Critical Thinking

LITERTURE resources, while some cannot get optimal benefits

LITERTURE
REVIEW

 

The study
shows effectiveness of financial leverage on capital structure and on
performance of firms. The finance management get or gather the funds very
hardly. Therefore, the maximum benefit which is obtained by using of these
funds is also very difficult for financial mangers. Generally, some finance
managers get benefit from the use of financial resources, while some cannot get
optimal benefits from utilization of financial resources. The corporate
performance provides sources of investment which is based on financial debt and
stockholder equity. The short- term and long-term benefits are obtained through
the design of capital structure (Horne, 2002). The Leverage can be explained as
the use of borrowed money to make an investment and return on that investment. A
firm which has a high ratio of financial leverage it is uncertain for the
performance of firm. The financial leverage can be defined as the ratio of
total debts to total assets. In other words it is the residual claim of financers.
However, the financial leverage may be a healthy indicator in terms of
identifying the performance firms in near future. There are many variables in a
capital structure that’s used to measure the performance of firms and periods
of debt maturity will also be affected performance of firms. Debt maturity will
influence a company’s decision in investing activities. Furthermore, financial
leverage will also affect company’s performance through tax rate. In the case
of examine the impact of financial leverage base on company’s performance will
present prove for a company’s performance due to the effect of capital
structure.  

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Akhtar, et
Al. had investigated the impact of financial leverage on shareholders return.
In their paper Relationship between Financial leverage and Financial
Performance: Evidence from Fuel & Energy Sector of Pakistan, they verified
that financial leverage has got a positive relationship with financial
performance (2012). Therefore, the companies in the fuel and energy sector may
enhance their financial performance and can play their role for the growth of
the shareholder wealth while improving at their optimal capital structures. In their research they used a sample of
20 listed firms from Fuel and Energy industry which are listed at Karachi Stock
Exchange (KSE) Pakistan. The objective of this study to explained the relationship
between financial leverage and the financial performance. To test the
hypothesis, the main variables used in the study consist of a dependent
variable which is used as performance of firms and an independent variable
financial leverage in fuel and energy sector

The relationship
between financial leverage and firm performance in the construction and development
companies of Hong Kong is examined by Hung et. Al (2002). The result shows that
capital structure is significantly positively related with assets and negatively
associated with income. The financial decision
affected the financial performance firms.

A study had been done by Abor (2005) on the
influence of financial leverage on profitability of listed companies on the
Ghana Stock Exchange for a five-year period. He found out that there is
significant positively interrelated between SDA and ROE and shows that firms
which get a lot use more short-term debt to finance their business. In other
words, short-term debt is an important source of financing in favor of Ghanaian
companies, by representing short term debts as 85 percent of total debt
financing. However, the results showed the negative relation between LDA and
ROE. The regression result showed that there is positive relationship between
DA and ROE which measure the relationship between total debt and
profitability,. This indicates that firms which earn a lot are depending on
debt as their key financing decision.

 

 

 

Obradovich
and Gill (2013), had researched on the Impact of Financial Leverage on the
Value of American Firms. For this purpose 
they take the data as a sample of 333 firms listed on New York Stock
Exchange (NYSE) for a period of 3 years from 2009-2011 was selected. The
co-relational and non experimental research design was used to conduct this
study by taking firm value as independent variable and CEO Duality, Board Size and
Financial Leverage as dependent variable. The purpose of this study was to find
the impact of financial leverage on corporate governance and on the value of
American firms. Overall results show that larger board size negatively impacts
the value of American firms and CEO duality, financial leverage, firm size,
return on assets and insider holdings positively impact the value of American
firms

Firms to be diversified is more, as they can get
funds from the capital market easily, may benefit from the higher credit
ratings for issue of debt in the capital structure and lower cost of
finance  on financial leverage. It shows
that financial leverage may increase the profit after tax due to lower interest
rates and in the end the higher financial performance and due to that results
financial debts affected the EPS positively. The dividend policy which may
change the performance of firms, If the additional profits as the result of
lower cost of finance and tax shields are retained for the company’s growth, it
may affected the company’s value in long term and may lead towards the achieved
the purpose of wealth maximization for which the real investor invest. The researchers investigated the relationship of
capital structure and firm performance in financial markets of Japan. They
found that the performance of the firm improve monotonically when mangers’
ownership has increased. They also found a important positive relationship
between firm value and ownership of block shareholders. However, Domsetz and
Villalonga (2001) suggested that there is no systematic relationship between
firm performance and capital structure to be expected. They have treated
ownership as endogenous variable. They have found that ownership structure is
insignificant in explaining the firm performance.

