Effect of Financial Gearing and Financial Structure On Firm's Financial Performance Evidence From Pakistan

Volume 6, Issue 9, September – 2021 International Journal of Innovative Science and Research Technology
ISSN No:-2456-2165
Effect of Financial Gearing and Financial Structure on

Firm’s Financial Performance
Evidence from Pakistan
M. Naeem Iftikhar Dr. Salman Masood

M. Phil Scholar Professor
Superior University, Lahore, Pakistan Superior University, Lahore, Pakistan
Abstract:- Finance has utmost importance like blood for have awareness about the statistical value of their investment
any company. However, better utilization of funds, interconnected with financial gearing where profitability of
resources or use of debt / equity mixture smartly, has the company may have adverse effect and can ultimately
remarkable influence on organization’s financial affect the stakeholders’ earnings if invested amount is greater
performance. Better implementation of gearing strategy than the company’s profitability (Afza & Hussain, 2011).
moderates the risk and improves operational efficiency as Accordingly, risk is integrally associated with leverage,
well as maximizes shareholders’ wealth. The key concept typically demarcated by the hostile effect on earnings of
is to explore how financial gearing and financial structure numerous uncertain discrete sources. While an organization’s
affect financial performance along with their link between level of risks and its type dependent on numerous aspects for
each other by observing the 12 publicly trading textile example, its volume, magnitude, complication of business
companies registered in the PSX having time span from activities and size etc. If companies have clear and better
2011 to 2020. The study used quantifiable approach awareness of risks can reduce its likelihood resultantly
together with multivariable regression models to analyze enhance the organizational control on its market activities and
the assumptions. Outcomes as a whole demonstrates that thus declines the volatility of its revenues & cash-flow.
when there is no downturn economically in the country, (Krause & Tse, 2016).
low levels of gearing inclined towards high margins of
profit along with high return on equity and assets also. An organization’s financial structure is consisted of
Those external borrowings which are an integral part of only equity shares called unlevered company while if
gearing should less depend but more concentrate to financial structure of an enterprise is consisted of equity and
develop strategies internally in order to enhance the debt called levered company (Olweny and Mamba, 2011).
company’s financial performance. This study also provide The proceeds of financial gearing are used to get high returns
confirmation by estimating different veracities that the than cost of debt as well as interest expense (Cheng and
key components of the Pakistani textile companies to Tzeng, 2010). In evaluating and directing economic industry
develop their operational and financial performance by and capital markets, the Financial Structure has utmost
using the gearing strategy might reap maintainable effective aspect. Therefore, management executives should
imminent development. consider increasing the size of their allocators by determining
the best financial mix for their company. Now recently in
Keywords:- Financial Structure, Gearing, Firm performance valuation of performance and to enhance the value of the
& value, Shareholder’s Wealth. firm, the financial decisions with regard to growing prospects
have become rational. In the year (2012 Tudose) explained
I. INTRODUCTION the performance in ways: organizational as well as financial
both are interconnected, that on the basis of variables which
The stock price of the company reflects the company’s include returns, development, productivity along with
success regarding value of firm in management of its satisfaction of the customer, the measurement of company’s
resources. If stock price increases value of the firm is also performance is possible.
increases towards the maximization of shareholders wealth.
More is the stock price in the market; more will be the firm’s Generally, it is considered that company performance is
value (Fenty & Rafiqoh, 2021). Every organization utilizes influenced by the use of leverage. Currently, company’s
sources of finances to support and/or to increase their sales as businesses lean towards continually modify their financial
a result to escalate profitability as well as wealth of structure with passage of time subject to variations in
shareholders towards the economic growth of the country numerous inward and outward aspects. (Bajaj et al, 2020).
(Dr.N.S. panday & Prabhavathi,2016). In this regard financial Ultimately, in this research the leverage effect on financial
managers are more concerned with the debt & equity level to performance of Textile Companies of Pakistan will be
establish optimal mixture of capital structure for their evaluated. The research results will support to understand the
operations for maximization of earnings along with ensuing facts affecting the earnings through performance by
minimizing the cost of capital (debt and equity). Financial considering choosing the type of leverage.
cost increases with the increase of financial gearing (Deavina
& Husodo, 2021). However, investors are generally don’t
IJISRT21SEP605 www.ijisrt.com 691

