DIRE DEWA UNIVERSITY

SCHOOL OF GRADUATE STUDIES

MASTER OF BUSINESS ADMINISTRATION PROGRAM FINANCIAL MANAGEMENT (MBA-721)
CAURSE
GROUP ASSIGNMENT
TERM PAPAR BASED ON

The Impact of Capital Structure on Financial Performance of Commercial

Banks in Ethiopia

SUMMITED TO :- NETSANET SHIFERAW (ASSI. PROF)

PREPARED BY:-
1. Girma Tefera Tilahun -ID No. DDU1400961
2. Biniyam Yitbarek -ID No. DDU1400966
3. Senayit Alemayehu -ID No. DDU1400957
4. Zelalem Haile -ID No. DDU1400958
5. Sinidu Salamon -ID No DDU1300262

March, 2023, Chiro, Oromia, Ethiopia

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 1. Introduction
The capital structure of a firm describes the way in which a firm raised capital needed to establish and expand
its business activities. It is a mixture of various types of equity and debt capital a firm maintained resulting from
the firms financing decisions. In one way or another, business activity must be financed. Without finance to
support their fixed assets and working capital requirements, business could not exist.
Capital structure decision is the mix of debt and equity that a company uses to finance its business (Damodaran,
2001). Capital structure has been a major issue in financial economics ever since Modigliani and Miller showed
in 1958 that given frictionless markets, homogeneous expectations; capital structure decision of the firm is
irrelevant. Modigliani and Miller (M & M) (1958) wrote a paper on the irrelevance of capital structure that
inspired researchers to debate on this subject. This debate is still continuing. However, with the passage of time,
new dimensions have been added to the question of relevance or irrelevance of capital structure. MM declared
that in a world of frictionless capital markets, there would be no optimal financial structure (Schwartz &
Aronson, 1967). This theory later became known as the “Theory of Irrelevance”. In MM’s over-simplified
world, no capital structure mix is better than another. MM’s Proposition-II attempted to answer the question of
why there was an increased rate of return when the debt ratio was increased. It stated that the increased expected
rate of return generated by debt financing is exactly offset by the risk incurred, regardless of the financing mix
chosen. The relationship of the capital structure decisions with the firm performance was highlighted by a
number of theories mainly, the agency theory, information asymmetry theory, signaling theory and the tradeoff
theory. The debt finance act as a controlling tool to restrict the opportunistic behavior for personal gain by
managers. It reduces the free cash flows with the firm by paying fixed interest payments and forces managers to
avoid negative investments and work in the interest of shareholders (Jensen and Meckling (1976)). The
asymmetric information theory states that the firm’s manager (insiders) has more information about their firm
compared to the outside investors. The well informed managers try to send positive information to the market or
ill-informed investors to increase the firm value. Signaling theory states that managers have incentives to use
various tools to send signals to the market about the difference that exist between them and weaker firms. One
of the key tools to send these signals is the use of debt. Employment of debt in capital structure shows that
managers have better expectations about the future performance whereas equity sends a bad news about the firm
performance in the future (Ross (1977)). In broader sense, financial performance refers to the degree to which
financial objectives being or has been accomplished or it is used as a general measure of a firm's overall
financial health over a given period of time, and can be used to compare similar firms across the same industry.
The purpose of this paper was to investigate the impact of capital structure on financial performance of selected
commercial banks in Ethiopia over the past five (5) year period from 2011 to 2015 using secondary data
collected from financial statements of the commercial banks. Data was then analyzed on quantitative approach
using multiple regression models. The study used two accounting-based measures of financial performance (i.e.
return on equity (ROE) and return on assets (ROA)) as dependent variable and five capital structure measures
(including debt ratio, debt to equity ratio, loan to deposit, bank’s size and asset tangibility) as independent
variable.Capital structure or resources must be needed, the main thing is that how can the business organizations
get that capital? In the other words what is the source of finances? Capital structure decision should answer this
question. An appropriate capital structure is important not only because of the need to survival and growth or
maximizing returns of business organizations, but also because of the impact of such decision on firm’s ability
to deal with its competitive environment.

