stress a firm industry control over the resources such as assets, technology and intellectual property as determinants of firm
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size. Legal institutions and laws improve the protection afforded the owner of the company over these critical resources, when the size of the firm increases (Kumar, Rajan and Zingales, 2001). Further, (Rajan & Zingales, 2000) postulated a model that proper control over the intangible factors makes the firm profitable. Thus, they concluded that the greater the importance of intangible factors like fixed assets, the lesser the firm is to grow. So, firm size and profitability sometimes lead to lower profits with the increase of size. However, small firms also need not necessarily be less profitable than large firms within a given institutional environment. Competency theories appeal that small firm can be just as profitable as a large firm in a different competencies that leads to surplus returns. (Niman, 2003) described that survival depends not on being better, but rather on being sufficiently different, so that the advantages of others do not prove fatal. (Dhawan, 2001) actually did find a negative relation between firm size and profitability for U.S. firms during 1970 to 1989 but at a highly aggregated level of services and manufacturing. Thus, from these existing theories and past research, it can be concluded that effect of firm size and profitability comes out with mixed results. Some studies conclude with negative relation, and some says no relation exists between profitability and firm size. Further, the above review also shows that profitability initially declines and then levels off or increases. The firm size can be measured in a number of ways, the commonly used measures are assets, sales, numbers of employees, and value added. Technological theories of the firm used assets or sales as a measure of firm size. In this study, firm size is measured by the log of sales. The researcher choose sales turnover because of its feasibility. It is also less prone to having measurement errors compared with other commonly used measures of firm size like net assets. Thus, from this theoretical background, the researcher advances the following hypothesis. Hypothesis 1: Firm Size Positively Affects Profitability. Ownership Structure and Profitability Ownership structure defines the institutional basis for power relationships between individuals within the organization and dealings with other organizations (Bowels, 1984). Companys capital structure decision should be properly analyzed and balanced to maximize the firm profitability. The owners being the equity shareholders of the company and the providers of risk capital would be concerned about the ways of financing a companys operations. There may also be a conflict of interest among shareholders, debt holders and management. Conflicts between shareholders and managers may
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arise on two counts. Firstly, managers may transfer shareholders wealth to their advantage by increasing their compensation and perquisites. Secondly, managers may not act in the best interest of shareholders to protect their jobs. Managers may not undertake risk and go for profitable investments. (Freeman & Lomi, 1994) claim that ownership rights system included in organizational structure plays an important role given that it generates collective behavior and drives individuals to control and promote their own interests. Based on ownership structure, firms can be classified as co-operative companies and capitalist companies. In the capitalist company, the underlying motivation is the possibility for owners to obtain benefits on the investment made in the business. However, in a co-operative company, the main incentive is the satisfaction of a common socio-economic necessity. In the co-operative company, the organizational power is related to the individual, through participating in the social objectives of the co-operative company where expectations are fulfilled and the need is satisfied, whereas, in the capitalist company the roles of supplier, entrepreneur and client are normally played by different individuals. (Locke & Schweiger, 1979) and (Schweiger & Leana, 1986) postulated the existence of a positive relationship of participation and the level of satisfaction and commitment on the part of the members. Recent studies also postulated the fact that the agency problem is expropriation of minority shareholders by the controlling owners rather than the conflict of interest between managers and dispersed shareholders. However, (Morck, 2004) conceded that in countries with weak institutions (education system, courts, financial regulators, and organ of government), family ownership and pyramidal control are more desirable than dispersed ownership because the managers can simply loot the firm, with no concern for its future or for the wealth of its shareholders. (Arnold, 1998), in his study concluded that there is an increased probability of the firm with high gearing levels. Jordan as a developing country had one of the largest stock markets in the region, i.e., Amman Stock Exchange (ASE). It capitalizes more than US $ 7 Billion in 2003. In 2004, the exchange listed 199 companies and has more than 500,000 investors (Jordanian Shareholding Company's Guide, 2004) Jordanian corporate and individual investors hold 54% of the shares where the rest is held by the government. Foreign investors account for 40% of share ownership. Investors enjoy the benefits of no withholding taxes, no taxes on dividends, and free repatriation of funds. Further, ASE listed firms that have no ownership limitation of any kind. For the purpose of this study, the researcher measured the ownership structure by Government Ownership,
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Non-government Ownership, and Others Ownership. Here, Government Ownership includes government owned firms and government agencies firm, Non-government firms includes private companies ownership and individual ownership, whereas Arab investors and Foreign investors comes under Others Ownership. Thus, from the above reviews and discussion, the researcher proposes the following hypothesis. Hypothesis 2: Firm Ownership Structure Positively Affects Profitability. Debt Ratio and Profitability A firm can avoid the risk of financial distress if it can maintain its ability to meet contractual obligation of interest and principal payments. A bad debt ratio is not necessarily bad. Debt has its merits and demerits. It saves taxes since interest is a deductible expense and at the same time it can cause financial distress also. If a firm can service high debt without any risk, it will increase shareholders wealth. On the other hand, a low debt ratio can prove to be burdensome for a firm, which has liquidity problem. In all, a firm should employ debt according to its capacity without servicing any problem. The stability of cash flows reduces the risk of insolvency and enhances the capacity of the new entity to service a larger amount of debt. The increased borrowing allows a higher interest tax shield, which adds to the shareholders wealth. Many studies had been found favoring the above idea. In contrast to the above ideas, the study of (Graham, 2000) estimated the magnitude of debt benefit. He pointed out that taxes benefit of US $ 0.2 for each unit of profit before taxes or the equivalent to 10% of the firms value, which are still below the potentially maximum benefit. Furthermore, he concludes that big and profitable companies present a low debt rate. He also pointed out that large companies, which have means to offer good collaterals, usually find relatively lower financial costs, which does not mean that they have a high debt level. Besides these factors, a lot of firms can opt to maintain flexibility reserves, using debt with below their potential devising a possible future need. The study done by (Fama & French, 1998) concluded that the debt does not concede taxes benefits. Besides, the leverage degree generates agency problems among shareholders and creditors that predict negative relationships between leverage and profitability. Thus, the negative information relating debt and profitability observe the tax benefit of the debt. Cash flow analysis indicates how much debt a firm can service without any difficulty. (Modigliani & Miller, 1963) affirmed that fiscal legislation allows the firm to deduce of the operational profit the amount expended in the payment of interests, the value of the tax levy on revenues would be reduced in the same proportion of the aliquot of
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Dr. Abdulsalam Abu-Tabanjeh

