IMPACT OF LEVERAGE ON FINANCIAL

PERFORMANCE OF THE ORGANIZATION

 Abstract

The purpose of this research article is to evaluate whether in Pakistani context an increase in
leverage positively or negatively impact on performance of organization. This research was
conducted using secondary data sourced from KSE and SBP. The sample of this study comprises
of 50 companies. The objective of this study is to analyze the effects of leverage on the
performance measures to better understand the dynamics and determinants of performance
within the Pakistani companies. In particular, this study’s findings suggest that leverage is
negatively related to performance.

Key words: Leverage, Size, Growth, Performance.

CHAPTER # 01

Introduction

Leverage means borrowing funds which are used by organization to finance. So leverage means
those funds which firms get through debts. In finance, the term leverage arise often both
investors and companies employ leverage to generate greater returns on their assets. However,
using leverage does not guarantee success, and the possibility of excessive losses is greatly
enhanced in highly leveraged positions.
There are two types of leverage that can be used: operating leverage and financial leverage. At
what degree a business or investor is using borrowed funds. Firms that are at high degree of
usage of borrowed money are always standing at high risk of insolvency and they are unable to
pay their debts. Now lenders are not ready to lend them money in future. Financial leverage is
not bad forever. It may be positive and increase the wealth of shareholders return and their
investment fund. It helps in reduction in tax. It is related to the degree of increase of combination
of variable and fixed cost.
When a business has few sales and the gross margin of each sale is very high then it is called the
business is highly leveraged. A business with many sales and margin of each sale is nominal; the
business is called less leveraged. With the increase in sale each unit of sale will contribute more
in profitability and less in fixed cost.
The business which have higher operating leverage where the proportion of fixed cost is high
then the leverage cost. The business is said to have use less operating leverage where the rating
of variable cost is high then fixed cost.
Financial leverage arises when a firm decides to finance a majority of its assets by taking on
debt. Firms do this when they are unable to raise enough capital by issuing shares in the market
to meet their business needs. When a firm takes on debt, it becomes a liability on which it must
pay interest.
1.1 THEORATICAL BACKGROUND

Though the Modigliani and Miller [1958] theorem suggested that the financial structure has no
influence on firm value, a number of theoretical works have provided arguments in favor of the
non-neutrality of financial structure in economic terms.
Among the works contesting the relevance of Modigliani-Miller theorem, a major strand
suggests a relation between leverage and corporate performance. The studies on the link between
leverage and corporate performance can in fact be classified in two categories. The first one
includes the works based on information asymmetries and signalling.
Firm insiders (managers or shareholders) possess some private information about the
characteristics of the firm. It has then been demonstrated that these information asymmetries
between borrowers and lenders induce some adverse selection problems: the impossibility of
lenders to price a loan according to the borrower‟s quality results in an imperfect pricing, leading
to credit rationing (Stiglitz and Weiss [1981]). Therefore, “high-quality” borrowers have
incentives to show their quality. However, they need to provide this private information by using
a credible signal, meaning a signal that cannot be provided by “low-quality” borrowers.
Debt can then be adopted as this signal as the choice of financing by debt rather than by equity
conveys valuable information to the lenders (Leland and Pyle [1977]). In particular, Ross [1977]
advanced that a “good-quality” company can issue more debt than a “low-quality” one, because
the issue of debt leads to a higher probability of default due to the debt-servicing costs which
represent a costly outcome for firm insiders.
As a result, debt is a credible signal of the quality of firms and “good-quality” firms are more
inclined to issue debt. Thus, this theory suggests that the most performing firms, those having the
more profitable investments, ask for more debt: there should then exist a positive relation
between corporate performance and leverage.
1.2 Problem Statement
Leverage is worldwide problem either for developed countries or developing countries. It is
important to know the problematic areas where a firm have to act carefully and handled the
problem. If borrowed capital can reduce the cost of capital, then to what extent the Pakistani
companies are engaging leverage in their capital structure and all such companies make use
of similar level of leverage and is there any variation among the companies.
1.3 Research Question
To what extent leverage affect the performance of organization?