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 2. Main body of paper
Purpose of this study was to examine the relationship between capital structure and financial performance of
listed licensed commercial banks in Ethiopia. Panel data were used to conduct the empirical study which were
extracted from the financial reports of five selected banks for the period from 2011 to 2015. This study consists
seven variables; return on Assets (ROA) and Return on Equity (ROE) as dependent variables, and measures of
firm‘s financial performance. Although there is no unique measurement of firm performance in the literature,
ROA and ROE were chosen because they are important accounting based and widely accepted measures of
financial performance. The independent (explanatory) variables in this study are the Debt ratio (DR), debt/
equity ratio, loan to deposit, size and tangibility. In the field of finance, various financial ratios; such as return
on assets (RoA), return on equity (RoE) and return on Asset (RoA) could be used as a proxy measure of
companies’ financial performance.
2.1. Financial Performance
Financial performance evaluation is a subjective measure to assess firm’s usage of assets from its primary mode
of business and generation of revenues. It also includes net operating income (NPI), earnings before interest and
taxes (EBIT), profit after taxes (PAT) and net asset value (NAV). This also measure of how efficiently a bank
uses its assets and other resources to generate revenues, which intern firm’s overall financial condition for a
given period, and can be used to compare industries with each other’s. Finance and its function play a very
significant role in determining the profitability and stability of the business.
Measures of financial performance take a variety of forms. These measures differ from each other on several
dimensions, and many issues concern the choice of which particular financial measure to employ. For example,
measures may be absolute, return-based, internal, and external, a level for a single period, a mean or a growth
rate over several years, or a variability about a mean or a trend. The following measures are often used to
measure financial performance: Profit margin ,Return on assets , Return on equity , Earnings per share ,
Price/Earnings ratio , Excess value , Return on capital , Economic value added, all mentioned measures were
considered in order to determine the most appropriate measures of financial performance.

Tpes of Capital Structure

The meaning of Capital structure can be described as the arrangement of capital by using different sources of
long term funds which consists of two broad types, equity and debt. The different types of funds that are raised
by a firm include preference shares, equity shares, retained earnings, long-term loans etc. These funds are raised
for running the business.
Equity Capital
Equity capital is the money owned by the shareholders or owners. It consists of two different types
a) Retained earnings: Retained earnings are part of the profit that has been kept separately by the organisation
and which will help in strengthening the business.
b) Contributed Capital: Contributed capital is the amount of money which the company owners have invested at
the time of opening the company or received from shareholders as a price for ownership of the company.
Debt Capital
Debt capital is referred to as the borrowed money that is utilised in business. There are different forms of debt
capital.
1. Long Term Bonds: These types of bonds are considered the safest of the debts as they have an extended
repayment period, and only interest needs to be repaid while the principal needs to be paid at maturity.

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 2. Short Term Commercial Paper: This is a type of short term debt instrument that is used by companies to
raise capital for a short period of time
Optimal Capital Structur

Optimal capital structure is referred to as the perfect mix of debt and equity financing that helps in maximising
the value of a company in the market while at the same time minimises its cost of capital.
Capital structure varies across industries. For a company involved in mining or petroleum and oil extraction, a
high debt ratio is not suitable, but some industries like insurance or banking have a high amount of debt as part
of their capital structure.
Financial Leverage
Financial leverage is defined as the proportion of debt that is part of the total capital of the firm. It is also known
as capital gearing. A firm having a high level of debt is called a highly levered firm while a firm having a lower
ratio of debt is known as a low levered firm.

The internal factors which are affecting capital structure are as follows:-
1. Cost of capital :
It is a process of raising the funds which involves the cost in planning the capital structure, the use of
capital should be capable of earning revenue to meet the cost of capital. There are changes in this
because of two reasons:
- Interest rates are less than dividend rates.
- Interest paid on borrowed capital is an allowable for income tax purposes.
2. Risk factor
Company raising the capital by borrowed capital, as it accepts the risk in two ways:
- Company maintains the payment of interest as well as installments of borrowed capital at predecided
rate and time without being concerned about the profits and losses.
- Borrowed capital is secured capital in the case where the company fails to meet the contract done with
the lenders of the money.
3. Control Factor
These factors have been considered by the private companies while raising additional funds and
planning the capital structure. In this company plans to raise long term funds by issue the equity and
preference shares. It doesn't have relation with the borrowed capital.

