Abstract
This study assessed the effect of financial leverage on the financial performance, using data from the annual reports of 7 quoted oil and gas firms in Nigeria, as well as from the Nigerian Stock Exchange (NSE) daily official lists over the period 2005- 2018. Descriptive statistics were used in data presentation, while random effects panel estimator was applied in determining the effect of financial leverage variables as short-term debt ratio (STDR), long-term debt ratio (LTDR) and total-debt equity ratio (TDER) on the financial performance, measured by the return on equity (ROE). The regression results from the random effects model (REM) indicate that STDR and LTDR have no significant effect on the financial performance, and TDER has a negative but significant effect on the financial performance denoted by ROE. The study concludes that higher financial leverage of quoted oil and gas companies in Nigeria attenuates shareholders’ wealth. The investment implication of this conclusion is that oil and gas companies should look more carefully at the utility maximization value of debt vis-à-vis equity in their capital structure.
Highlights
Financial leverage is the extent to which firms employ debt in the capital structure
Descriptive result is used in presenting the data, variance inflation factor (VIF) is used in taking decision about the existence of multicollinearity in the model and regression results are used in examining the effect of the independent variables on the dependent variable
The results indicate that short-term debt ratio (STDR) has a mean value of 0.29, implying that during the period 2005- 2019, approximately 29 per cent of the capital of the firms utilized in this study was financed by short-term debt
Summary
Financial leverage is the extent to which firms employ debt in the capital structure. Increase in the use of debt in a firm’s capital structure increases the risk of financial distress and probability of bankruptcy which may arise as a result of default. There are certain benefits and costs associated with using debt financing. Firms can take advantage of tax shields benefits of debt by employing more debt in the capital structure. There are certain costs associated with debt financing vis-à-vis fixed interest payments, cost of financial distress and bankruptcy costs arising from inability of firms to meet up their debt obligations as at when due. Trade-off the tax shields benefits of debts against the financial distress and bankruptcy costs of debt (Abubakar, 2016)
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