June 2006

the income tax. Therefore, the profit would be smaller with comparison with a company without debts, and as the profit will be proportional to a smaller equity, the profit per share tends to be larger. (Brealey and Myers, 1992) claim that if the cost of the debt is lesser than the cost of equity, the firm with larger financial leverage tends to present, in normal conditions of operation, higher indexes of profitability on equity. (Myers, 1984) conveyed that profitable firms are less likely to borrow because of their preference for and the rewards of retaining earnings. (Chittenden et. al., 1996), (Michaelas et. al., 1999) and (Cassar & Holmes, 2003) also supported the idea of Myer. They indicate that profitability is negatively related to total gearing. (Gedajlovic et. al, 2003; Lincoln et. al, 1996) also suggest that firms with higher level of debt earn less profitability. (Hall et. al., 2000) suggest that profitability is not statistically significantly related to long-term debt. (Jordan et. al., 1998) argued and gave no support for the negative impact of debt on profitability. From the above reviews, the researcher concludes that most of the studies support the general notion that lower debt level decreases the risk of solvency with increases of profitability to a firm. In this study, debt ratio is defined as total debt by total assets. In order to test this general notion, the researcher postulates the following hypothesis. Hypothesis 3: Debt Ratio Positively Affects Profitability. Age and Profitability The hypothesis of age influence on organizational structure is put forward in organizational theory. It is considered that the older the firm, the organization will be more stable in nature. The firm will benefit more developed activity because of its more experience business. A number of studies had been found accepting and favoring this view. The work of (Chittenden et. al, 1996) postulated that younger firms rely more on shortterm finance than more mature firms, as a result of a positive relationship between age and profitability. The study furthermore suggests that the use of both short-term and long-term debt falls with age. (Hall et. al, 2000) also favor this idea. (Michaelas et. al, 1999) postulated that younger firms have higher average gearing ratios than older firms because the latter being more profitable and having accumulated internal sources. (Romano et. al, 2001) found that business age is not a significant predictor of debt as a source of financing. Thus, according to this literature and in order to verify the same results for the Jordanian industrial companies, the researcher postulates the following hypothesis. Hypothesis 4: Firm Age Positively Affects Profitability.
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Research Methodology The researcher employed the industrial companies listed on the Amman stock Exchange. For a homogeneous selection and accurate results of the analysis, the researcher excluded companies under liquidation and those established after 1995, i.e., the beginning of the year under study. Thus, the final number of the sample employed for the study included 48 industrial companies. The sources of data consist of the annual balance sheets, income statements and audit reports of the selected industrial companies. Other relevant data which were not available in the above sources were taken from the Jordanian Shareholding Company's Guide. The present study is confined to the period of one decade, i.e., from 1995 to 2004. The main reason behind selecting this period is data availability. The aim of this study is to examine the relationship between firm structure and profitability. Many researchers use different measures of firm profitability in the analysis of the relationship between firm structure and profitability. The profitability measures mostly used in empirical studies are Rate of Return on Equity (ROE), Rate of Return on Capital (ROC), or Rate of Return on Investment (ROI). The researcher used ROI and ROE. The Return on Equity (ROE) is calculated as Net Profit after Tax by Total Shareholders Equity. This ratio shows the profit attributable to the amount invested by the owners of the business. It shows potential investors into the business what they might hope to receive as a return. The stockholders equity includes share capital, share premium, distributable and nondistributable reserves. The Return on Investment (ROI) is calculated as Net Profit after Tax by Net Assets. The rate of return on investment indicates the degree of efficiency with which management has used the assets of the enterprise during an accounting period. Most scholars primarily focus on these two factors to measure financial performance and operating performance. The current study use correlation analysis to identify the association between profitability and the independent variables, as well as regression analysis to estimate the causal relationship. The Models The researcher considered the following regression models: Model 1: ROI as the Dependent variable