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Conclusions will also specify the performance & 2. Future researchers and scholars with experience of this
gearing association of the organizations in a way to evaluate research will quote this study and it can be referred as a
their financial necessities and to know at what level leverage base for further research and the study results on the
should employ to have positive yields for shareholders. This relationship between these factors and the current
research study will provide help to the organizations to economic situation of Pakistan can be used as a basis for
evaluate their operational and financial requirements, future studies along with its relationship with other factors
proficiency to progress and in what way it is useful to of capital and industrial performance.
increase returns for investors and in the end for Pakistan’s 3. Competitive power refers to the fact that strong pressure
economic growth. can be exerted by the other parties having market share or
on the profitability in the same company. Hence, this
Research Problem study provides guidelines for business executives and
Borrowings and company’s own funds are the two basic policymakers in the company’s business process that
financing modes. Choosing an appropriate financing is the should be carefully planned before selecting funding.
basic requirement of the companies. Management tries to 4. The significance of this study stems from the current need
implement most suitable way to finance keeping in view the for economic and trade capital of Pakistan. The
maximum benefits of shareholders. Practically, Companies importance of this study comes from considering three
are functioning in an ambiguous situation (Markovitz, 1959). important factors - cost, equity and interest that affect
That is why; companies may face variations in returns. corporate profits in and around the Pakistani industry.
Practically, the actual situation is much different having 5. This study is to expand understanding and documentation
complications in a competitive market as compared to theory. of how leverage works in the financial system based on
Financing through debt is valuable in case if return on equity high interest rates.
and levels of profits is increased (Kale, 2014). Many 6. The current research is beneficial for listed companies
deliberations are still stand regarding optimum mixture of because it shows the cash flow effect and investment
funds to progress the firm’s financial performance considers towards financial performance.
reducing the risks collectively interlinked with resources of 7. Through this study, companies will also be able to
funds. Past studies explored a little with respect to financial comprehend the significance of retaining the best
gearing as well as financial structure impact on financial optimum financial structure to maximize market and
performance but did not find the influence in liquidity as well economic benefits in Firm’s value.
that have vital role to establish that firms utilizing financial 8. This study adds to the current knowledge about the need
gearing could meet their financial commitments or not. The to leverage the company along with how to help with the
previous studies do not demonstrate the long run impacts of company’s financial performance.
inappropriate gearing levels on performance which finally hit 9. With the knowledge of the authors, the current study
the shareholder’s wealth. Definitely, the firm’s achievement discovers the path of trade relations in connection with
is depended upon the perfect financial structure ascription. In labor as well as capital.
view of the above, the research problem can be framed as per 10. Current research investigates the magnitude in which
below question: financial structure and strong performance is based on
“What is the separate as well as combined impact of high level of competitiveness that companies perceive first
financial gearing and financial structure on firm’s in Pakistan.
financial performance?” 11. This study will be useful in recommending the type of
business plan that is better or more appropriate should be
Study Significance: initiated to maximize performance and industry standards.
The study’s main objective was to focus on 12. Empower the management Executives like CFO or CEO
profitability, mainly in the Pakistani capital market and to of the firms to know how financial structure options to
assess the impact of a mixture of costs and equities, as select the best capital mix ratio have influence on
measured by the leverage, and company’s financial company’s financial performance.
performance. 13. The investors will get help from this study in Pakistan to
1. Though several researches have investigated the relation generate a portfolio in earning the highest profit and
of gearing level with financial performance, but the maximum financial benefits.
numerous research studies have been selected markets of
developed countries and the relation in between financial Contribution in the Research Studies
structure and financial performance has been developed Former researches were primarily related to analytical
through tax incentives and tariffs between prices and subject matter or indicators which are stated in initiatives in
profits using capital payments. Therefore, current research general, the relationship between financial structure, financial
was designed to observe 3 related relations affecting gearing and financial performance has also revealed in some
financial performance: investment, financial structure and researches capturing only the business areas of export,
financial performance. Hence, this method was helpful to tourism, mining, hotels etc. On the contrary, textile industry
study the relation of optimum financial structure mixes comprises of its particular features and remarkable
and low gearing level towards the firm’s financial differences among various markets. The final results of these
performance. researches were not grasped in the same line because of the
difference between making and setting the assumptions under
various circumstances.

