Modeling the Relationship between Capital Structure and Company Value in the Perspective of Agency and Trade-Off Theory

Abstract

This study is carried out to investigate the link between capital structure and company value from the perspective of agency and trade-off theory. This model formulates that the use of debt can increase profitability through monitoring mechanisms and disciplining by creditors. Profitability can reduce and increase financial distress and company value. The sample consists of companies in the LQ45 index for the period 2017-2020 and model testing uses path analysis. The results show that (i) there is a positive influence of capital structure on profitability, (ii) profitability significantly increases company value (iii) profitability affects the decrease in financial distress (iv) Financial distress significantly increases company value, (v) profitability and financial distress do not mediate capital structure on company value, (v) profitability mediates the influence of capital structure on company value (vi). These results have important implications, where an increase in debt positively affects company value due to the supervisory mechanism and discipline from the debtor. Meanwhile, the theoretical implication is to confirm agency theory and trade-off theory.