ROI = 0 f, y + logsize f, y + logage f, y + debt f, y + 4 1 2 3 non govow f, y + govow f, y + othow f, y + l f, y 5 6

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Dr. Abdulsalam Abu-Tabanjeh

June 2006

Model 2: ROE as the Dependent variable

ROE = 0 f, y + logsize f, y + logage f, y + debt f, y + 4 1 2 3 non govow f, y + govow f, y + othow f, y +l f, y 5 6

where

ROI : measures the parental corporations financial profitability, with profit after tax by net assets for firm ( f ) in year ( y ), ROE : measures the parental corporations financial profitability, with profit after tax by total shareholders equity for firm ( f ) in year ( y ),

0 f,y : constant term for firm ( f ) in year ( y ),

: regression coefficients. logsize f,y : logarithms of the firm size (total sales) for firm ( f ) in year ( y ),
logage f,y : logarithms of the firms age for firm ( f ) in year ( y ), debt f,y : debt ratio (total debt by total assets) for firm ( f ) in year ( y ),
non- govow f,y : non-government ownership (represent private companies ownership and individual ownership) for firm ( f ) in year ( y ),

govow f,y : Government ownership (represent government owned firms

and government agency firms ) for firm ( f ) in year ( y ),

othow f,y : other ownership (represent Arab investors and foreign investor )
for firm ( f ) in year ( y ),

l f,y : disturbance term for firm ( f ) in year ( y ).

Results and Interpretation Table 1 shows some descriptive statistics for the dependent and independent variables, while Table 2 shows the correlation coefficients.

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STD All Samples Mean 0.084 0.082 0.072 0.085 0.091 0.093 0.093 0.056 0.084 0.067 0.092 0.053 0.074 0.050 0.062 0.060 0.060 STD Mean 1995 STD Mean Variable 0.064 0.069 0.145 0.137 ROI 0.147 0.144 0.097 0.108 0.094 0.094 0.093 0.100 0.148 0.203 ROE 0.189 0.189 0.272 1.283 0.290 1.254 0.311 1.222 1.187 1.187 0.369 1.146 0.412 1.097 Logage 0.165 1.309 0.190 0.257 0.735 6.712 0.756 6.700 0.731 6.682 0.701 6.758 6.757 6.757 0.724 6.703 0.887 6.284
Logsize

-0.018

-0.067

0.040

0.023

0.085

0.154 0.193 0.131 0.212 0.184 0.211 0.192 1.308 6.712 0.254 0.733 0.232 0.370 0.248 0.381 0.225 0.387 0.190 0.377 0.173 0.355 0.360 0.360 0.186 0.352 0.205 0.384 Debt 1.356 6.701 0.377 0.232 0.785 0.365 0.152 0.080 0.180 0.095 0.184 0.096 0.187 0.099 0.186 0.098 0.187 0.106 0.112 0.112 0.195 0.110 0.186 0.099
Govow

