Advances in Economics, Business and Management Research, volume 145

8th International Conference on Entrepreneurship and Business Management (ICEBM 2019) UNTAR

The Effect of Capital Structure and Firm Size on Firm

Value Through Profitability as Intervening Variable
Khairina Natsir1*, Yusbardini Yusbardini2
Faculty of Economics and Business, Universitas Tarumanagara, Jakarta, Indonesia1,2
*Corresponding author. Email: [email protected], [email protected]

ABSTRACT
The aim of this study was to investigate the effect of capital structure and firm size on firm value through
profitability as an intervening variable. This study was conducted among manufacturing companies in various
industrial sectors in Indonesia Stock Exchange (IDX) during the period 2013-2017. The dependent variable was
the value of the firm measured by PBV. The independent variables were the capital structure measured by DER
and firm value measured by ln (total assets). Profitability as intervening variable was measured by ROA. This
study used secondary data extracted from the financial statements of 17 public companies. Analysis was
conducted using multiple regression of panel data, path analysis and sobel test. The results showed that firm
size and capital structure had significant effect on profitability, while firm size, capital structure and profitability
had significant effect on firm value. The results also showed that profitability was able to mediate the effect of
firm size and capital structure on firm value.
Keywords: Firm Value, Profitability, Capital Structure, Firm Size, Intervening Variable
The phenomenon that occured in this various industrial
1. INTRODUCTION sectors arises our interests to investigate the factors
affecting the value of the company (or firm) in these
In this modern times, human beings’ needs are not only sectors.
limited to meeting the basic needs, but also extended to the The up and down in stock prices reflects the value of the
secondary needs that can support their activities and welfare, firm. Low stock prices indicate the low value of the firm,
such as the need of vehicles, electronic goods, and travelling. which means the low interest of investors to invest their
Companies that are members of various industrial sectors in funds in such firm. Conversely, high stock prices reflect
the Indonesia Stock Exchange (IDX) are engaged in investors’ confidence in the firm, because it is considered
industries that support these needs. The various industrial having high value.
sectors meant in this study are the nine industrial sectors For firms that have already gone public, the value of the
listed on the IDX. These sectors include automotive and firm will be reflected in the market value of its stock
components, textiles, electronics, and others. Table 1 shows price. The firm's high stock price will cause its value to
the growth of the average stock prices of various industrial
increase. Maximizing the value of the firm is the main
sectors over the past six years.
goal of every firm, because high firm value means
Table 1. The growth of stock prices among various
increasing the owners’ prosperity [2]. The higher the
industrial sectors value of the firm will further increase the investors’
JKMISC interest to invest, so the firm can grow bigger or expand
EoY PRICE(IDR) INCREASE/DECLINE I/D with the capital invested by investors.
(IDR) (%) Research about firm value has been done a lot, but they
2013 1.205,01 (131,51) (9,84) Decline haven’t produced consistent results yet. Some researches
2014 1.307,07 102,06 8,47 Increase showed that profitability has positive and significant
2016 1.057,28 (249,79) (19,11) Decline impact on firm value, which have been conducted by [3]
2016 1.370,63 313,35 29,64 Increase and [5]. Research conducted by [6] and [7] showed that
2017 1.381,18 10,55 0,72 Increase
2018 1.394,43 13,25 0,96 Increase
profitability did not have significant effect on firm value.
Furthermore, another research showed positive and
The years of 2013 and 2015 were the worst years for these significant relationship between capital structure and
sectors due to an extraordinary decline in average stock firm value [6][8]. On contrary, based on the research
prices. In 2016, the situation improved with an increase of results by Lubis et al. [9], capital structure did not affect
29.64%, but unfortunately the increase in the following firm value. Research conducted by [3] and [10] showed
years was only a very small figure (below 1%), even though significant effect of firm size on firm value. In contrast,
companies in these sectors were producing life-support the results from the research by [8] showed that firm size
products that were very important for community activities had no significant effect on firm value.
[1].