1.4 Objectives
The main objective of this study is to find solution to the research question.

1.5 Significance
This study is very useful for the financial manager to know the variables, which affect the
debt equity mix of the companies in Pakistan. The result of this study is significant to the
lending institutions to prevent and to reduce non-performing assets, while granting loans
and advances to companies belonging to companies in Pakistan. Shareholders too stand to
gain out of the results of the study.
CHAPTER # 2
Literature Review
Corporate Leverage has remained one of the fascinating fields of research in finance; many
researchers have been continuously studying the various dimensions of leverage of a firm.
Studies on leverage are abundant and several attempts are made on this topic in foreign
Countries.
Modigliani Miller (1958) theorem is concerned with the question of how the market value of a
firm is affected by the volume and structure of its debts. The central proposition of the theorem
gave a clear answer to the proposition –neither the volume nor the structure of the debts affect
the value of the firm, provided that financial markets work perfectly, that there are no taxes and
that there are no bankruptcy costs .
Gordon (1962) found that, return on investment was negatively related to debt ratio. He also
confirmed the negative association between operating risk and debt ratio. While analyzing the
tax effect in the cost capital.
Modigliani Miller (1963) found that in the presence of corporate income taxes but in the absence
of the bankruptcy risk, there is a linear relationship between the value of the levered firm and
that of its debt. This implies that a firm should maximize its uses of debt in order to enjoy the
benefit of tax subsidy on interest payments.
Baxter (1967) reported that leverage would depend on the variance of net operating earnings.
Since business with relatively stable income streams are less subject to the possibility of ruin,
they may find it desirable to rely relatively heavily on dept financing. On the other hand, firms
with risky income streams are less able to assume fixed charge sources of finance. Hence, he
concluded that negative association existed between net operating earnings and leverage.
Gupta (1969) conducted a study on the financial structure of American Manufacturing
Enterprises. The focus of the study was to analyze the industry effect and the growth effect on
the financial structural relationship of American Manufacturing Enterprises.
It was a cross sectional study for the year 1961-62. The study confirmed that total debt ratios
were positively related to growth and negatively related to size. He also found significant
industry effect on debt ratio. He further observed that “family pattern of ownership” is an
important determinant of leverage in the paper and allied product industry. Sarma and Rao
(1969) conducted a study on capital structure and cost capital and found that the cost of capital is
affected by debt apart from its tax advantages. Toy et al (1974) reported that the higher the
operating risk companies showed, the higher the debt ratio is. They found that debt ratios were
positively related to growth typically measured as sales growth and return on investment was
negatively related to debt ratio. They also concluded that the corporation size and the industry
class did not appear to be determinants of debt ratio.
Chakarboty (1977) conducted a study to investigate debt -equity ratio in the private corporate
sector in India. He tested the relationship of debt-equity ratio with age; total assets, retained
earnings, profitability and capital intensity. He found that age, retained earnings and profitability
were negatively correlated, while total assets and capital intensity were positively related to debt-
equality ratio.
Ferri and Jones (1979) examined the determinants of financial structure. The objective of their
study was to investigate the relationship between a firm‟s financial structure and its industrial
class, size, variability of income and operating leverage. They found that the industry class was
linked to the firm‟s leverage, but not in a direct manner as was suggested in other researches.
Secondly, a firm‟s use of debt is related to its size, but the income could not be shown to be
associated with the firm‟s leverage. Finally, operating leverage does influence the percentage of
debt in a firm‟s financial structure and the relationship between these two types of leverage is
similar to the negative linear form which financial theory suggests.
Sarkar (1980) carried out a comprehensive study on the background of the central government
companies in respect of their capital structure and the change over 1960-61 to 1969-70 and found