In Pakistani financial market, Hasan and Butt
(2009) examined the impact of ownership structure and corporate governance on
capital structure of Pakistani listed companies covering the period of (2002,
2005) for 58 non financial firms listed at Karachi Stock Exchange. They found
that board size and managerial shareholding have a significant negative
correlation with financial leverage to equity ratio. Their results also showed
that the corporate financing behavior has no significant effect of the presence
of non-executive directors on board and chair duality. They recommended that
corporate governance factors such as ownership structure, size of the board of
directors and managerial shareholding are important in determining the capital
structure of the firms. In this study we consider the
peculiarity between the long-term regular impact and short-term, more immediate
effects of using leverage in private equity real estate investment funds. We
specifically draw on the argument, put forward in the corporate finance literature
that financing decisions are informed by the state of the market, allowing a
manager to issue debt when the economic environment is most favorable
recommended by Baker and Wurgler (2002).

 

However, not only does a firm’s level of leverage
affect corporate performance and failure but also its debt repayment structure.
Schiantarelli and Sembenelli  
investigated the effects of firms’ debt maturity structure on
profitability for Italy and the United Kingdom (1999). They proved a positive
relationship between initial debt maturity and average performance. A study by
Barclay and Smith   provides empirical
evidence that large firms and firms with low growth rates prefer to issue
long-term debt. Another study by Stohs and Mauer found that larger and less
risky firms usually make greater use of long-term debt (1996). They also found
that debt repayment period is negatively affected to company tax, the firm’s
risk and net income. In other words, the selection of debt structure could have
a effect on both corporate performance and failure risk. Furthermore, there are
other factors, besides capital structure, that may influence firm performance
such as firm, age, growth, firm size, risk, rate of taxation, factors specific
to the sector of financial activity, and factors specific to macroeconomic
environment of the country. These variables will be measured in this stud

 

 Performance
of firms based on Effectiveness on financial or operational activities. Profit
maximization, wealth maximization of shareholder, and maximizing return on
assets are examples of financial effectiveness measures. Increase in sales,
growth in the value of market share, and sales per employee are examples of
operational effectiveness actions. Kotha and Nair (1995) found that the
usefulness of a measure of effectiveness may be impacted by the objectives of a
particular national culture. For example, U.S. firms generally focus on
financial measures of effectiveness, while, in general, Japanese firms focus on
operational measures. For these reasons, any cross cultural study should
consider both financial and operational measures of performance. Therefore in
different cultures, in different industries, the standard to measure the
performance of firms are dependent on the adverse factors of capital structure. Mohammad Fawzi Shubita, the authors given a result of a strong negative
relationship of financial leverage and profitability of firms by analyzing a
data of 39 Industrial Jordanian companies. Based on the result, it was stated
that performance of companies tend to depend more on equity financing rather
than debt financing, thus these companies should look for an optimal structure
of capital to gain more quality of profitability (2012).

 The concept of performance is a controversial
problem in finance mostly due to its 
different dimensional meanings. Research on firm performance emanates
from organization theory and planned management (Murphy et al., 1996).
Performance measures are also financial or organizational. Financial
performance such as profit maximization, maximizing return on assets, and
maximizing stockholders’ wealth are at the core of the firm’s effectiveness
(Chakravarthy, 1986). Operational performance measures, such as increase in
sales and growth in market price of share. The effectiveness of a measure of
performance may be affected by the objective of a firm that could affect its
choice of performance measure and the development of the stock and capital
market. Performance of firms based on the performance of stock market if the
stock market is not highly developed and active then the market performance
results will not provide a good result. The most commonly used variables to
measure the performance of firms are return on assets (ROA) and return on
equity (ROE) or return on investment (ROI). These accounting measures representing
the financial ratios from balance sheet and income statements have been used by
many researchers ( Gorton and Rosen, 1995, Mehran, 1995, and Ang, Cole and
Line, 2000, Demsetz and Lehn, 1985).

 

However,
there are other procedures of performance called market performance measures,
such  as market value of equity to book
value of equity (MBVR), price per share to the earnings per share (P/E) (Abdel
Shahid, 2003), and Tobin Q. Tobin’s Q mixes market value with accounting value
and is used to measure the firm’s value in many studies ( McConnel and Serveas,
1990, and Zhou, 2001). The performance measure ROA is commonly regarded as the
most useful measure to exanimate firm performance. Return on assets ROA and
Return on equity ROE, two accounting measures are used as proxy measures for
corporate performance, and three market performance measures, P/E, MBVR. The
stock market efficiency and other economic and political factors could affect a
firm’s performance and its reliability ( Abdel Shahid, 2003).

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