The effects of debt ratios on firms’ financial performance in two financial systems

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This study shows the effects of firms’ debt ratios on their financial performance and compares them between the bank- and market-based financial system. Based on two theories and some empirical studies, a negative relationship is expected between the level of debt and firms’ financial performance. It is expected to be more negative in the market-based financial system, because of strong relationships between firms and banks in the bank-based financial system. The analyses show that the non-current liabilities to total assets ratio and the total liabilities to total assets ratio in the market-based financial system have a more profound negative effect on firms’ return on assets than in the bank-based financial system. The current liabilities to total assets ratio does not have such a significant effect on the return on assets. A comparison of the effects of the level of debt on firms’ financial performance between the two financial systems cannot be conducted if the return on equity or Tobin’s Q is the financial performance indicator, due to insignificant or positive results. These findings are based on a data sample of German and Japanese firms for the bank-based financial system and UK and US firms for the market-based financial system.
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