that government agencies played a major role in the finance of PEs. He pointed out that the
distinctive forms of public undertaking required serious notice while financing their modus
operandi.
De Angelo and Masulis (1980) demonstrated that with the presence of corporate tax shield
substitutes for debt (e.g. depreciation , depletion amortization and investment tax credits) , each
firm could have “ a unique interior optimum leverage decision with or without leverage related
costs” .
Bhat (1980) studied the impact of size, growth, business risk, dividend policy, profitability, debt
service capacity and the degree of operating leverage on the leverage ratio of the firm. He used
multiple regression models to find out the contribution of each characteristic. Business risk
(defined as earnings instability), profitability, dividend payment and debt service capacity were
found to be significant determinants of the leverage ratio.
Ho and Singer (1982) argued that even if short-term and long-term debts have the same priority
in bankruptcy, short-term debt has a higher effective priority outside bankruptcy, because it is
paid first. Thus, issuing short term debt to finance new investment projects offer potential
benefits that are similar to those from issuing secured debt for controlling the underinvestment
problem.
Boquist and Moore (1984) findings did not support the tax shield hypothesis at the firm level;
however, they did find weak evidence in support of the theory at the industry level. They
however, like other researchers, found that total leverage especially debt leverage varied across
industry groupings.
Myers and Majluf (1984) have argued that if managers have better information about the future
investment opportunities of the firm than the potential investor, they might find it difficult to get
external finance. This is because outsiders ask for a premium in order to compensate for the
possibly of finding a bad firm. If the firm tries to finances its new projects by issuing equity, then
the under-pricing may be so severe that a good firm may find it profitable to reject some of its
projects even with positive Net Present Value (NPV). Thus the firm will always try to choose a
security, which minimizes this problem known as Lemon problem.
Stulz and Johnson (1985) demonstrated theoretically that secured debt reduced firm‟s
opportunities to engage in asset substitution. Firms with proportionately more tangible assets,
which can serve more easily as collateral find it difficult to shift to riskier projects when specific
assets secure their debt.
Pandey (1985) reveals that the levels leverage in the Indian Industry is moving upwards and that
the large majority of companies leverage decisions seem to be independent of their size
profitability growth and industrial variations.
Brander and Lewis (1986) showed that the oligopolies had a tendency to increase business risk
by adopting a more aggressive products market strategy supported by a positive debt level. This
result in this model was driven by the fact that due to limited liability, equity; holders of
leveraged firm received pay-off only in good conditions. Given the assumption that the marginal
product was higher in good condition the leverage created an incentive to product more.
Sarig(1988) argued that firm‟s whose workers have easily transferable skills should have more
debt. Maksimovic and Titman (1991) have held that firm‟s that manufacture products that are
unique or require service, and firm‟s for which a reputation for producing high quality products
is important, may be expected to have less debt, other things being equal.
Athreya (1994) observes that the trend, all over the world, is to leave economics activity to
market forces and restrict government‟s role to the minimum. The emerging and desired
corporate response to this is also widely believed to be „restructuring‟. The private corporate
sector in India, as elsewhere in earlier periods, is responding with one, two or all the three
dimensions of restructuring .i.e., Business Restructuring, Organizational Redesign and Financial
Engineering. All three dimensions are also relevant to the PEs. Financial engineering involves
and includes activities like changing the debt-equity ratio, reducing wastages, cutting costs,
improving margins, profitability and market capitalization.
Carelton and Siberman (1997) concluded that higher the variability in the rate of return on
invested capital, lower will be the degree of financial leverage adopted. Hence it is the variance,
not the rate of return that is the ultimate determinant of leverage. They also found return on
investment to be negatively related to debt ratio.