1.256 0.221 1.377 6.744 0.272 0.077 0.800 0.212 0.147

6.676

0.361

0.098

0.840 0.163 0.865 0.163 0.868 0.186 0.838 0.192 0.837 0.191 0.827 0.189 0.833 0.186 0.832 0.821 0.821 0.197 0.834 0.191 0.843
NonGovow

0.061

-0.412**

-0.325**

Table (2): Pearson Correlation Coefficient Matrix (n = 48)

0.088

0.075

1.000 0.054 0.069 0.048 0.080 0.067 0.082 0.067 0.082 0.075 0.074 0.069 0.068 0.065 0.066 0.066 0.070 0.055 0.077 0.057 Othow

Mean STD Mean STD Mean STD Mean STD Mean STD Mean STD Mean

Table (1): Descriptive Statistics (n = 48)

Govow

2003

2002

2001

1.000

Journal of Economic & Administrative Sciences

-0.056

1999 1998 STD Mean

0.024

0.584**

ROE

1997

1996

1.000

ROI

1.000

1.000

Non-govow

Logsize

Logage

Govow

ROE

Debt

ROI

49

2000

Othow * significant at the 0.05 level (2-tailed), ** significant at the 0.01 level (2-tailed),
0.456** -0.092* -0.084 0.364** -0.077 0.040

2004

0.346**

0.065

0.120**

Logage Logsize

0.288**

-0.055

-0.086

1.000

Debt

1.000

-0.317**

Nongovow

-0.085

STD

0.069

1.000

0.088

0.173

0.310

0.761

0.228

0.180

0.185

0.074

-0.097*

Othow

-0.302**

Dr. Abdulsalam Abu-Tabanjeh

June 2006

Table 2 shows that firm age, debt ratio, and non-government ownership have positive insignificant correlation, whereas firm size, government ownership, and other ownership structure have a negative insignificant correlation with ROI. However, debt ratio has a positive significant correlation and government ownership have a negative significant correlation with ROE. This indicates that the more shares the government owned for the companies, the more negative impact on profitability. For more concrete results, Table 3 shows the results of estimating the regression equation of ROE for the pooled sample with the overall period of the years under study as well as for each year separately. The values of R square and F test are also given. Table 3 shows that firm size has no significant effects on profitability measured by ROE, showing a consistent basis during the years of the study. However, in the overall pooled sample, firm size showed significant negative relation with profitability (ROE). This effect is multiplied when the firm size is large, evidenced by the significant negative coefficient of logsize. This could be due to the changes in output either because of increased demand or reduction of costs. The reduction in costs could come directly from more productive capital equipment, while increased demand could stimulate expansion on the part of the firm, hence affect profitability. Thus, the current study does not support Hypothesis 1, as the effect of size on profitability, measured by ROE, is significantly negative at the 0.05 level. We mention here the study of (Szymanski et. al, 1993) who found a negative association between firm size and profitability. In the same vein, (Peltzman, 1977), (White, 1982), and (Porter, 1980) argued that rapid expansion of firm size ensures incumbent strong financial performance even in the presence of market share gains from new entrants. As far as debt ratios relation with profitability of the selected Jordanian industrial companies is concerned, there was a significant positive relation during the years 1999-2003 as well as for the pooled sample. This indicates a high positive influence on profitability, confirming Hypothesis 3. This result conforms to the conclusions of (Modigliani and Miller, 1963), and (Hadlock and James, 2002) who interpret the loan as a positive step, imagining that the company preferred that type of financing because it anticipates high returns. Thus, the selected industrial companies of Jordan might have depended upon the external funds to operate the necessary working capital finance rather than to finance from internal operation. It is also apparent from Table 3 that firm age has no significant effects on profitability measured by ROE, showing a consistent basis during the years of the study. Thus, the current study does not support Hypothesis 4.
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Table (3): Regression Analysis for Firm Structure and Profitability (Model 1 ROE, as the dependent variable) (n=48)

t-statistics -1.132 -3.865 -1.122 -3.314 -0.163 -0.513 0.834 2.158 1.481 1.016 0.091 -0.061 -0.093 -0.689 -0.729 1.173 0.091 1.240 0.070 0.065 0.589 -0.597 -0.026 -1.647 -0.056 -2.534 -0.085 -0.864 -0.024 0.018 -0.022 0.095 -0.346 2.557 0.437 4.765 0.484 6.630 0.657 4.657 0.504 1.843 0.176 0.017 -0.021 0.317 0.116 -0.500 4.161 -0.071 -0.035 0.011 4.480 1.152 3.418 0.146 0.479 -0.826 -2.252 -1.287 -2.757 0.267 0.407 0.667 0.717 -0.426 -0.785 0.074 1.313 2004 t-statistics 2003 t-statistics 2002 t-statistics 2001 t-statistics 2000

