The effects of leverage

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1. Based on this article, the effects of leverage on the financial performance of general insurance companies in Malaysia have been examined. It investigates whether the leverage-performance relationship is a function of or contingent on the extent of product diversification. Based on the finding, it indicates that financial performance of general insurance firms, contingent on the extent of product diversity of the firm could be beneficial or detrimental by the leverage. There will be the higher leverage (risk) for larger insurance firms because they tend to have larger insurance funds as compared to the smaller firms. (Cummins and Sommer, 1996). However, higher leverage exists because there are little incentives for shareholders to increase their equity investment for expansion of their business operations. According to Roy and Witt (1976), there will be a negative impact on performance of insurance companies due to increased leverage. Moreover, from this article, we also found that product diversity itself might not affect leverage. The relationship between leverage and performance may provide the beneficial “gearing” effects, but it also increases bankruptcy costs and agency costs. According to the research framework, there are two hypotheses. First is leverage is positively associated with the financial performance of general insurance company and second is the product diversity moderates the relationship between leverage and performance of general insurance company. In conclusion, firms with high leverage and high product diversity perform significantly better than firms with high leverage but low product diversity. Firms with low leverage are largely the smaller general insurers and these firms should focus on their respective niche product segments.

2. Based on the article, financial leverage affects cost of capital, ultimately influencing firms’ profitability and stock prices (Higgins, 1977; Miller, 1977; Myers, 1984; 1 Sheel, 1994). Also, several researchers suggested the determinants of financial leverage by reporting that firm’s debt-equity decision is generally based on a trade-off between interest tax shields and the costs of financial stress. There are three hypotheses in this article to investigate the relationship between financial leverage and profitability and risk. In the first hypothesis was proposed that restaurant firms using a lower level of financial leverage have higher profitability. Next, hypothesis 2 was restaurant firms with a higher level of financial leverage are riskier than those with a lower level of financial leverage. Hypothesis 3 was market-based measures and accounting-based measures are positively correlated to each other. As a result, based on the research for the hypotheses one, it suggests that the restaurant firms with larger assets were more profitable. But the findings indicate that financial leverage does not influence the restaurant firms’ profitability. For hypotheses 2, it indicated that high leveraged firms were less risky in both market-based and accounting-based measures. Lastly, for hypothesis three, the correlation between accounting-based measures and market-based measures was tested and found to be positively significant. In order to more effectively investigate the relationship between firms’ level of debt use and their profitability and risk, the better model can be create by include more operating leverage and economy-related variables.

3. This article is to analyze and understand the effect of leverage on the profitability of the oil and gas sector of SAARC countries. Relationship between financial, operating, combined leverage and EPS have been analyzes to determine how earning capacity is affected by operating costs and fixed financial charges. First is to investigate the leverage and Return on Investment (ROI). ROI comes from leveraged appreciation of the assets value by which is normally based upon the return. The more leverage, the greater returns, but the largest losses can be occur. Secondly, they also make some research on Return on equity (ROE). Leveraged investments which are riskier may increases the expected rate of ROE. A business could have higher fixed costs than variable costs with higher operating leverage. When sales rise, a higher degree of operating leverage boosts ROE but when the sales drop lower in ROE may occur. Lastly is the Return on Asset (ROA). The result shows that it is better for a company to have higher ROA number, this show that the company is earning more money on less risky investment and is making more profitable and returns. But, this comparison ratio only is suitable for the same sector of companies. Based on the examine through the ROA Ratio and financial leverage gain, its shows that the businesses earning more profit on the money it has borrowed than the interest paid for the use that borrowed money when a business have a financial leverage gain for the year. The leverage is an important factor which impacts on the profitability of the organizations and the wealth of the shareholders can be maximized while during the firm is able to employ more debt.

4. The purpose of this article is to explore this leverage situation and examine the effects on air carrier profitability that results from this state. Some industry argued that the long-term stability of the airline industry was adversely influenced by the operating and financial cost. They argued that on the operating side, there is a continual threat to industry stability due to the pressures of an intensely competitive marketplace and the high fixed-cost structure of the industry. Moreover on the financial side, increases in interest rates and/or economic downturns may occur due to the highly-leveraged nature of airline financing leaves the industry particularly vulnerable to. Some basic risk measures have been proposed to assess risk in the airline industry [Gritta, et.al., 1998]. All firms face three types of risk [Moyer, McGuigan & Kretlow, 2005], which are business risk, financial risk and combined risk. An important measure of a firm’s business risk is its degree of operating leverage (DOL), generally, the value of DOL are determine by using the fixed costs. High business risk may be occurring due to the inefficient management policies which will affect the variable costs or gross revenues. In the airline industry, unfavorable DOLs may also be occurring due to the poor cost controls or inefficiencies in a carrier’s route structure. Degree of financial leverage (DFL) is used to measure the financial risk. When operating profits increase, net profits will increase. Larger net profit may result in the low value of DFL. When operating profit is lower than the interest, negative DFL and net loss of the firm will result. Based on analysis, aggressive debt strategies have been following by many carries as evidenced by the high degrees of financial leverage (DFL). Combined risk can be measured by its degree of combined leverage (DCL). Since they have indicated that the losses are larger, low absolute values for DCL are alarming in the airline firm and that responsiveness to improvements in revenue will be sluggish. More than 50% of the carries are having negative DCL. As a result, if DOL or DFL is negative, DCL will be reported as negative too. From the analysis it is shown that there is a significant relationship between DFL, DOL and DCL. Therefore, it will affect the earning capacity and ability of the firm.