The external factors which are affecting the capital structure are as follows:-
1. Economic Conditions:
If the economy is in state of depression, preference is given to equity form of capital which involves less
amount of risk but it is avoided in some cases where the investor is not ready to take the risk. In this case
company go on with the borrowed capital.
2. Interest Rates level :
Form of borrowed capital will be delayed if the funds are available in high rates of interest but raising is
not favourable.
3. Lending Policy :
If policy is hard to understand and not flexible then it is good to go with the borrowed capital.
4. Taxation Policy:
This policy should be viewed from both the sides from individual as well as corporate perspective. From
the individual point of view both interest as well as dividend will be taxable in hands of lender.
The general factors which are affecting the capital structure are as follows:-
1. Company constitution :

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 In companies capital structure is very important as many companies treat it as a different entity. Private
companies considers control factor as important whereas public company finds cost factor more
important.
2. Company characteristics :
Characteristic of the company which describe its infrastructure as size, age and credit plays pivotal role
in deciding the capital structure. Smaller or newly started companies depend more on equity capital as
they can do limited bargaining. Large companies or having good credit companies are in the position to
get funds from the source of their choice.
3. Stability of Earnings :
Fluctuations occurs if the sales and earnings of the company are not stable enough over a period of
time. Stable company can take the risk.
4. Attitude of the Management:
Attitude plays an important role as if the attitude is conservative then control factor gets the importance
and if it is liberal then cost factor gets important.
2.2. Capital Structure and Financial Performance
This section summarizes experiential discoveries of various researchers who have analyzed the impact of CS on
market value and profitability. Although financial performance can be indicated by variety of measures, the
current paper focuses on five measures namely return on Asset, Return on Equity, Earnings per Share, Market
Value and Tobin’s Q ratio.
2.2.1. Return on Asset (ROA)
Return on assets (ROA) is a popular and well-known ratio. It is used by analysts to measure the profitability of
a firm and by researchers to make predictions on financial variables and events. ROA in their investigation of a
firm’s financial position, performance, and future prospects. Gibson (1987) surveyed Chartered Financial
Analysts about the importance of many financial ratios.it computed as:
Return on Assets=Total Asset /net Income
ROA is one of the most commonly used measures of firms’ performance is ratio of its operating profit to total
assets popularly known as RoA (Abor, 2005 & 2007;
Adewale & Ajibola, 2013; Azhagaiah & Gavoury, 2011; Ebaid, 2009; Pandey, 2004; Saeedi & Mahmoodi,
2011; San & Heng, 2011; Zeitun & Tian, 2007; Oke, Saheed, & Quadri, 2019). Authors have carried their
research work in different countries and with different industries by employing various capital structure
variables. Outcomes of various studies reveal contradictory results pertaining to relation of RoA and CS
variables. Ross (1977) has argued profitable firms can afford to mitigate the interest obligation of borrowings
which indirectly provide signal towards firms’ financial health. Borrowings further reduces tax liability and
therefore results into higher profitability hence findigs suggest positive impact of debt financing on RoA.
(Adewale & Ajibola, 2013; Mujahid & Akhtar, 2014; Nirajini & Priya, 2013). On the contrary, researchers such
as Pouraghajan and Malekain (2012), Riaz (2015), Velanampy and Niresh (2012), and Vijaykumar and
Karunaiathal (2014) have deduced inverse relationship between RoA and CS (measured by Debt-Asset Ratio).
Probable reasons for such consequence could be inefficient utilization of funds, higher cost of interest and cost
of financial distress. Eriotis, Frangouli and Neokosmides (1997) have used economic measure of profitability to
assess the impact of financial structure on it. They have concluded inverse relationship between debts financing
on profit margin.
Authors have used long-term debt ratio and short-term debt ratio as CS variables as maturity of debt is an
important moderator (Abor, 2005 & 2007; Ahmad, Abdullah & Roslan, 2012; Chavali & Rosario, 2018; Emin,
2016). Longterm debt is having higher cost associated and require securities to be pledged whereas short term
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borrowings are available at lower cost and without mortgage. Due to such differences long-term debt has
negative impact on RoA (Abor, 2007; Emin, 2016; Kodongo, Mokoteli & Maina, 2014; Nawaz & Ahmad,
2017; Oke, et. al., 2019) and short-term debt improves profitability (Abor, 2005; Goyal, 2013; Oke, et. al.,
2019). Table 1 provides summarized view of various studies conducted by taking RoA as dependent variable.
2.2.2. Return on Equity (ROE)
Return on equity measure the amount of income generated from equity financing of assets employed by
dividing profit (earning) before tax (EBT) by total owners’ equity of a company. Here, R0E calculated by
utilizing Earning before tax instead of earning before tax and interest since interest expenses are not presented
separately in Ethiopia’s Metal and Engineering sector companies’ profit and loss statements. Therefore,
ROE= Earnings before Tax (EBT) / Total owners’ Equity