Mathew (1997) had made an attempt to analyze the relationship between ownership structure and
financial structure with a view to know whether the former had any impact on the latter. The
analysis was based on three hypothetical relationships that existed between ownership structures
on one hand and unsystematic risk, non- manufacturing expenses and profit appropriation
policies on the other hand. He concluded that where the management stake is high, leverage will
be low and vice versa and there existed a significant relationship between ownership structure
and financial structure of firms.
Booth, Aiazian, and Kunt demirgne, and maksimoie (2001) found that optimal capital structure
choice in developing countries is strongly influenced by factors such as size, asset structure,
profitability and short term financial distress cost.
Bradley, Jarroll and Kim (2002) found that debt to asset ratio is negatively related to the
volatility of annual operating earnings and advertising and Research and Development expenses.
Fama and French (2002) argued that dividend and debt convey information about profitability,
which clearly shows the tax effects of finance decision. They have discussed how a firm‟s value
is related to dividend and debt. Accordingly, simple tax hypothesis says that firm value is
negatively related to dividend and positively related to debt. With a good control for profitability,
one can show how the taxation of dividend and debt affect the value of a firm.
Saumitra N Bhaduri (2002) attempted to study the capital structure choice of developing
countries through a careful study of the Indian corporate sector. He used factor analytical model
to determine a minimum number of unobservable common factors by studying the co-variance
among a set of observed variables. He found that growth, size cash flow, uniqueness, and
industry character influenced a capital structure of variation of corporate firms.
Mohanty (2003) found that leverage is negatively related with profitability and value of the firm
both within industry as well as within the Indian economy. It has been found that companies that
spend a large sum of money on advertisement and Research and Development expenditure are
least levered.
Rao and Lukose (2003) analyzed the determination of the capital structure of non-financial firms
in India prior to, and following the significant liberalization of financial markets after 1997.
Cross sectional models of market and book value leverage were estimated for the pre (1990-
1992) and post- (1997-1999) liberalization periods using conventional explanatory variables of
capital structure.
Prashanth and Narayanan (2005) use feasible generalized least squares to estimate a panel model
of capital structure for the Indian manufacturing sector. Their model controlled for a variety of
factors including firm size, taxes, cash, interest coverage ratio, and profitability. They also
analyzed the effect of firm tenure on leverage by interacting each independent variable with a
dummy variable for age as well as size. Size and profitability were found to be the most
important determinants of the capital structure for young firms. The authors found that size was
positively related to leverage while profitability was inversely related to leverage.
Ayesha Mazhar and Mohamed Nasr (2011) attempted to examine the factors influencing the
firm‟s choice of a debt-equity ratio. They selected a sample of Pakistani companies registered on
Islamabad Stock Exchange. The sample comprised 91 Pakistani companies out of which
companies are private and are government owned covering the period of 1999-2006. Tangibility,
size growth rate tax provision, Return on Assets and profitability are used as independent
variables, while leverage is the dependent variable. For analysis purpose descriptive statistics,
Spearman‟s correlation and Regression analysis are used. The result implied that government
owned and private companies of Pakistan use different patterns of financing and that government
owned companies employ more leverage than private companies. Further, he concluded that
variables like size do not matter in determination of capital structure of Pakistan companies. The
results suggest that asset tangibility (Ta) profitability (PF) and ROA is negatively correlated with
debt. Where size (SZ), Growth rate (GT), and Tax rate (TAX) is positively related with leverage.
Financial leverage being a sensitive area in finance has attracted the attention of many scholars.
Studies reviewed reveal that focus has been given to examine the of capital structure of firms,
from different angles researchers have extensively examined the determinants of leverage of
different companies.
CHAPTER # 03