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 Advances in Economics, Business and Management Research, volume 145

Since there are still gaps in previous research on the between the use of external and internal capital. The
factors that affect firm value, this study aimed to provide previous study showed that capital structure has positive
empirical evidence about the effect of firm size and effect on profitability [18]
capital structure on firm value. The novelty of this study H2: Capital structure has positive effect on profitability
is the use of profitability as a variable that intervenes the
effect of capital structure and firm size on the value of
manufacturing companies in various industrial sectors 2.1.3 The Effect of Firm Size on Firm Value
listed on the IDX during 2013-2017.
Firm size is assessed from the total assets that can be used
to seize profitable investment opportunities, such as
expanding prospective of market share. The research
2. THEORETICAL BACKGROUND conducted by Hardinis [19] showed that firm size has
Firm value is the selling value of a firm as an active business positive effect on firm value.
[11]. Any increasing in stock price will cause an increase in H3: Firm size has positive effect on firm value
the value of the firm. High firm value illustrates that the firm
performance is good and can build some trust to investors
about the prospect of the firm [5]. 2.1.4 The Effect of Capital Structure on Firm
Profitability shows the ability of a firm to generate profits Value
for investors and is generally reflected in the financial
condition of the firm [5]. Another perspective said about Funding the firm operations by using debt can save tax
profitability as the ratio which can be used to determine the obligations, so that shareholders will get a greater net profit.
firm's ability to generate profit [12]. The implementation of However, usually the firm will prioritize the payment of
signaling theory provides the information about obligations to creditors rather than the generation of
profitability or the amount of profit obtained from the assets profitability to investors, so this can reduce investors’
used. confidence to invest in the firm. Thus, the value of the firm
According to Riyanto [13], firm size is a description of the will decrease. Research conducted by Faidah [20] showed
size of a firm that is shown in total sales, average sales, and that capital structure has negative and significant effect on
total assets. The size of this firm generally influences firm value.
investors' decisions to invest [14]. H4: Capital structure has negative effect on firm value
Capital structure is defined as a balance in using the firm
capital and foreign capital. The firm capital is obtained from
retained earnings and also share ownership, while foreign 2.1.5 The Effect of Profitability on Firm Value
capital can be obtained from the debt [15]. The trade-off
theory states that there is a balance between the benefits The growth of ROA shows that the firm prospects are
derived from debt-financing and the possibility of problems getting better, because it means that there is a potential for
arisen from potential bankruptcy [16]. increased profits by the firm. If the demand of firm shares
experiences an increase, it will indirectly lead to an increase
in the price of these shares in capital market. Previous
2.1 Research Hypothesis research showed that profitability had positive and
significant effect on firm value [21]..
H5: Profitability has positive effect on firm value
2.1.1 The Effect of Firm Size on Profitability
Firm size explains how effective a firm in using working 2.1.6 The Effect of Firm Size on Firm Value with
capital that comes from the firm assets in order to achieve Profitability as Intervening Variable
maximum firm value. By having a large resources, the firm
can carry out the desired investment activities with the aim Firms with large assets will try to get large profits by
of expanding market share, so that the firm profits will optimally utilizing their assets. The larger the size of the
increase. The research conducted by Laksitaputri [17] firm will tend to increase investors’ trust to invest in the
showed that firm size has positive effect on profitability. firm. Previous research showed that profitability can
H1: Firm size has positive effect on profitability significantly mediate the magnitude of firm size effect on
firm value [20] [17].
H6: Profitability mediates the effect of firm size on firm
2.1.2 The Effect of Capital Structure on value
Profitability
Capital structure is the company's strategy for financing
operations and overall growth by utilizing various sources
of fund. firms can increase profits by making a balance