A high percentage of R0E indicate better performance while low percentage represents the reverse. Chin Ai Fu
(1997), Abor (2005), Carvaliho and Edison (2007), Abu rub (2012), Ahmed et al. (2012) and Osuji and Odita
(2012) also used R0E to measure performance.
Various stake holders use different indicators to analyses financial health of organization. For equity
shareholders, RoE is one of the key determinants of profitability and it indicates return generated on equity
funds. RoE has been used by scholars to measure how much value addition is made by managers towards the
wealth of shareholders. (Abor, 2005; Azhagaiah & Gavoury, 2011; Gill, Nahum & Mathur, 2011; Krishnan &
Moyer, 1997; Majumdar & Chhibber, 1999). Modern corporate functions on agency principle i.e. funds are
provided by one party and management and decisions are taken by other. Such agency relationship creates a
possibility of conflicting interests of creditors and owners (Jensen & Meckling, 1976). Debt holders expect
regular interest payment and principle, so they prevent organizations to take up risky but profitable projects. On
the other hand, equity providers are risk takers who expects higher return to compensate the risk. Debt financing
improves profitability as tax advantage and lower cost of debt improves earnings available to equity holders
(Myres, 1984). Like RoA, empirical findings relating to RoE and CS are also of mix opinion. Adewale and
Ajibola (2013) have concluded a strong positive impact of debt ratio on RoE which further supported by Danis
et al., (2014); Ebrati, Emadi, Balasang and Safari (2013); Fosu (2013). As against this, pecking order theory
pioneered by Donaldson (1961) and modified by Myres and Majluf (1984) suports contradictory view. The
notion of inverse relation between RoE and borrowings is argued by Vijaykumar and Karunaiathal (2014);
Singh and Singh (2016); Puwanenthiren (2011); and Pouraghajan and Malekain (2012) based on their empirical
research work on various industries and countries.
Considering debt maturity as mediating factor, Abata, Migiro, Akande and Layton (2017) have argued that
long-term debt has strong negative impact on RoE. Model based study carried by Emin (2016); Kodongo, et al.,
(2014); Salim and Yadav (2012); Shubita and Alsawalhah (2012); and Twairesh, (2014) concludes negative
impact of both long-term as well as short-term borrowings on RoE. Abor (2005 & 2007) have tested the relation
between CS and RoE for large size as well as SMEs and concluded that long-term debt has unfavorable impact
on RoE whereas short-term debt has positive relation with RoE. Such findings were also validated by Gill,
Nahum and Mathur (2011); Goyal, (2013); Tailab, (2014) who reported similar results. In below table 1 view of
relation between RoA & RoE and CS variables has been portrayed RoE & which highlights major findings
along with moderating variables used by researcher.
2.2.3. Debt ratio (DR)
Leverage measured by Debt ratio; total liabilities (short term liabilities and long term liabilities) by total assets
used as one of the independent variables to represent capital structure. This ratio reveals that how much

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percentage of the total assets is financed by debt financing and also viewed as a proxy for what is left for
owners in case of liquidation. This ratio stated as; Dr = Total Liabilities Total Assets Debt ratio is more familiar
as a measure for Leverage in empirical researches of capital structure studies. Among those Rajan and Zingales
(1995), Booth et al. (2001), Gaud et al. (2003), Reimoo (2008), Daniel (2011), Bayeh (2011), and Netsanet
(2012) used it to measure leverage.
2.2.4. Bank Size
Bank size financial performance factor,bank size included as a control variable. And to achieve the normal
distribution and linearity Size of a company measured by natural logarithm of total assets. SZ= natural
logarithm (Total assets) Nguyen and Ramachandran (2006), Shah and Hijazi (2004), Adenkule and Sunday
(2010), Daniel (2011), Bayeh (2011) and Osuji and Odita (2012) similarly used natural logarithm of total assets
to measure company size
2.2.5. Asset Tangibility
Asset tangibility (Tang); Asset tangibility has been found in most literature of capital structure that affects
company’s performance and included as a control variable which is measured by dividing Net fixed assets to
Total assets. This is written as; Tangibility= FA/ TA Assets It has also been used by Chen and Hammes (2003),
Han-suk Song (2005), Zeitun and Tian (2007), Daniel (2011), W/ Mikael (2012) and Amanuel (2012) .
2.3.6. DER
This financial tool gives an idea of how much borrowed capital (debt) can be fulfilled in the event of liquidation
using shareholder contributions. It is used for the assessment of financial leverage and soundness of a firm and
is typically calculated using previous fiscal year's data.
A low debt-equity ratio is favorable from investment viewpoint as it is less risky in times of increasing interest
rates. It therefore attracts additional capital for further investment and expansion of the business.
Also See: Long-Term Debt, Debt Ration, Benefits to Costs Ratio, Return on Debt, Effective Debt, Long-Term
Debt to Capitalization Ratio.
debt-to-equity ratio shows how much of a company is owned by creditors (people it has borrowed money from)
compared with how much shareholder equity is held by the company. It is one of three calculations used to
measure debt capacity—along with the debt servicing ratio and the debt-to-total assets ratio.
Debt capacity shows both a company’s ability to service its current debt payments and its ability to raise cash
through new debt, if necessary. This might include helping the company through a market downturn or helping
the company take advantage of opportunities as they arise.
The debt-to-equity ratio is primarily used to evaluate a company’s ability to raise cash from new debt. That
assessment is made by comparing the ratio to other companies in the same industry.
The higher a company’s debt-to-equity ratio, the more it is said to be leveraged. Highly leveraged companies
carry more risk of missing debt payments when revenues decline
The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and
debt used to finance a company's assets.[Peterson, Pamela (1999). Analysis of Financial Statements. New York:
Wiley. p. 92. ISBN 1-883249-59-7.] Closely related to leveraging, the ratio is also known as risk, gearing or
leverage. The two components are often taken from the firm's balance sheet or statement of financial position
(so-called book value), but the ratio may also be calculated using market values for both, if the company's debt