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From the review of the different studies there is still a II. RESEARCH METHODOLOGY
deficiency of such type of practical research in Pakistan
which can focus on determining the impact and connection This research study has targeted population of Pakistani
between financial structure, gearing & company’s financial textiles firms registered in PSX. In this present study, the
performance in consideration of financial aspects paying secondary data was collected from the annual reports of 12
special attention on that criterion which adds value to the textile firms having time span from 2011 to 2020. Keeping in
earnings of the Textile companies. Hence, this study will help view the secondary data type e-views software is used to get
in providing solutions of the problems in researches done best results. The current study has used balanced panel data.
before and seek a revised model concerning effect of To grip the findings estimation techniques, (fixed and random
financial gearing on firm’s financial performance in the form effects and OLS technique to confirm relationship) are used
of profitability and liquidity toward the value of the firm in Whereby Hausman’s test has been applied to confirm which
the end. On reviewing literature of earlier studies, there has technique (fixed effect or random effect) is best to accept for
been no research which has dispensed with this angle. analytical purposes.
Hence, knowledge of the researcher which differentiates III. LITERATURE REVIEW

the study is that it brings together with financial aspects that
are quite significant for the financing discipline towards both Defining structure of the capital at its optimum level to
practical side as well as the applications side because add value of the firm is an argumentative subject area in the
financial gearing is one of the elementary columns in literature of finance. Many studies depict the suitability of
operational and financial decision making. This study scope mix structure for one company while the same is not suitable
has financially two-fold effect on firm’s financial for other sectors or areas. Bhatti & Nguyen (2012) studied
performance in the shape of firm’s structure and financial dire need of structure amongst financial markets. Some of the
gearing represented in this research. following theories describe the development process of mix
optimum capital structure involved leverage in the form of
Objectives of the Study debt which creates fixed expense cost who eventually
The present study tries to contract the below mentioned influence the company’s performance. The base of these
key objectives which are: theories was to define the debt-Equity guidelines in a
 To observe the effect of financial gearing and financial company’s capital structure originated on tax and insolvency
structure on financial performance of Pakistani ruins also.
companies of textile industry separately.
 To observe the financially mutual impact of gearing along Theories Related to Financial Gearing and Financial
with structure of capital on financial performance of Structure
Pakistani textile companies. In 1958 Modigliani & Miller determined the
“Irrelevancy of financial structure” to hit firm’s value
Research Questions called M.M. Theory (Ebaid 2009). The value of the firm is
The below mentioned research questions are the part of not dependent or relate to ratio of Debt and equity. A
this research study: company’s avg. capital cost is totally independent against its
 Whether any relation exists in connection with financial financial structure while equity is equal to its capitalization
gearing and financial structure with organization’s rate. In 1961 Donaldson presented “Pecking order theory”
financial performance? the firm performance or profitability stresses preference to
 What is the combined effect of financial gearing and use readily available internal funds to be spent first, followed
financial structure on organization’s financial by debt as such funds are relatively cheaper to raise fresh
performance? equity; and then if funds are still needed, firms should go for
new equity as a last option. Later on, in (1999, Shyam et al)
Research Hypothesis and in (2018 Zeidan et al) explored implementation of this
The business model states that capital is appropriate theory in Brazilian companies. In 1932 from Berle & Means
based on how a company adjusts the value of its capital the history of stockholders or shareholder theory started but
components. This can be attained by generating equilibrium in 1962 Friedman presented “Shareholders’ theory” called
concerning tax revenue and debt, and then reducing corporate the father of this theory. He believed that it’s the fundamental
costs, as well as the risk of lack of funding and financial crisis duty of management executives is to enhance wealth of the
(Ayen & Oruas 2008). The business’s profit margin trades shareholders in any authorized manner (Danielson, Heck &
against its value to maximize the company’s profitability. Shaffer 2008). In 2000 O’Sullivan debated that shareholder
Therefore, in such a case, the real capital would be used to depend on others to make the company’s operations effective.
pay the minimum and maximum amount. The company should operate in the interest of shareholders
towards the shareholders wealth maximization as they are the
Hypothesis principals of the organization. Based on M & M theory, in
H1: Firm’s financial gearing and financial Structure 1973 Kraus & Litzenberger eliminated irrelevant assumptions
significantly influences the organization’s financial of M & M theory where they overlooked the taxes impact or
performance. crooked evidence. In contrast Kraus presented a “Trade-off
H2: A significant relation is existed among financial gearing, Theory” that “there should be comparable of same financial
financial structure and Firm’s performance. gearing ratios of companies of the same industry because