5. From the articles show that JIAHR has carried out some study to identify how firm’s risk affected by operating and financial leverage. JIAHR compared the most risky firms; hospitality firms, utilities firms, restaurant firms and show how systematic risk affected by operating, financial leverage during 1990-1991.Based on finding hotel are less risky to market compare to restaurants. Different hospitality business compared to other industries has been determined the impact of operating and financial leverage by JIAHR. According to Keown Martin, and Petty, 1985, operating leverage has given a lot business risk that impacts the company. The more its profit changes by percentage in sales, then it will direct result operating leverage become greater too. Apart from that, the greater the degree of financial leverage will cause the financial wave motion either positive or negative in earning per share.Firm’s management will adopt more financial leverage in order to fulfil common shareholder demand. Greater operating and financial leverage may lead to greater inconsistency in earnings and greater systematic risk for the firm. Used of debt will cause financial leverage to increase inconsistency in earning.Mandelker and Rhee 1984 make an analysis on the relationship between the operating and financial leverage and beta. They used a large proportion of 38%-48% to analyse beta at the portfolio to explain operating and financial leverage. Therefore, degree of operating leverage rises followed by increasing systematic risk (beta)

6. This journal is about financial performance of Lanka ORIX Leasing Company plc in Sri-Lanka and to analyse the impacts of financial and operating leverage during the year 2001-2010.This study examines that financial leverage show the potential of a firm gain or lose and it also measures the debt in capital structure of a firm. While, fixed costs in firm’s cost structure is also recognise as operating leverage. Operating leverage and firm’s profit usually is affected by inconsistent changes in sale volume. In the other hand, higher operating leverage is due to higher percentage of total costs. Besides that, a high degree of operating leverage cause by small change in sales and results in a large change in ROE. Lanka ORIX Leasing Company PLC was established in March 1980. It show that LOLC have a very good reputation and management controlby the CSE and also the Securities and Exchange Commission.It indicated that negatively or positively the financial, operating leverage influences on signallingin the LOLC’s financial performance during 2001-2010. Accordingto the Smith (2002), use of borrowed money or apply loan to make investment and get the return on investment is called leverage. Moreover, the rise profit on company’s equity will cause higher financial leverage too. Garrison et al., 2004.examined the correlation between risk of its equity and real asset risk of a firm. While,Percival (1974) found out that fixed- variable cost that related to Degree of operating leverage and suggested some weakness. In conclusion, companies that have systematic risk should increase in its Degree of operating leverage.

7. This article is to analyse operating and financial measures of leverage and tests their association with market based measures of equity risk. It simply shows the accounting-based data to derive the leverage measures. It also will show result that operating costs have a greater impact. Based on the article, operating leverage in the UK and international context is particularly reasons- First, it provides a linking the stock price return to the underlying short-run cost structure of the firm. It included cost, some knowledge and capital activities that linked to competitive advantage. The impact is high fixed cost investment make they exercise greater caution in the borrowing decision. There are two main important factors, the degree of financial leverage (DFL) and the degree of operating leverage (DOL). DFL depends on the degree of fixed interest charges that must be paid irrespective of the level of profit. DOL can be used to compute an ‘operating’ or ‘asset’ beta by relating the proportion of fixed cost to total cost for one particular firm to the proportion of fixed cost to total cost for all firms. According to Lev, 1974, Gahlon and Gentry, 1982, Huffman, 1983 and Mandelker and Rhee, 1984) indicated that the risk is depend jointly on underlying accounting and market numbers. For example, a financial managers facing high DOL risk can reduce through using financial plans that involve low DFL to achieve an appropriate level of total stock risk. Thus, changes in DOL and DFL will direct affect the changes in total leverage is a product of DOL and DFL. Stock risk may be the problem in finding the correct measurements of the two types of leverage due to the unstable in working experiences of the relationship between DOL and DFL. By using consistent use of accounting data also helps to overcome those problems. As conclusion, it is important to use operating leverage to determination systematic risk. Whereas, financial leverage was not important although there is some evidence in support of the notion of capacity trade off and critical levels of financial leverage. According to Huffman, 1983, as the benefits of fixed cost is increasing from financial leverage, it contributes a step-down of managerial commitment thus those operating interest have a big influence on systematic risk.