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and equity are publicly traded, or using a combination of book value for debt and market value for equity
financially.(Manglik, Rohit (2020-06-09).
The Debt to Equity ratio (also called the “debt-equity ratio”, “risk ratio”, or “gearing”), is a leverage ratio that
calculates the weight of total debt and financial liabilities against total shareholders’ equity. Unlike the debt-
assets ratio which uses total assets as a denominator, the D/E Ratio uses total equity. This ratio highlights how a
company’s capital structure is tilted either toward debt or equity financing.
It also a measure of the relative contribution of the creditors and shareholders or owners in the capital employed
in business. Simply stated, ratio of the total long term debt and equity capital in the business is called the debt-
equity ratio.
2.3.7. Long term debt ratio (LDr
Similarly, Long term debt ratio depicts how much of total assets are financed by using long term debt financing
means. And it is measured; LDr= Long term Liabilities Total assets Note: long term liability is defined for this
study as liabilities which will mature beyond one year or one operating cycle. Long term debt ratio also
captured to measure maturity level of leverage in the studies of Bas, Muradoglu and Phylaktis (2009), Luper
and Isaac (2012), Ellili and Farouk (2011), Bayeh (2011), and Amanuel (2012).
2.3.7. LDR
The loan-to-deposit ratio (LDR) is used to assess a bank's liquidity by comparing a bank's total loans to its total
deposits for the same period. The LDR is expressed as a percentage. If the ratio is too high, it means that the
bank may not have enough liquidity to cover any unforeseen fund requirements. Conversely, if the ratio is too
low, the bank may not be earning as much as it could be.
To calculate the loan-to-deposit ratio, divide a bank's total amount of loans by the total amount of deposits for
the same period. You can find the figures on a bank's balance sheet. Loans are listed as assets while deposits are
listed as liabilities.In study the result indicate that LD has an insignificant relationship with the performance of
the bank measured by both ROA &ROE.
Table1. Impact of Capital Structure on ROE & R0A
Dependent Source Control Variable Impact
Variable

ROA Adewale &Ajibola (2013) DR Positive

Kodongo et al. (2014) Tangibility Negative
Abor (2005 & 2007); Oke, et. al. (2019) Size Negative
Velanampy & Niresh (2012); Vijaykumar DER Negative
& Ka runaiathal (2014); Chadha &
Sharma (2015); Yadav (2018)
ROE Adewale &Ajibola (2013), DR Positive

Kodongo et al. (2014) Tangibility Negative

Abor (2005 & 2007); Oke, et. al. (2019) Size Negative

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 Velanampy & Niresh (2012); Nirajini & DER Positive
Priya (2013)

2.3. Conceptual Model

Based on review of existing below mentioned a conceptual model has been developed for further investigation.
Model is framed into two broad section i.e. (i) Accounting Performance Indicators & (ii) Capital Structure
Variables. In first section factors like ROA (Abor, 2005; Chavali & Rosario, 2019; Ebaid, 2009; Tailab, 2014),
RoE (Adewale & Ajibola, 2013; Ahmad, Abdullah & Roslan, 2012; Emin, 2016; Mihaela & Claudia, 2017) are
categorised as accounting indicators.in the fact that accounting measures present historical view of financial
position which may not be attractive to current investors. Performance of company is reflected by indicators of
capital market provides real time information.