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2.1.7 The Effect of Capital Structure on Firm 2. Fixed Effect, is used whenever there is possibly a
Value with Profitability as Intervening Variable problem of omitted-variables, such as a change in the
intercept in time-series or cross-section data. The model
The use of debt to increase market share can cause the is formulated as follow: Yit = α1 + α2D2 + ..+ αnDn +
increase of profitability. This is consistent with the balance β1X1it + .+ βnXnit + εit, (2)
theory and is supported by Laksitaputri’s research [17]. 3. Random Effect. This model increases the efficiency in
When profitability increases, it will lead to an increase of the least square process by calculating the error of time-
capital structure. And then, the value of the firm will also series and cross-section data. The model is formulated
increase, since it gives a positive signal to investors about as follow: Yit = α0+ β1X1it + ... + βnXnit + εit+ μit (3)
good firm performance. Previous research showed that
profitability is able to mediate the effect of capital structure The selection of the best model from the three estimation
on firm value. models mentioned above was conducted by the Chow-Test,
H7: Profitability mediates the effect of capital structure on the Housman-Test, and the Lagrange Multiplier-Test.
firm value

3.3.2 Path Analysis and Sobel Test

3. RESEARCH METHOD
"Path analysis is a technique for analyzing the cause and
effect relationships occured in multiple regression if the
independent variable affects the dependent variable directly
3.1 Population and Sample and indirectly "[23]. Sobel test is used to show the
significant impact of the mediating variable generated on
Population in this study was manufacturing firms in various
the path analysis. The sobel test is conducted by testing the
industrial sectors listed in the Indonesia Stock Exchange
power of the indirect effect of the independent variables X1
(IDX) during the period 2013-2017. As sample selection
and X2 on the dependent variable Y through the mediating
method, we used the purposive sampling, of which 17 firms
variable Z. The indirect influence is calculated by
were acquired as samples.
multiplying the paths [28] as follows:
X1  Z (a), Z  Y (b), X2  Z (c), Z
 Y (d).
3.2 Operationalization of Variables
The standard errors of indirect effect sab and scd are
Table 2. The Definitions of Variable Operationalization
Variable Definition Proxy Measurement Scale calculated by using the formulas as follows:
Firm Value The ratio PBV 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑝𝑝𝑝𝑝𝑝𝑝 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 Ratio
between market 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉𝑉 𝑝𝑝𝑝𝑝𝑝𝑝 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎
[21] 𝑠𝑠𝑎𝑎𝑎𝑎 = �𝑏𝑏 2 𝑠𝑠𝑎𝑎2 + 𝑎𝑎2 𝑠𝑠𝑏𝑏2 + 𝑠𝑠𝑎𝑎2 𝑠𝑠𝑏𝑏2 (path 1) and 𝑠𝑠𝑐𝑐𝑐𝑐 =
prices and book

Profitability
prices
The company’s ROA 𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 Ratio
�𝑑𝑑 𝑠𝑠𝑐𝑐 + 𝑐𝑐 𝑠𝑠𝑑𝑑 + 𝑠𝑠𝑐𝑐 𝑠𝑠𝑑𝑑 (path 2)
2 2 2 2 2 2
(4)
[22]
capability to earn 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
profits by
optimizing the
utilization of
t-statistics values are calculated by using the following
𝑎𝑎𝑎𝑎 𝑐𝑐𝑐𝑐
Firm Size
company assets
Size of company SIZE Ln (Total Assets [2] Ratio
formula: 𝑡𝑡 = and 𝑡𝑡 = . (5)
𝑠𝑠𝑎𝑎𝑎𝑎 𝑠𝑠𝑐𝑐𝑐𝑐
assets
Capital The ratio DER 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 Ratio
[6]
Structure between the use 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸
of own capital
and the use of
foreign capital 4. RESULT AND DISCUSSION
The dependent variable is firm value, while the independent
variables are capital structure and firm size, along with
profitability as an intervening variable.
4.1 Model Selection Results
The selection of model 1 and model 2 was conducted by
using the Chow-Test, Housman-Test and LM-Test. The
3.3 Data Analysis results were as follows:

Table 3. Model Selection Results

3.3.1 Multiple Linear Regression of Panel Data Chow
Cross
Hausman
Cross Section
Lm (cross
Section
Best
Model
section F. Random Prob. Breusch Selected
Three methods used in modeling panel data [22] are shown Prob Pagan Prob)
as follows: Model 0,0000 0,7312 0,0000 Random
1 effect
1. Common Effect, is used when there is no differences Model 0,0000 0,2563 0,0000 Random
between individuals and differences between time, due 2 Effect
to having the same intercept (α) and slope (β). The
model is formulated as follow: Yit = α0 + β1 X1it +
β2 X2it + β3 X3it + … + βn Xnit + εit (1)