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companies try to optimize the tax savings due to the market Donaldson and Schoorman (1997) demonstrated that agency
value of levered firms equals the market value of unlevered theory is the base of the theory of Stewardship as a hostage
plus tax shield benefit subsequently eliminating the financial approach. In 1977 Ross established this model hypothetical
costs”. This theory explains that a company must successfully structure as an incentive–signaling to define the theory of
balance components costs of financial structure in order to get company’s financial structure. This theory indicates that a
optimum financial structure. The advantages of this theory to company having positive projections will generate new
enhance the value of the firm are traded against their costs. In capital via financing through debt while a company having
the year 1976 Jensen and Meckling define in their “Agency negative projections will prefer financing through equity.
Theory” about the relation between firm’s value and the However, signaling theory may be used to raise the value of
leverage. This theory is interrelated with agency problems firm’s stocks. Hence, theory of signaling expresses that
generates in the corporation due to clashes between management executives of the company sent signals to the
shareholders and management executives or other investors through their financial decisions to stir the
stakeholders or clashes of benefits (Ayen & Oruas 2008). In irregularities. The policy of financial infrastructure is based
the light of this theory the principal (shareholder/s) engross on these signals. While considering “Market Timing” theory
with the agent (other person/s) to execute a particular deal on researchers hypothesize “time” in their research study
behalf of them which contains to authorize decision making because time matters for companies to issue new equities.
power to the agent. Large organizations having shareholders Basically, this theory is in comparison of both trade-off and
large in size may have more ability to lessen agency costs Pecking order theories and called latest financial structure
with respect to small organizations having shareholders small theory. Boudry, Kallberg and Liu (2010) stated that when a
in size. The reason is that shareholders large in size have company’s management feels that their firm is overvaluing in
more funds and inducements to watch organization’s the market, they decide to issue new equity. It all depends on
management executives (Zerni, Kallunki & Nillsson 2010). their value of the firm in the market.
Another theory “Cash flow & Free Cash flow” deals with
costs of free cash flows and the way how to balance the flow Cronqvist et al. (2012) explained in theory of
of cash while debt averts management executives to continue Behavioural consistency that companies’ management of
the intentions individually, as the risk of insolvency would top level steadily act where there is need to select company’s
increase. Thus, in the light of this theory, profitability and gearing. Lam et al. (2013) presented Norm theory about
leverage at high level would have a favorable relation. But behavior (norms) of the managers in the line of environment
some other research studies depicted the adverse relation and regarding their dealings with juniors which influence the
between free cash flow and the debt. For instance, in the year decisions about financial structure. The latest theory related
1995 Hart & Moore described that the debts which are long- to gearing is the theory of Bargaining presented by Chu and
term in nature controls the management’s capability Wang in (2017) explained that suppliers of the company raise
regarding to finance the investments in future. While under their gearing in response of raised gearing by the company in
the “Stakeholders’ theory” the management executives not order to sustain negotiation power with their substantial
only deliberate the shareholders but must also consider customers. On the contrary, when gearing raised by the
stakeholder’s benefit while making the decisions (Jensen customers, in response Company will reduce its’ gearing
2002). This theory emphasizes that stakeholder’s interest level to decrease its risk of insolvency.
should be take into account as they have bargaining power.
More expressively, this theory describes that customer, Review of Literature of the Factors in Selecting the Debt
investors, employees of the organizations and management or Equity Option
groups are included in stakeholders. In 2004 Freeman et al., If a company has tangible assets in large amount it uses
depicted that management executives must generate such to prefer debt capital while it has significant percentage of
relationships which can motivate the stakeholders in making intangible assets, it uses to prefer equity (Harris & Raviv
the communities so that each person can take part actively in 1991). Myers (2001) described that still no complete theory
value addition of the company. Consequently, the “Theory of has been developed to choose the ratio of debt / equity and
Dual-Investor” provides the solution of conflicts between have no cause or motive to suppose a comprehensive
both theories of shareholder and stakeholders. Schlossberger debt/equity theory to select the ratio option. Various research
(1994) demonstrated this theory that projects of each business studies used methodologies different in nature have different
have two types of investors. Firstly, owners of the stock who outcomes along with dissimilar clarifications. Some
deliver particular capital to the business project while researchers Al-Saleh, Abo Hussain and Al-Ajmi (2009)
secondly, the whole society which delivers opportunity defined another factor for variation in the outcomes is to
capital. Hence, a balancing relation exists between account for different situations. They explained that one
shareholders and stakeholders to increase the value of the situation could not be inevitably generalized or fit for other
company. A substitute of agency theory is the “Theory of environments. Organizations have different options to choose
Stewardship”. Herberg, Mausner and Snyderman (1959), different resources to raise their funds. Charalambakis &
McClelland (1961) recommended that managers itself Garrett (2010) described in his research study that companies
interested in disposition to attain, get gratification to give preference to issue debt in case of high rates of average
effectively execute the work of challenging in nature in order tax, on the contrary those companies which have probably
to enforce obligation along with power to provide advantage high distress in financial point of view are unwilling to raise
to the organization. Irrespective of above said research debt. Those companies which are making large amounts of
studies which observe the theory of Stewardship, Davis, profits and have durable position of their finance are