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Over all this study indicate that regression result of Variables Such as: DR, DER, SIZE and TANG were the
statistically significant factors affecting financial performance measured by ROA; while LD has an insignificant
relationship with the performance of the bank measured by ROA. The regression results also indicate that there
is a significant effect of DR, DER, SIZE and TANG on financial performance measured by ROE; while LD has
an insignificant effect on ROE. The debt ratio (DR) is used as a proxy for capital structure and it has a positive
and significant relationship with the dependent variables (ROA and ROE) which means that, when debt ratio of
the bank increases, it will result in increasing of bank’s financial performance. The Impact of Capital Structure
on Financial Performance of Commercial Banks in Ethiopia Regression results suggest that DER is statistically
significant negative association with return on asset (ROA) and is statistically positive association with return
on equity (ROE) with P-value of 0.018 and 0.087.

This result implies that as a bank’s debt level increases its return on asset is expected to decline because the
excessive use of the leverage might impose high interest costs. The positive relationship between DER and
ROE reveals that as debt equity ratio increases it will result in increasing return on equity The bank size which
measures log of total asset has negative and significantly affects the financial performance of banks at 1%
significant level for both ROA and ROE which indicates that large commercial banks performs lower than small
commercial banks because of the loss of control by top managers over strategic and operational activities within
the bank. This shows that small banks utilize their resources efficiently. The composition of the asset structure
(TANG) has a negative and significant impact on the accounting measure of performance (ROA) at 10%
significant level and ROE at 5% significant level. This result indicates that banks with a high ratio of TANG
have a lower performance ratio, which implies that banks invest too much in fixed assets in a way that does not
improve their performance, or that they do not use their fixed assets efficiently, so it has a negative impact on
the performance.

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 3. Conclusion
In conclusion, the study aimed to investigate the impact of capital structure on financial performance of
selected commercial banks in Ethiopia.

 The study used panel data for the period of 5 years and 8 banks operating in the country. The study used
fixed effect regression model to estimate the relationship between the capital structure and firm
performance measured by ROA and ROE.

 The study used two accounting-based measures of financial performance (i.e. return on equity (ROE)
and return on assets (ROA)) as dependent variable and five capital structure measures (including debt
ratio, debt to equity ratio, loan to deposit, bank’s size and asset tangibility) as independent variable. The
results indicate that financial performance, which is measured by both ROA, is significantly and
negatively associated with capital structure proxies such as DER, SIZE and TANG whereas DR have
negative impact.

Capital structure has found to be one of the highest researched topics in the field of finance which leads to
abundant theotrical as well as empirical contributions. Research work reviewed under this paper mainly focuses
on how the choice of debt and equity affects the financial performance of firm. The financing decision of capital
structure and their impact on financial performance has been a major field

in the corporate finance literature. Since then, numerous studies have attempted to investigate the relationship
between capital structure and financial performance of the firms. Even though, the area of capital structure and
its impacts on financial performance made many investigation and analyzed in the other countries, it is not yet
investigated in Ethiopia but some of the attempt has been made to investigate the determinants of capital
structure: it indicate that there is limitation on the sector and important area which require further investigation.
In addition to this, The research conducted by Woldemikael Shibru (2012) examine the relationship between
leverage and determinants of capital structure decision and to explore which capital structure theory is
applicable in commercial banks in Ethiopia. He uses profitability, tangibility, growth, risk, size and liquidity as
a factor that determine the mix of debt equity ratio. The results of the analysis indicate that profitability,
tangibility, liquidity and growth have negative relationship with leverage. Size and leverage has a positive
relationship. The Impact of Capital Structure on Financial Performance of Commercial Banks in Ethiopia
support to identify the level of leverage is affected by risk. In his conclusion of the study made by Shibru (2012)
is that profitability, liquidity, tangibility and bank size are the major factor to determine capital structure of
commercial banks in Ethiopia and the predominant capital structure theory applied in Ethiopian banking
industry is pecking order theory. The paper also propose a conceptual model that describes the interrelationship
between CS and financial performance based on detailed discussion of widespread literature. This model
important variables of financial performance affected by CS which help research scholar’s further investigation.

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