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Based on the results of the Chow-Test, Hausman-Test and

LM-Test, the best estimation obtained for both model 1 and
model 2 were the Random Effect model as follows:
Model 1: ROAit = α0+ β1SIZE1it + β2DER2it + ε1t+ μ1t (6)
Model 2: PBVit = α1+ β3SIZE1it + β4DER2it + ε2t+ μ2t (7)

4.2 Test of Goodness of the Model

The determination test resulted from Model 1 showed that Fig. The paths coefficients of the model
capital structure and firm size had a contribution of 4.7% in
explaining the profitability (ROA), while Model 2 showed
that capital structure, firm size, and profitability contributed
only 37% in explaining PBV.
4.5 The Results of Sobel Test in Detecting the
Effect of Mediating Variable
4.3 Statistical T-Test Results The sobel test result is showed in Table 7 below:
For Model 1, the results of the statistical t-test were as
follows: Table 7. Sobel Test Result
Indirect effect Standard T_statstic Result
error of (calculated)
indirect effect
Table 4. Results of Statistical t-tests on Profitability (ROA) Path SIZE→ROA = 3.634902 (a) Sab = 0,426283
𝑡𝑡 =
𝑎𝑎𝑎𝑎
= 2,823255
Significant
1 ROA→PBV = 0.331097 (b) 𝑠𝑠𝑠𝑠𝑠𝑠
Variable Coefficient Std. Error t-Statistic Prob. Result Path DER→ROA=-0.514368 (c) Scd = 0,051206 𝑐𝑐𝑐𝑐 Significant
LOG(SIZE) 3,634902 1,246422 2,916270 0.9946 Significat 2 ROA→PBV = 0.331097 (d) 𝑡𝑡 =
𝑠𝑠𝑠𝑠𝑠𝑠
= −3,325893
LOG(DER) -0,514368 0,147984 -3,475843 0.0008 significat

From Table 4, it can be seen that SIZE had positive and

significant effect on profitability (ROA), while DER had 4.6 Discussion
significant effect on profitability in negative direction.

For Model 2, the results of t-test were as follows: 4.6.1 Test of the effect of firm size on
profitability
Table 5. Results of Statistical t tests on Firm Value (PBV).
Variable Coefficient Std. Error t-Statistic Prob. Result Based on the results in Table 4, firm size (SIZE) had
LOG(SIZE) 3.163801 0.910205 3.475923 0.0008 Significant
LOG(DER) 0.315230 0.094111 3.349567 0.0012 Significant positive and significant effect on profitability (ROA). This
LOG(ROA) 0.331097 0.0.027794 11.91261 0.0000 Significant finding fits the research of [17], which stated that firm size
has positive effect on profitability. The consequence of this
From the results presented in Table 5, it can be seen that research is that management needs to improve its
firm size (SIZE), capital structure (DER), and performance in the quality and quantity of all assets as an
Profitability (ROA) had positive and significant effect on indicator of firm size, so that these assets can contribute
firm value (PBV). maximally to increase the value of the firm.