RESEARCH METHODOLOGY

The research methodology followed to carry out the study is explained in this chapter. Sampling
procedure, data and sources of data and tools used for analyzing the data are discussed in detail.
The analysis of this study is based on ratio. Ratio is a largely acknowledged tool to analyze
financial position as well as performance of the firms (Gorton and Rosen 1995).

3.1 Data

The sample consists of 50 companies listed in the KSE and SBP for which firm level time series
data for six financial year periods (2006–2011) were available. In determining the sample
population, an exhaustive list of companies listed in KSE and SBP. In order to select the sample for
the study, first a list of companies, which satisfied the following criteria have been identified:

 Continuous financial data for the last 03 years starting from 2009 to 2012.

 Debt and equity capital in the capital structure.
This study finally comprise of 50 companies as sample.

Econometric Equation:

ROA= α + βX1 + βX2 + βX3 + βX4 +µt

ROA= Return on assets as dependent variable

X1= Leverage

X2= Size

X3= Growth

X4= Liquidity
3.2 Variable Selection
This paper aims to examine to know the determinants of leverage. In essence, the model
encompasses elements of market structure studied by Hall and Weiss (1967) with enhanced
performance measures used by Sarkaria and Shergill (2000) as determinants of performance.

3.2.1 Dependent Variable

Three accounting based measurements of financial performance as dependent variables,

which are return on assets Return on Equity and Return on Investment to determine firm
performance. These are also the most commonly used performance measure proxies.
These accounting measures represent the financial ratios from balance sheets and income
statements. In the literature, a number of researchers used these accounting based
measurements of financial performance such as Majumdar and Chhibber (1999), Abor
(2005), Demstz and Lehn (1985), Gorton and Rosen (1995), Mehran (1995), Ang, Cole
and Line (2000).

3.2.1.1 Return on Asset (ROA)

Return on asset is very important ratio. It shows the return of all the assets used in
a division or in firm to generate the earnings. Through this everyone can evaluate
the division or firm profitability and its efficiency. It is very important ratio which
provides the guide to finance manager. ROA provides good information about a
firm‟s financial performance in terms of using assets to create income.

Formula:

Return on Assets = (Net Profit / Total Assets) *100

3.2.2 Independent Variables

The study used measurements of leverage as independent variables according to research

question. Concerning the independent variables, study employed long-term debts and total
debts as a ratio of total assets.

3.2.2.1 Leverage

Leverage has been employed widely as a measure of risk in previous studies of financial
performance reflecting a trade-off between shareholders' returns and risk (Hall & Weiss,
1967; Scott & Pascoe, 1986; Pant, 1991). The usual supposition is that a leveraged firm
with relatively more borrowed capital represents a greater financial risk to equity holders
than a firm with relatively low debt (Bothwell, Cooley & Hall, 1984). Depending on the
cost of debt, the effect of leverage may be favorable or unfavorable. When the cost of debt
is lower than the company's rate of return, shareholders' earnings will be magnified.
However, when the rate of return on the company's assets is lower than the cost of debt
capital, then the leverage effect will be unfavorable. In line with Sarkaria and Shergill
(2000), leverage in this analysis is assumed to arise as firms venture to borrow capital when
they expect to earn more than the cost of debt capital, and hence, a positive relationship
between leverage and performance is expected. In order to measure the effect of leverage
we use:

This is a financial ratio which shows the relative proportion of equity and debt used to
finance an entity's assets. How much assets of firm is purchased by using total debts.

3.2.2.2 Size
As discussed earlier, the relationship between firm size and profitability remains unclear.
On the one hand, it is generally argued that big firms possess economies of scale
(Montgomery, 1979; Sidhu & Bhatia, 1993) and better access to capital markets (Hall &
Weiss, 1967) to achieve lower costs and higher returns. However, the opposing view (linked
in part to diseconomies of scale) from strategic perspectives suggests that bigger firms are
mired with increased coordination requirements, thus making the managerial task more
difficult (Downs, 1967).
The size-profitability relationship is perhaps best explained as a curvi-linear relationship
where beyond a certain point, scale economies cease to exist and the relationship then may
reverse owing to the problems associated with size as highlighted by Downs. Ahuja and
Majumdar (1998) conclude that the arguments remain unclear and must be empirically
resolved on a case-by-case basis. using ln of total assets as the measure for firm size.

3.2.2.3 Growth
Growth rate is employed in this model as a measure of change in demand. One would
therefore expect that high growth should be associated with higher profitability. However, it
has been argued that extreme profitability in one period may contribute to reductions in
profitability in the following period. Growth may also be achieved via pricing strategies
which sacrifice current profitability (Gaskins, 1970).
3.2.2.4 Liquidity

Increase the assets to generate more profits, companies might use leverage. One type of
leverage that companies use is debt. When debt is used to expand the companies by adding
more operational assets, then it can generate more cash flows which are expected to
increase the value of return on equity ratio (Brigham and Ehrhardt, 2005).
Moreover, return on equity can also be useful in comparing the profitability of the company
to the other company in the same industry. This is important because different industry
might produce different profitability. As it is explained by Michael Porter that industry
presents different pattern of profitability due to different forces that the industry exposed to
such as concentration, entry barriers, and growth (Spanos, Zaralis, and Lioukas, 2004).
CHAPTER # 04

