Capital Structure and Firm Performance in the Financial Sector: Evidence from Australia

How does capital structure affect firm performance of Authorised Deposit-taking Institutions (ADIs) using explicitly Australian data? This paper investigates the relationship between capital structure and firm performance of Australian ADIs. Our findings show a significant and robust quadratic relationship between capital structure and firm performance of Australian ADIs. At relatively low levels of leverage an increase in debt leads to increased profit efficiency hence superior bank performance, at relatively high levels of leverage increased debt leads to decreased profit efficiency as well as bank performance. This can most likely be attributed to financial distress outweighing any gains made from managerial performance improving.