All Samples -0.051 0.031 -0.027 0.294 0.147 0.248 1.288 4.343 1.208 3.546 0.226 0.739 -0.756 -2.060 -1.348 -2.972 0.301 0.473 0.778 0.844

-0.085

1.098

-2.428

8.703

0.243

0.406

0.411 0.251 1.229 4.099 1.041 3.031 0.167 0.547 -0.828 -2.240 -1.169 -2.570 0.634 0.993 0.980 1.100 1.417 4.533 0.179 0.411 3.597 0.356 0.547 0.078 14.139 0.158

8.641

0.571

Furthermore, Table 3 shows that the ownership structures, measured by government ownership, non-government ownership and other ownership, have low non-significant impact on profitability in separate years as well as in the pooled sample. It also highlights that for all the ownership structures, there was a negative impact in 1996, 1997, 2000 and 2001. This might be a consequence of economic crisis and unstable period of time. However, in
June 2006

t-statistics

Journal of Economic & Administrative Sciences

t-statistics 1999 t-statistics 1998 t-statistics 1997 t-statistics 1996 t-statistics 1995
Variable Name

5.273 1.373 1.292 0.979 1.321 0.054 .6620 0.015 -0.555 -0.041 -1.449 -1.134 -1.323 -1.039 -1.050 -0.828 1.148

0.448 0.174 0.150

0.620 0.574

2.884 0.134

-0.784 -0.020

0.937 0.072

-0.622 -0.599

-0.518 -0.501

-0.687 -0.658

1.669

0.204

-0.108 -0.196

-1.663 -0.105

0.053 -0.196

0.663 0.075

0.271 0.485

0.270 0.484

0.187 0.333

0.727

0.101

Constant Logage

Logsize

Debt

Govow Non-govow Othow

F value

R Square

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June 2006

general, ownership structure does not show a significant impact on the profitability performance, and Hypothesis 2 is not supported. Thus, it can be concluded from Table 3 that firm size has negative impact, while debt ratio has a high positive impact. In contrast, firm age and ownership structure have almost no impact on profitability. Furthermore, in order to test the influence of the independent variables on profitability, measured by ROI, and to see how far this supports the results of Table 3, the researcher extended the regression analysis using Model 2. Table 4 describes the results of estimating the regression equation of profitability measured by ROI for the pooled sample as well as for each year separately. Table 4 shows firm age and firm size with no significant effect on profitability measured by ROI. However, the overall pooled sample shows a positive effect for firm age and a negative effect for firm size on profitability (ROI). These results confirm and support the former results of Table 3. As far as debt ratio is concerned, its effect on ROI is in total contrast to that on ROE. The table shows mixed results with a significant negative impact in 1997 and a significant positive impact in 2001 and 2003. Viewing the pooled sample, a very low insignificant positive impact is found for ownership structure on profitability (ROI). This result comes out similar and confirms the results of Table 3. However, in 2001 a negative significant result is shown, while 2003 shows positive significant results. Again, viewing the overall pooled sample, non-government ownership shows a slight impact on profitability as was also found in Table 3. Thus, in a general conclusion, ownership structure has almost no influence on profitability, therefore supporting and confirming the regression results of profitability measured by ROE. Summary and Conclusion The primary aim of this study was to test the postulated hypotheses and to provide evidence with respect to the impact of firm structure to firm profitability, by examining such major factors as firm size, firm age, debt ratio and ownership structure. In this specific case of Jordan economy, the difficulties are enlarged due to the unstability of the economic environment. This country went through a process of monetary adjustment and economic crisis, which also has an impact due to the uncertainty of the local economy as well as the external unstable environment. The study employed two model specifications in order to test the hypotheses, using profitability measured by the Rate of Return on Equity (ROE) and the Rate of Return on Investment (ROI) along with other independent variables, for the selected Industrial Companies of Jordan.
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Table (4): Regression Analysis for Firm Structure and Profitability (Model 2 ROI, as the dependent variable) (n = 48)

