Dynamic Capital Structure Adjustment, Liquidity and Firm Profitability: Evidence from India’s Cement Industry

Abstract

Capital structure decisions play critical role in shaping firm performance, particularly in capital-intensive industries operating under financial constraints in emerging markets, where financing frictions alter the traditionalperformance relationship. This study examines the dynamic relationship between capital structure, liquidity and firm profitability in India’s cement industry. Using balanced panel data from 21 cement firms listed on National Stock Exchange and Bombay Stock Exchange over the period 2016-2025 (210 firm-year observations)which enables consistent dynamic panel estimation.The study employstwo-step system generalized method of moments (GMM) estimator to address endogeneity, unobserved heterogeneity and profit persistence. The results indicate that liquidity has statistically significantpositive impact on return on assets and return on equity, highlighting the importance of internal financial flexibility in sustaining firm performanceindicating that financial flexibility is primary driver of profitability. In contrast, leverage and equity intensity exhibit negative effects, suggesting that excessive reliance on external financing may reduce profitability in capital-intensive emerging market industries. The findings confirm the dynamic nature of profitability and capital structure adjustment. This study contributes to capital structure theory by demonstrating that liquidity functions as a structural determinant of profitability within a dynamic adjustment framework in financially constrained emerging market industries.