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anticipated to raise additional debt instead of equity. Situation connectivity with procedures of accounting and it is easily
of the market and tax related matters effects the option in calculated from the final accounts of the company to find the
using the financial tools. By taking into account the tax shield return on invested capital. Its formula in accordance with
benefits companies are often preference in using the debt ACCA financial management study text is
option instead of to raise equity capital.
Empirical Review of Financial Structure and

Performance of the Firm:
Tan and Hamid (2016) examined the relation between
cost and industry performance by select an example of 41 In this formula capital employed can be calculated as:
companies listed in the agricultural sector in Malaysia for
time span from 2007 to 2011. The survey results show a
favorable and relevant relation between large salaries and
selected Malaysian firms’ performance. By selecting 136
listed companies in Abata and Migiro (2016) studied the
capital impact assessment and performance of listed Gansuwan & Onel (2012) described that creation of
companies in Nigeria. Examples of 30 companies surveyed value for shareholders is only valuable when a company
during 2005 to 2014. The results of a multi-tasking survey receives return on employed capital greater than the invested
showed that both operating employees returning equity capital’s cost. Bender and Ward (2002) examined that if a
reduced the debt burden. Mauwa et al., (2016) used head-to- firm increases the ROI in that case more funds will be
head data for firms registered on the Rwanda Stock Exchange available to reinvest capital which will cause to escalate the
(RSE) of Nigeria to analyze the relationship of gearing and maintainable level of growth.
performance. The survey results show iterations that show
that all aspects of a company’s performance, i.e., ROE and IV. DEBT ANALYSIS
ROA, are in the company influencing and influencing
profitability. External borrowings in a financial structure are called
debt capital. Normally, the safest type of borrowings is the
Performance Analysis long-term debt. The reason is that firms have much time to
The performance perception has multidimensional payback the principle but just to pay the interest only (Nawaz,
meanings due to which it has become debatable. There are et al. 2011). Different organizations used the public money by
two types of performance measures like operational and depositing it in the company as debt finance. For example,
financial. In accordance with Tudose (2012) the selection of companies received money as a loan from their employees,
alternative performance methods (financial or operational) is customers and shareholders without issuing shares and
depended on set objectives. According to Abdul-Malik et al. debentures. Companies consider that money as public deposit
(2014), financial performance factors such as increasing or loan from public. When a company decides to run its
profits on assets, and increasing benefits of the shareholders operations through external borrowings, the company runs a
are key factors for company performance. Market growth as financial risk and calls it a payroll company. Earhardt and
well as sales growth represent performance characteristics; Bringham (2011) define financial risk as an additional benefit
deliver a comprehensive description of performance. The for shareholders result in borrows money decision. Debt has a
reason is that they emphasis such factors towards financial fixed income which is typically in the interest form causes to
performance. Malm & Roslund (2013), explained that increase risk.
performance can be measured for a company’s specific
department or can check as overall. This study will focus on Financial Gearing:
the overall firm’s performance. This research study will In financial structure of every business, financial
concentrate on comprehensive measures of performance for gearing is the capability to smartly use its sources of fund like
whole of the company keeping in view the profitability preference shares, shareholders equity and external
towards the enhancement of shareholders’ wealth. borrowings to enhance its positive impacts on EBIT towards
net income. Shareholders tolerate fixed charge of financial
Profitability Analysis gearing with the expectation to get more future returns than
Response Variables: Normally, most common response its fixed cost. Financial gearing mostly used to enhance the
variables ROA, ROE and ROI are used to evaluate firm’s capability of EBIT towards the improvement in EPS (Saleem,
efficiency in producing the profits, performance and financial Rahman & Sultana, 2013). Financial gearing having
health. Ehrhardt & Bringham and Ross et al. (2011) while distinction due to the interlinking with firm’s financial
Gitman and Zutter (2012) calculated ROA by Net annual structure along with its relation with capability keeping in
Income to total assets and ROE with net profit to total equity view Several stakeholders’ interest.
while Lindow (2013) calculated ROA by taking EBIT to total
assets and ROE with EBIT to total equity. Malm & Roslund Financial Structure
(2013) explained that ROE indicates the firm’s ability to find Corporate financial statements have shown that not
the opportunities for investments which have a substantial many educated people describe financial structure or
importance for the companies to stay competitive. resources in a narrow way, putting long-term debt into it
Accordingly, the third response variable ROI has direct (Graham, 1996; Devic & Krstic, 2001). However, short-term

