Effect of financial leverage on shareholder’s returns in a dynamic business environment

Abstract

Modigliani and Miller’s (1963) paper made revelations on the importance of leverage in reducing tax payment obligations. Shareholders’ return may affect the risk premium associated with the use of leverage. However, the literature on leverage and shareholder returns relationships for a dynamic business environment such as Nigeria is still growing. The one-step differenced generalised method of moments (GMM) estimator is used in analysing an unbalanced panel data of 18 insurance firms for the period 2008-2017. The data used are gleaned from the annual reports of the sampled insurance companies. Results showed that the debt ratio has a significant negative effect on shareholders’ returns. However, the results become positive and significant when debt-equity and interest coverage ratios are used as the leverage ratio. This study supports the pecking order theory. It concluded that the effect of financial leverage on shareholders’ returns depends largely on the decomposition of financial leverage; hence both theories examined are relevant. This study recommended, among other things, that there is a need for the management of insurance companies to reassess the costs and risks associated with financial leverage when financing decisions have to be made. Furthermore, high indebtedness should be trimmed to reduce its negative influence on shareholders’ returns by ensuring an appropriate finance option, which will be in accordance to maximise shareholders’ wealth.

The Impact of Leverage on Financial Performance of Tunisian Quoted Firms

“…Interest expenses increase with a higher amount of debt been incurred. Therefore as the level of debt relative to equity increases a small percentage change in earnings before interest and tax will led to a percentage change in net income (Oyinloye et al, 2020).…”

“…They found a positive relationship between leverage and firm performance. Oyinloye et al (2020) studied 18 insurance firms in Nigeria for the period 2008-2017. They found a negative relationship between leverage and financial performance.…”

Impact of Financial Leverage on Shareholders Return and Financial Performance: Evidence from Top 100 Listed Companies in National Stock Exchange

“…• Return on Equity= Net Profit/ Total Equity (Pandikumr et al, 2020;Oyinloye et al, 2020;Deb and Banerjee, 2018) • Earnings per share= Profit after tax/ Number of shares outstanding (Gaffar and Akal, 2021;Abdulkareem and Meghanathi, 2020;Pandikumr et al, 2020).…”

“…Financial leverage is stated as Debt Equity Ratio= Debt/ Equity (Randika, 2022;Ehiedu et al, 2022;Rajesh et al, 2021;Abdulkareem and Meghanathi, 2020;Oyinloye et al, 2020;Sinha, 2019;Bhayani and Ajmera, 2018;Jose, 2017;Kannadhasan et al, 2016).…”