All Samples -0.017 -0.962 -1.396 -2.649 -3.095 -0.010 -0.018 2.243 1.968 1.650 1.628 -0.662 -0.447 -0.942 -0.530 -0.222 -0.009 1.349 0.047 1.216 0.036 0.001 0.024 0.753 0.011 -0.628 -0.010 -1.809 -0.027 0.275 0.004 0.039 0.009 0.347 0.229 -0.457 -0.045 2.043 0.070 1.748 0.081 0.896 0.043 -0.626 -0.032 0.006 0.001 0.115 0.098 0.049 3.814 0.012 0.000 -0.062 1.475 2.649 3.109 -0.060 -0.114 -2.208 -2.043 -1.292 -1.296 0.817 0.558 0.778 0.444 0.168 -0.012 -0.946 1.017 0.027 -0.006 0.024 0.049 0.107 1.035 1.483 2.705 3.142 0.023 0.044 -2.144 -1.983 -1.464 -1.511 0.897 0.630 0.923 0.532 t-statistics 2004

-0.053

1.773

-1.005

1.274

0.147

0.320

0.221 0.074 0.946 1.341 2.758 3.176 -0.049 -0.093 -2.118 -1.944 -1.428 -1.470 0.999 0.700 1.070 0.638 0.296 1.669 0.044 0.204 3.979 0.380 0.539 0.077 1.372 0.018

t-statistics

t-statistics

t-statistics 2001 t-statistics 2000

2002

2003

2.244

0.257

It was hypothesized that larger size firms receive more attention from analysts and investors with a larger more option, and hence increased profitability. This idea is supported by (Baumol, 1959; Michaelas et. al, 1999; Chittenden et. al, 1996; Hall et. al, 2000; Cassar & Holmes 2001, 2003). However, a significant negative impact has been found at the 0.05 level in Table 3. Thus, this result does not support the formulated Hypothesis 1. However, this conclusion is in conformance with the work of (Dhawan,

t-statistics

Journal of Economic & Administrative Sciences

t-statistics 1999 t-statistics 1998 t-statistics 1997

1.021 0.874 1.247 0.605 1.635 0.043 0.631 0.009 -2.405 -0.114 -1.359 -0.681 -1.222 -0.615 -1.039 -0.525 2.093

0.136 0.119 0.244

t-statistics 1996 t-statistics 1995

Variable Name

1.152 0.759

1.915 0.064

-1.120 -0.020

1.007 0.055

-0.993 -0.681

-0.924 -0.636

-1.101 -0.751

1.096

0.144

-0.518 -0.901

1.245 0.075

0.832 0.025

-1.430 -0.153

0.451 0.767

0.522 0.892

0.316 0.537

1.111

0.146

Constant logage

Logsize

Debt

Govow

Nongovow

othow

F value

R Square

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Dr. Abdulsalam Abu-Tabanjeh

June 2006

2001) who also found a negative relationship between firm size and profitability. Further, ownership structure has almost no impact on profitability. However, the non-government ownership shows a little impact albeit not significant. This could result in what (Johnson et. al, 2000) called the tunneling effects where the controlling shareholders transfer out resources from the firm for their own private benefits at the expense of minority shareholders. The result does not fully support the postulated Hypothesis 2, that firm ownership had a positive impact on profitability as it has only a very low insignificant positive impact. Furthermore, the current study extends the very interesting discussion about the influence of debt ratio on firm profitability. Many researches give mixed results on such a relationship. Studies like (Graham, 2000; Myers, 1984; Chittenden et. al, 1996; Michaelas et. al, 1999; Cassar & Holmes, 2003) provided that profitable companies present a low debt rate, whereas (Fama & French, 1998; McNutty et. al, 2002) concluded that debt does not concede tax benefits. The results of this study shows that debt had a great positive impact on profitability as shown in Table 3, even though Table 4 shows a much lower impact. This could be a result from the lack of indicators that could approximate idiosyncratic firm competencies such as organizational knowledge or instability of the monetary rate politics. The uncertainty of the local economy as well as external instable environment might also convey operational and financial risks that hinder the managerial planning and encourage the adoption of more risky debt politics. Hence, this result supports the formulated Hypothesis 3, that debt ratio positively affects firm profitability. Referring the firm age as a variable affecting the profitability, the study shows an insignificant result which implied that firm age does not affect the profitability of a firm. Therefore, Hypothesis 4 was not supported. In Conclusion, these findings have an interesting policy implication, which may add to the ongoing debate on the issues of firm structure and the firm profitability relations. The empirical findings of this study suggest that firm structure emerges as an important factor affecting profitability. However, the results indicate that some of the independent variables considered in this study have weak impacts on profitability. These findings should be useful to the managerial authorities to decide on the extent to which firm structure needs to be monitored and controlled. Specifically, the results appear to indicate that debt ratio is a useful factor influencing firm performance. Provided these finding are confirmed in national contexts, it is suggested that smoothing and successful firms improvement rely much on the effectiveness of the national level policies and plans for structural
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Journal of Economic & Administrative Sciences

