Capital Structure and Firm Value: Examining the Mediating Effect of Cost of Capital and the Moderating Influence of Macroeconomic Uncertainty

Abstract

This study examined the relationship between capital structure and firm value by incorporating the mediating role of cost of capital and the moderating influence of macroeconomic uncertainty in non-financial firms listed on the Pakistan Stock Exchange. Using a quantitative research design and a balanced panel dataset of 120 firms over the period 2014–2023, the study employed Structural Equation Modeling to analyze direct, indirect, and interaction effects among the variables. The findings revealed a significant negative relationship between capital structure and firm value, indicating that higher leverage reduces firm valuation in the context of emerging markets. The results further confirmed that cost of capital partially mediates this relationship, demonstrating that capital structure affects firm value through its impact on financing costs. In addition, macroeconomic uncertainty was found to significantly moderate both the direct and indirect relationships, intensifying the adverse effects of leverage and cost of capital on firm value during periods of economic instability. The study concludes that firm value is shaped by an integrated mechanism involving financial structure decisions and external macroeconomic conditions. These findings provide important implications for corporate managers, investors, and policymakers in developing optimal financing strategies under uncertain economic environments.