Business Cycles Effect on Relationship between Financial Leverage and Profitability

This paper is aimed to investigate the effect of business cycles on relationship between financial leverage and profitability. For this aim, a sample composed of listed firms in Tehran Stock Exchange is investigated for 1380 to 1393. Because interaction effect of capital structure and profitability, contemporaneous equation system is used to test the effect of business cycles on the relationship between later variables. Hodrick- Prescott and Crostino Fitzgrald Filters are used to determine business cycles. The findings from investigating the relationship between capital structure and profitability during recession situation show the reverse relationship between them. Study for this relationship in economic expansion indicates the negative effect of capital structure on profitability. Expansion years coincide with organizing stock exchange information situation, initiation of significant growth in trend of cyclical reports publications, physical expansion in capital markets and establishing over the counter markets that they consequently reduce information asymmetry that in turn result in higher motivation for stock issuance and lower borrowings and hence, debt to equity ratio is reduced.