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adjustment on specific actions. The validity and the generalization of the conclusions mentioned are pending future research in other industries or sectors that ratifies or refutes them. As for limitations, this study measured firm size by sales and the choice of firm age, debt ratio, ownership structure and firm size as the only independent variables affecting profitability was dictated by the available data sources. The database employed is unique and reliable consisting of the annual balance sheets, income statement, audit reports, and Jordanian shareholding company's guide. The measurements of profitability are consistent with those used in previous studies, using Return on Investment (ROI) and Return on Equity (ROE). Given the limitations mentioned above, there are several lines of research which could be undertaken as a follow up on this paper: (a) adding more variables to study the relationships between firm structure and profitability, (b) improved ways to measure / detect profitability as well as investigate it in different contexts, e.g., different time periods, economic cycles, or stock exchange, and (c) Examination of the impact of industrial market structure and firm conduct in a homogeneous sample.

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Dr. Abdulsalam Abu-Tabanjeh

June 2006

References Amato, L., and Wilder, R.P., (1985), The Effect of Firm Size on Profit Rate in U.S. Manufacturing, Southern Economics Journal, 52 (July), pp. 181-190. Amman Financial Market, Jordanian Shareholding Company's Guide, Jordan, 2004. Arnold, G., (1998), Corporate Financial Management (1st ed), U.K.: Financial Firms, Pitman Publishing. Bain, J., (1951), Relation of Profit Rate to Industry Concentration: American Manufacturing, 1936-1940, Quarterly Journal of Economic, 65, pp. 293324. Bain, J., (1956), Barriers to New Competition, Harvard University Press: Cambridge, M.A. Barney J., (1991), Firm Resources and Sustained Competitive Advantage, Journal of management, 17: pp. 99-120. Baumol, W.J., (1959), Business Behavior, Value, and Growth, (New York: MacMillan). Berk, J.B., (1997), Does Size Really Matter?, Financial Analysts Journal, 53, pp. 12-18. Bowels, R., (1984), Property Right and the Legal System, in : E, Dwhynes (ed.), GAT is Political Economy, New York, Basil Blackwell, pp. 187208. Brealey, R.A., Myers, S.C., (1992), Principios de Financas Empresariais Lisboa. Ed, Mcgraw Hill de Portugal. Cassar, G., and Holmes, (2001), Capital Structure and Financing of SMEs: Australian Evidence, Paper Presented to the Annual Conference of the Accounting Association of Australia and New Zealand, Cassar, G., and Holmes, (2003), Capital Structure and Financing of SMEs: Australian Evidence, Accounting and Finance Journal, 43 (2), pp. 123147. Chittenden, F., Hall, G., and Hutchinson, P., (1996), Small Firm Growth, Access to Capital Markets and Financial Structure: Review of Issues and Empirical Investigation, Small Business Economics, 8 (1), pp. 59-67. Chu, E. Y., and Cheah, K., (2004). The Determinants of ownership structure in Malaysia. The Malaysian Finance Association 6th Annual Symposwm 5-6 May. Langkawi Jabaatan Penerbitan dan Teknologe Media Universiti Utara Malaysia. Demsetz, H., (1973), Industry structure, marker Rivalry and Public Policy, Journal of Law and Economics, 16, pp. 1-19. Dhawan, R., (2001), Firm Size and Productivity Differential: Theory and Evidence From a Panel of US Firms, Journal of Economic Behavior and Organization, 44, pp. 269-293.
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Fama, Eugene, F., and Kenneth, R. French, (1993), Common Risk Factors in the Returns on Stocks and Bonds, Journal of Financial Economics, 33, pp. 3-56. Fama, E. F.; French, K. R. (1998), Financing Decision and Firm Value, The Journal of Finance, V. LIII, n 3. Freeman, J., and Lomi, A., (1994), Resource Positioning and Founding of Banking Co-operatives in Italy, in: J.A.C., Baum and Singh J.V. (edu.), Evolutionary Dynamics of Organizations (New York, Oxford University Press, pp. 259-263. Gedajlovic, E.R., D.M., Shapiro, and Buduru., B., (2003), Financial Ownership, Diversification and Firm Profitability in Japan, Journal of Management and Governance, Vol. 7, pp. 315-350. Gibson, B., (2002), Clusters of Financial Structure in Australian Small Firms, Small Enterprise Research: The Journal of Seaanz, 10 (1), pp. 5974. Hadlock, C.J.C. James, C.M., (2002), Do banks provide financial stock? The Journal of Finance, V.LVII, n3, June 2002. Hall, G., Hutchinson, P., and Michael, M., (2000), Industry Effects on the Determinants of Unquoted SME Capital Structure, International, Journal of the Economics of Business, 7 (3), pp. 297-312. Hecht, Peter Andrew, (2001), The Cross Section of Expected Firm (not Equity), Return. (June, 26, AFA, New Orleans. Jordan, J., Lowe, J., and Taylor, P., (1998), Strategy and Financial Policy in U.K. Small Firms, Journal of Business Finance and Accounting, 25 (1-2), pp. 1-27. Kumar, K.B. and R.G. Rajan, and L. Zingales, (2001), What Determines Firm Size, Working Paper, University of Chicago. Leledakis, G., I., Davidson and J. Smith, (2004), Does Firm Size Predict Stock Returns?, Evidence fro the London Stock Exchange, EFMA 2004 Basel Meetings Paper. Lincoln, J.R., M.L., Gerlach, and C.L., Ahmadjian (1996), Reiretsu Networks and Corporate Performance in Japan, American Sociological Review, Vol., 61, pp. 67-88. Locke, E., and Schweiger, D.M., Participation in Decision-Making, One more Look, in : L.L., Cummings and Staw. B.M., (edu.), Research in Organizational Behavior (Greenwich, 1979), pp. 265-339. Lopez Garcia, J, and Aybar-Arias, c., (2000), An Empirical Approach to the Financial Behavior of Small and Medium Sized Companies, Small Business Economic Journal, 12 (2), pp. 113-130. Mason, E., (1993), Price and Production Policies of Large Scale Enterprises, American Economic Review, 29, (Suppl. 29), pp. 61-74.
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June 2006