4.1 Data Analysis

The data samples used in this study are yearly and observations of 50 companies listed on KSE
over the period 2006–2011. The descriptive statistics of variables use in the regression model are
reported in Table 1. The information related to companies control variable is as follows:

Table 1

Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis

ROA 0.146 0.124 0.534 -0.150 0.133 0.539 3.072
CR 1.794 1.255 15.280 0.060 1.654 0.160 27.288
LEV 1.566 1.170 25.990 -2.000 2.043 1.430 72.199
GROWTH 0.097 0.107 0.623 -1.264 0.193 -1.514 11.537
SIZE 15.132 15.053 20.295 12.268 1.552 0.697 3.375

Measures of central tendency, variance, skewness, and kurtosis were calculated on responses to
all of the items. Skewness measures for all of the items were within the range of: -1.514 to 1.430,
which is considered to be a good range for most research that requires using statistics appropriate
to normal distributions.

The descriptive statistics are thus valid and reliable. The extreme figures, for instance, the
maximum of leverage. In this study outlier is removed. Outliers are data, which is far from rest
of data and the general linear pattern. In order to avoid fluctuating, the regression analyses are
bound between 1 and -1 in light of Cassar and Holmes (2003, p. 132) research paper. This is also
called Cook‟s distance, which is used by many researchers (Weinberg & Abramowitz, 2008).

The reason to exclude outliers is thus to explain the regression model better and to be “ensure
that the analysis is not overly influenced by outliers” (Cassar & Holmes, 2003, p. 132). “In
particular outliers (i.e., extreme cases) can seriously bias the results by "pulling" or "pushing" the
regression line in a particular direction, thereby leading to biased regression coefficients.
Often, excluding just a single extreme case can yield a completely different set of results”
(Statsoft.com, 2012). Therefore, it is obvious that regression analysis with outliers does not
represent a majority.

Table 2

ROA LEV CR GROWTH SIZE

ROA 1.0000

LEV -0.3421 1

CR 0.2078 -0.3017 1

GROWTH 0.0721 0.0094 -0.0047 1

SIZE 0.1855 0.1069 -0.1890 0.0759 1

Table 2 explains the relationship between explanatory and dependent variables. In table 2 it is
clearly shown that leverage negatively affect the performance of organization. Similarly other
variables are positively correlated with performance of organization.

Table 3 ordinary least square regression to find out the relationship between leverage and ROA.
Output of regression analysis enables us to find the relationship and the correlation among
independent variables and one dependent variable.

The structure of this part aims to present important outputs of regression and analyze them in
order to answer our research question. Furthermore, to check the results whether they are
statistically significant at the 0.05 level or not.

So regression run for the aim to provide essential results. Results are more apparent and visible
with tables. Thus, it simplifies matters to compare, contrast, and conclude for readers and it is
easier to explain results. It is necessary to compare it with other adjusted R2 found in previous
articles. Hence, this article used Ebaid‟s paper (2009, p. 483, 484) as a benchmark because
our dependent variables, independent variables and structure of regression analysis are similar to
it. In that paper, adjusted R2 is 0.518213.

Table 3

Dependent Variable: ROA_?

Method: Pooled Least Squares
Date: 12/31/13 Time: 17:54
Sample: 2006 2011
Included observations: 6
Cross-sections included: 50
Total pool (balanced) observations: 300

Variable Coefficient Std. Error t-Statistic Prob.

C 0.305846 0.432876 0.706545 0.4805

LEV -0.121052 0.039243 -3.084638 0.0023
GRO 0.080787 0.030149 2.679564 0.0079
SIZ 0.120753 0.028411 0.378469 0.0054
LIQ 0.009387 0.010320 0.909585 0.0340

R-squared 0.611670 Mean dependent var 0.145859

Adjusted R-squared 0.518213 S.D. dependent var 0.132891
S.E. of regression 0.092240 Akaike info criterion -1.754487
Sum squared resid 2.050502 Schwarz criterion -1.026077
Log likelihood 322.1731 Hannan-Quinn criter. -1.462976
F-statistic 6.544933 Durbin-Watson stat 1.705815
Prob(F-statistic) 0.000000

As can be seen from regression, the value of adjusted R2 is 0.518213., which means that 51.8
percent of the total variance in ROA has been explained. When it is compared to Ebaid‟s
research (2009), it is an acceptable result. However, it may be increased by adding more
independent variables.