4.4 Hypothesis Test Results of Path Analysis 4.6.2 Test of the effect of capital structure on
profitability
In this study, the effect of capital structure and firm size on
firm value was mediated by profitability. The path From the results of t-tests in Table 4, capital structure (DER)
coefficients for both models are displayed as follows: had significant effect but in negative direction on
profitability (ROA). This result was contradictory to the
Table 6. Path Coefficients Summary research of [18], which stated that capital structure has
Variable Coefficient Std. Error t-Statistic Prob. Result
LOG(DER)→LOG(ROA) -0.514368 0.147984 -3.475843 0.0008 significant positive and significant effect on profitability. However,
LOG(SIZE)→LOG(ROA) 3.634902 1.246422 2.916270 0.0046 significant
LOG(SIZE)→LOG(PBV) 3.163801 0.910205 3.475923 0.0008 significant this research is consistent with the research conducted by
LOG(DER)→LOG(PBV)
LOG(ROA)→LOG(PBV)
0.315230
0.331097
0.094111
0.027794
3.349567
11.91261
0.0012
0.0000
significant
significant [17] stating that capital structure (DER) significantly affects
profitability. The implication from this result is that
Based on Table 6. above, the path coefficients can be management is expected to always strive in improving the
described as follows: performance of debt management in order to contribute
better in enhancing firm values. In this case, management
must strive to improve its competence in managing debt, so
that the firm's capital structure is still in the optimal range.

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4.6.3 Test of the effect of firm size on firm value 4.6.7 Test of the effectiveness of profitability in
mediating capital structure on firm value
The results of t-tests in Table 5 showed that firm size (SIZE)
had significant effect in positive direction on firm value The Sobel test result in Table 7 Path 2 revealed that
(PBV). This result is consistent with the research conducted profitability (ROA) had significant effect in mediating the
by [19], which showed that firm size has significant effect relationship between capital structure and firm value. This
on firm value in positive direction. On contrast, the research result is on contrary to the research conducted by [26],
conducted by [17] showed that SIZE does not significantly which stated that profitability cannot mediate the effect of
affect firm value. The consequence of this research is that capital structure on firm value. However, this research is
management must always be active in improving the consistent to the research conducted by [20] stating that
performance of firm assets management as an indicator of profitability can function as a mediator between capital
firm size, so that these assets can contribute to increasing structure and firm value. The result showed that profitability
the value of the firm. is capable to mediate the effect of capital structure and firm
size on firm value. The implication of this result is that
capital structure and firm size must be optimized in order to
4.6.4 Test of the effect of capital structure on generate profit. High profit will increase the value of the
firm value firm. In other word, good capital structure and large firm
size have not been able to increase the value of the firm, if
The results of t-test in Table 5 showed that capital structure the firm profitability is in poor position. Therefore, it is
(DER) significantly affected firm value (PBV) in positive recommended that management of the firms in various
direction. This result is conform to the research of [19], industrial sectors in IDX must manage their assets in such a
which stated that capital structure has positive and way to optimize the capital structure in order to generate
significant effect on firm value. maximum profit. Firms that are able to maintain the
achievement of high profitability will be trusted by
investors, so that the value of the firm will always be high.
4.6.5 Test of the effect of profitability on firm
value
5. CONCLUSION
The results of t-test in Table 5 showed that profitability
(ROA) had significant effect in positive direction on firm After conducting the research procedures starting from
value (PBV). This findings fits the research conducted by selecting the sample, selecting the model that best suits the
[24] and [25], which stated profitability has positive and data in the sample, as well as conducting a series of
significant effect on firm value. The logical consequence of statistical tests in accordance with the selected model and
this study is that management must continue to strive in research method, the conclusions of this study can be
increasing net income, because high profit indicates that the obtained as follows:
company has good prospect in the future. So, it can 1. Firm size has positive and significant effect on
influence the investors to increase the demand for their profitability.
shares, which will ultimately increase the firm value. 2. Capital structure has negative and significant effect on
profitability.
3. Firm size has positive and significant effect on firm
value.
4.6.6 Test of the effectiveness of profitability in
4. The capital structure has positive and significant effect
mediating the effect of firm size on firm value on firm value.
5. Profitability has positive and significant effect on firm
The Sobel test result in Table 7 Path 1 revealed that
value.
profitability (ROA) had significant effect in mediating the
6. Profitability can significantly mediate the effect of firm
relationship between firm size and firm value. It implied
size on firm value.
that profitability could mediate the value of the firm that is
7. Profitability can significantly mediate the effect of
influenced by firm size. This means that the greater the firm
capital structure on firm value.
size is, the greater the firm’s opportunity to increase its
profitability, which in turn will increase investors’
confidence to the firm. This result is consistent with the
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