McNutty, J.J.;Yeh, T.D.; Schulze, W.S.C.; Lubatkin, M.H., (2002), Whats its Real Cost of Capital ? Harvard Business Review, V.N., Oct., 2002. Michaelas, N., Chittende, F., and Poutziouris, P., (1999), Financial Policy and Capital Structure Choice in U.K. SMEs; Empirical Evidence from Company Panel Data, Small Business Economics Journal, 12 (2), pp.113130. Morck, R., m., (2004), Corporate Governance and Family Control, Discussion Paper no. 1. Myers, S.C., (1984), The Capital Structure Puzzle, The Journal of Finance, 39 (3), pp. 575-592. Niman, N., (2003), The Evolutionary Firm and Cournots Dilemma, Cambridge Journal of Economics. Peltzman, S., (1977), The gains and Losses from industrial concentration, Journal of Law and Economics, 20: pp. 229-263. Porter, M., (1980), Competitive Strategy: Techniques for Analysing Industries and Competitors, Frce Press: New York. Porter, M., (1991), Towards a Dynamic Theory of Strategy, Strategic Management Journal, Winter Special Issue, 12, pp. 95-117. Rajan, R, and L. Zingales, (2000), The Firm as a Dedicated Hierarchy, A Theory of the Origins and Growth of Firms, NBER Working Paper No., W7546. Romano, C.A., Tanewski, G.A., and Smyrnois, K. X., (2001), Capital Structure Decision Making: A Model for Family Business, Journal of Business Venturing, 16 (3), pp. 285-310. Schweiger, D.M., and Lean, C.R., Participation in Decision-Making, In E.A., Locke (ed), Generalizing from Zoboratory to Field Studies (1986), pp. 147-166. Szymanski, D. M., Bharadwaj, S. G., Varadarajan, P. R., (1993), An analysis of the market share profitability relationship, Journal of Marketing, 57: pp. 1-18. White, L., (1982), The determinants of the relative importance of small business. Review of Economics and statistics, 64 (February): pp. 42-49.

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84 5991 4002 . .

95