The Casual Relationship Between Debt and Profitability: The Case of Italy

This paper examines the impact of debt on corporate profitability using a longitudinal sample of 7,370 Italian SMEs operating in the commerce sector during 2006-2010. Being based on the simple moving-average analysis of the profitability ratios, as a result of debt changes, econometric evidence supports the hypothesis that there is a non-monotonic relationship between debt and profitability. However, if the nonmonotonic correlation is ignored, the debt-profitability relationship is likely to be negative in some areas of Italy. Otherwise, in regions where the demand for bank credit is higher (or the bank supply is lower), the negative correlation is muffled by a reverse effect: less financial resources make the evaluation of credit-worthiness more selective. Consequently, highly levered firms are considered to be those that have primarily higher profitability, and, then, the best rating.