Impact of Operating Leverage on Stock Return A Case of Karachi Stock Exchange

Abstract

Efficient financial management requires the existence of some objective or goal because judgment as to whether or not a financial decision is efficient must be made in light of some standard. Various objectives are possible of which the primary goal of the firm is to maximize the wealth of the firm’s present owners. This study sought to find out the effect of operating leverage on firm’s performance. The objective of this study is to evaluate the relationship between operating leverage, firm profitability and stock return. Industry Capital Structure norms and the performance of companies in the Industry. Secondary data was collected from the KSE. All sectors of the KSE are involved in the study with exception of the financial and investment sector whose leverage is subject to regulation. The sample period was five years between 2004 and 2008. The findings of the study were commercial and services sector had the highest figures for leverage ratio, market value to book value and price earning ratio. Among the companies involved in the study. We use a set of data on all Thai films to examine whether firm size affects the relationship between financial leverage and operating performance during the global financial crisis of 2004-2008. From a data set of 496,430 firm- year observations of a sample of 170,013 firms during 2004-2008, we find that after controlling for firm characteristics, GDP growth, and interest rates, the relation between leverage and operating performance exists across the range of firm sizes, but the magnitude of the effect is conditional on firm size. We show that the effect of leverage on operating performance is non-monotonic, and that leverage change is associated with changes in operating performance. Past operating performance is strongly related to leverage change for medium-sized films, but this relationship does not exist among very small and very large firms. Conditional on leverage and operating performance in 2007, leverage change during 2007-2008 has a negative effect on the change in operating performance over the same period. Firms adopting Industry leverage had low leverage ratio, similar to that of the industry, higher MV/BV and a higher PER as compared to the rest of the firms. This leads to the rejection of the null hypothesis that conformist firms do not record higher performance than non-conformist firms and acceptance of the alternative hypothesis. Further, in carrying out regressions tests and Analysis of Variance tests (ANOVA) it was found out that there was a significant difference in leverage for different Industries. Commercial and services sector had the highest financial leverage followed by Industrial and Allied sector and finally Agricultural sector. This is a manifestation of capital structure theories that different firms have different optimal capital structures depending upon firm characteristics.