The mediating role of cost of capital in the relationship between capital structure and loan portfolio quality

Abstract

Purpose – The purpose of this paper is to establish the mediating role of cost of capital in the relationship between capital structure and loan portfolio quality in Uganda’s microfinance institutions (MFIs). Design/methodology/approach – A cross-sectional research design was adopted to collect data and partial least squares structural equation modelling was used to test the study hypotheses. Findings – Cost of capital partially mediates the relationship between capital structure and loan portfolio quality. Hence, cost of capital acts as a conduit through which capital structure affects loan portfolio quality. Research limitations/implications – Cost of capital was generalized as financial and administrative costs. The impact of costs like dividend pay-outs, interest rates and/or loan covenants on loan portfolio quality could be investigated individually. Practical implications – MFIs should be vigilant about loan recovery by using strategies like credit rationing to ensure timely repayments. Originality/value – The study contributes to the ongoing academic debate by identifying the significant indirect role of cost of capital in explaining loan portfolio quality.