Does Firm Performance Affect Cost of Debt? Evidence From an Emerging Economy

This paper examines the relationship between firm performance and cost of debt. More specifically this paper shows the empirical evidence that fund providers charge lower cost on debt for highly performing companies compared to lower performing companies. We argue that profitable companies are more resilient, and they have more survivable capacity which motivate fund providers thereby results in lower cost of debt. In contrast, lower performing companies are more prone to financial distress or may have higher chance of non-repayment of loans thereby fund providers charge higher interest to compensate the risks. Consistently, analyzing 547 firm year observations for the period of 2015 to 2019 we find that cost of debt is lower for highly performing companies compared to lower performing companies. The negative relation between cost of debt and firm performance is highly pronounced only in smaller companies compared which suggests that fund providers create opportunities for smaller companies thereby results in balanced growth in the economy. Our results are robust to a set of alternative measures of firm performance. This study has several policy implications and contributions to literature of cost of debt and cost of equity particularly in developing economies