8. In a study of Abel in 2008, purpose study is to investigate the nature and significance of firm size as a determinant of corporate financial leverage in Nigeria. In the findings, the study reveals that 91.4% of total finances of Nigerian-quoted firms is of short-term liabilities and 8.6% constituting long-term liabilities. The results appears to be the firm size is negatively and significantly related to financial leverage. The firm size related to the firm earnings as well where the bigger firm may have higher earning with higher expenses or bigger firm with higher earning with lower expenses or vice versa. This study provides some reasonable disclosure on the effects of firm size on the corporate financing behaviors of firms operating in the country with an undeveloped, inefficient and complex financial system. This study also finds some pecking order patterns in the financing choices of the firms, with large, more profitable and older firms tending to rely less on debt financing, and more on other sources. However, because of the constraints in the country’s financial system, Nigerian firms have common practice of pecking on short-term financing than on the long-term financing, irrespective of their corporate sizes. Which it meant, regardless the firm size in Nigeria, pecking on short and long term financing is common due to the problem of itself country financial system. In report it also shown that 70.7% percent found as the average total debts to total assets ratio among the firms. For instance, 91.4% is from short term liabilities and only 8.6% of long term liabilities. Practically implied that because of predominant use of short term finances, even the larger firm in Nigerian may remain constraint in making capital investment necessary for growth. Therefore, need to take advantage of their size to build strong reputation and high-collateral values that help to guarantee access to long term equity and debt finances.

9. Strategic cost structure choices determine how firms divide operating costs between fixed and variable components, and therefore have important implications for financial performance. Purpose of this study is to examine the effect of operating leverage on equity Betas when managers have discretion over firms’ cost structure by Robert, John & Harriet, 2012. The research is about an analysis of the US trucking industry and using panel data for publicly listed trucking firms over years from 1994 to 2006. The results of this study generally show positively significant coefficients on all three operating leverage variables. In the study, emphasizes the changes in equity Beta imply changes in the firm’s cost of capital, managers should consider the impact of cost structure decisions on their firm’s stock price variability. Achieving and sustaining high operating margins with less risky cost structures that reduce firms’ cost of capital has value enhancing implications. This study also giving a major limitation that the result may not be generalizable across all industries since managers do not always have discretion over Operating Leverage (OL) Levels ; for example, technological constraints in some capital intensive industries compel firms to adhere to an inflexible high fixed cost structure. Suggesting managers should nevertheless identify and be aware of the market risk effects of ‘discretionary’ fixed cost. Example, the finding strongly suggest that a trucking firm manager’s choice between employee driven and owner-operated trucks significantly impacts the firm’s equity Beta. Hence, within the context of the firm’s industry and in conjunction with other operational factors, managers should consciously consider the impact of cost structure choices on the firm’s systematic risk.

10. Another study by Kristoffer & Gerhard in 2014, study investigate the effect of operating leverage, and the subsequent abandonment option available to managers, on the relationship between corporate earnings and optimal financial leverage. The findings analysis reveals that manager’s flexibility to abandon the project introduces nonlinearities into the valuation that are sufficient to reconcile the trade-off theory with the empirically observed negative earnings or financial leverage relationship. Trade-off theory assumes that a manager sets a target debt ratio in order to trade-off the benefits (tax advantages) and cost (bankruptcy cost) of debt financing. In another implication of trade-off theory is that, predicts a positive relationship between earnings and leverage; a prediction which appear inconsistent with the well-established empirical evidence of a negative earnings or leverage relationship ( Kristoffer & Gerhard, 2014). In the existing model of study Kristoffer and Gerhard, existing theoretical modelling provides contradictory conclusions on the relationship between corporate earnings and optimal financial leverage. However, there is strong empirical evidence of an inverse relationship between corporate earnings and optimal financial leverage for a reconciliation of theory and evidence. Besides, the study also provides insights into the relationship between fixed cost and financial leverage, postulating a positive relationship between the fixed cost and financial leverage. Empirical analysis employ data from various cross-sections firms and confirms the relationship and other theoretical predictions made for this study model. Most preciously, many results hold true for the periods before, during and after the global financial crisis, indicating robustness of this study findings. In addition to this research, researchers found that operating revenue and cost structures depends heavily on the industry in which a firm is situated and noting the empirical finding that industry leverage has been found to be strong predictor of firm leverage. Researchers recommendation is that regards to the effect of fixed costs on leverage may yet provide further insights into the effect of industry membership on financial leverage and this is a currently an avenue of an ongoing research.

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