The effect of exchange rate risk on capital structure and financial performance

Volatility in exchange rates is known to be a crucial factor affecting the operations, planning and profitability of companies. In this context, the relationship between exchange rate risk and the capital structure and financial performance of companies is the main subject of this study. Companies should consider macroeconomic variables as well as firm-specific variables in their financial decisions. Therefore, this paper examines the relationship between exchange rate risk, which is one of the macroeconomic variables, and firms' performance and debt relations. The main aim of the study is to examine whether there is a relationship between exchange rate risk and the capital structure and financial performance of manufacturing firms. The sample of the study consists of the quarterly frequency data of 109 firms in the manufacturing sector of Borsa Istanbul between 2012 and 2022. Differently from the literature, the study is performed with quarterly financial statement data and also foreign currency net position data is used to measure the exchange rate risk. Within the scope of the study, the System Generalized Moments (System-GMM) estimator, one of the panel data analysis estimators, was used to analyze the data. Accordingly, the relationship between the foreign currency net position, which is used to measure the exchange rate risk, and the financial leverage ratio, debt-equity ratio, short and long term debts/total debts ratio among the capital structure ratios, as well as the relationship between the foreign currency net position and the return on invested capital ratio, return on equity and Tobin's Q ratio among the financial performance measures are analyzed. As a result of the study, the relationship between the net foreign currency position, capital structure and financial performance ratios of firms in the BIST manufacturing sector is determined. A positive relationship was found between the firms' net foreign currency position and all capital structure indicators, and a positive relationship was found between the firms' net foreign currency position and return on invested capital, one of the financial performance measures. No relationship was found with return on equity, while a negative relationship was found with Tobin's Q ratio. Keywords: Exchange Rate Risk, Financial Performance, Capital Structure, Panel Data Analysis, System-GMM