In Table 3 all variables are statistically significant and leverage has negative relationship on
return on assets. Table 3 shows that there is negative relationship between leverage and ROA
exist and it means 1% change in leverage impact adverse change in financial performance of
organization .12%.

R2 indicates that there is 51 % impact of explanatory variables on performance and it can be

improved by adding more explanatory variables.
 Table 4

Dependent Variable: ROA_?

Method: Pooled EGLS (Cross-section random effects)
Date: 12/31/13 Time: 17:56
Sample: 2006 2011
Included observations: 6
Cross-sections included: 50
Total pool (balanced) observations: 300
Swamy and Arora estimator of component variances

Variable Coefficient Std. Error t-Statistic Prob.

C -0.151863 0.119544 -1.270351 0.2050

LEV -0.155133 0.035696 -4.345957 0.0000
GROWTH? 0.072256 0.029602 2.440947 0.0152
SIZE 0.018837 0.007763 2.426481 0.0159
LIQUIDITY 0.020246 0.008861 2.284919 0.0230
R-squared 0.114966 Mean dependent var 0.145859
Adjusted R-squared 0.087499 S.D. dependent var 0.097001
S.E. of regression 0.092660 Sum squared resid 2.489899
F-statistic 4.185667 Durbin-Watson stat 1.428553
Prob(F-statistic) 0.000042

Furthermore Hausman test is used to check the specification of model. Hausman test results
show the significant results, it there is no error in model.
CHAPTER # 05

Conclusion and recommendations

5.1 Conclusion

Leverage is one of the extensively research areas of corporate finance. Several theories have
been developed to explain the impact of leverage on the firm value. In general, many companies
go in for borrowed capital because of cost effectiveness of borrowed capital. A company„s
dependence on borrowed capital and extent of leverage engaged are determined by several
factors. Companies require capital for starting up of new business and its expansion. Every
business transaction involves fund directly or indirectly. With the increasing financial
requirements firms tend to have large amount of capital.
The aim of this article was first to establish the relationship between firm performance and
leverage. The research presented here has provided new evidence on the relationship between
leverage and performance of organization. This study has found empirical evidence that leverage
is negatively linked with financial performance in Pakistan. Contrary to the conventional
economic theory which advocates that larger firms leverage economies of scale to realize higher
returns. The evidence from this study is also showed that capital structures vary by industry.

5.2 Recommendations
This research result can give insight to the investor and the companies themselves on measuring
their companies‟ performance based on how well the companies manage their debt to increase
profit. Even though the result indicates that in different industry generate different relationship,
one of the important things is that the relationship between debt and performance of all samples
is negatively significant. Moreover, the relationship between firm size and profitability could be
an additional indicator of company‟s profitability since the relationship indicates positively
significant. The research can also provides additional information to researchers that
simultaneously all the independent variables are significantly affects company‟s performance.
This is important to investors and companies to set the strategies that suitable for them to have
their optimum profit.
Future research in leverage and capital structure should include a number of factors. Method for
sample selection needs to be revisited as sample contained some bias. Allowing all firms an
equal chance to being selected.

5.3 Limitations
 This study is limited to specific companies.

 There is limited time.

 Its results cannot be generalized upon other companies.

 There are limited resources.
CHAPTER # 6

References

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Allan J. Taub(1975), “Determinants of firms capital structure”, Review of Economics

and Statistics, vol. 57 (Nov 1975), PP. 410-416.

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 Dedication

To God be the glory, for great things He has done, to allow me health and prosperity to finish
this work. There are a few people who are so luxuries and so precious to me especially my
beloved fiancée, Sadia Wasiq who really support me. Words fail me to express how important
my parents are. So I dedicated this work to my glittering diamonds.
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