Abstract
The objective of this study is to investigate the impact of financial leverage on corporate financial performance of Pakistan’s textile sector from 1999-2012 using panel data. The leverage-performance relationship is examined with a special focus on the Global Financial Crisis of 2007-2008. Both accounting-based (Return on Assets - ROA) and market-based (Tobin’s Q) measures of corporate financial performance are used. Regression analysis is performed with and without inclusion of financial crisis dummy. Total Debt to Total Assets (TDTA), Long Term Debt to Total Assets (LDTA), Short Term Debt to Total Assets (SDTA) and Debt to Equity (DE) ratios are used as proxies for financial leverage whereas firm’s size and firm’s efficiency are used as control variables. The results indicate that financial leverage has a negative impact on corporate performance when measured with ROA. Whereas in case of Tobin’s Q, SDTA coefficient is positive. It can be concluded that since cost of borrowing is high in Pakistan and debt capital markets are less developed, firms are forced to resort to banks as their source of debt finance and thus have to repay huge amount of principal and interest which has a heavy toll on their financial health. In addition to this, financial crisis was found to have a negative impact on corporate performance and also affect the leverage-performance relationship.
Highlights
Every firm needs financing to invest in different assets in order to operate efficiently, i.e. to provide tangible or intangible products to its customers
The mean value of Return on Assets (ROA) is 1.65% whereas its standard deviation is 21.79. This shows that corporate performance of the textile sector of Pakistan has remained volatile over the period of this study, i.e. 1999-2012
This study investigated the relationship between financial leverage and corporate performance and analyzed annual data of 112 companies from the textile sector of Pakistan over a period of fourteen years (1999-2012)
Summary
Every firm needs financing to invest in different assets in order to operate efficiently, i.e. to provide tangible or intangible products (i.e. services) to its customers. The need to raise funds for successful operations gives rise to a very crucial concept in corporate finance, the capital structure. The capital structure decisions of a firm’s management have a significant bearing on a firm’s financial performance and since firms operate in different sectors of the economy, the impact that those decisions can have on a firm’s financial performance is bound to be different across various industrial sectors owing to the fundamental differences. The level of debt financing that a firm uses in its capital structure is referred to as financial leverage. Financial leverage has been documented to affect firm’s financial performance in many empirical studies in the capital structure literature (San & Heng, 2011; Salim & Yadav, 2012; Khan, 2012), though no conclusive relationship has yet been documented and further research in the area has been encouraged lately
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