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payments as well as long-term capital to participate in capital factor in improving a company’s performance. When a
planning also incorporated due to a number of reasons. First, company announces an increase in new shares, it gives its
Lindsay & Harwood and Rasu (2000) also found that tax distributors a negative signal and as a result reduces the
rates are directly related to debt growth because long-term market share of those shares. In addition, companies with
debt leads to higher interest rates now. Second, emerging weak financial resources spend their earnings from equity
financial institutions may offer them shorter wages and less only to spend with potential investors. As a result, company’s
support for large-scale conditions associated with asymmetric profitability is affected by investment. Furthermore, the
information and unsatisfactory sales (Demirguc-Kunt & concept of “late in order” also explains that the main cost of
Maksimovic, 1998). Third, in times of low interest rates, using the right host presence can undermine a company’s
companies may incur short debts, such as bank loans, profitability. Numerous researches as Abor (2005), Baum,
business insurance, and so on. In addition, the management Schafer & Talavera (2006), Dwilaksono (2010), Gill, et al
role of corporate executives by lenders is becoming (2011), Shubita & Alsawalhah (2012), have shown a
increasingly effective due to short-term debt (Delcoure, 2007; correlation between wage and industrial value. Companies
Fung & Goodwin, 2013). Therefore, containing of long and must have an optimal financial structure as they have to strike
short-term prevention in the design of corporate headquarters a balance between profit or loss (Myers & Majluf, 1984). The
is better (Omet & Mashharawe, 2003; Nikolaos et al., 2007; best design of the house makes the economy more profitable
Joeveer, 2006; Gaud et al., 2005). by reducing the price of financial options.
Financial Performance Corporate Financial Structure in Developing Countries

Yahaya & Lamidi (2015) stated that giving the The reporting of firm’s financial structure along with its
performance financially states to a company’s capability to elements would be fascinating which work under the uneven
attain its objectives along with financial tasks. Kajirwa (2015) circumstances of economic and political in nature and make a
concluded that company’s financial performance depends on comparison of available literature with outcomes. Bas,
company’s assets usage to operate its financial well-being. A Muradoğlu and Phylaktis (2009) discuss capital planning
company can generate and increase profits based on its decisions for companies and emerging markets involving 25
business performance and capabilities. Vijayalakshmi & countries from different regions. Unlike previous researches,
Manoharan (2014) explained that the power of a business is to concentrate on small firms is the main purpose. The reason
the function of financial management to get money when is that these small firms have vital role to more contribute in
needed from the lowest source of corporate income. Business GDP as compared to large companies but they constitute a
activity refers to the efficient use of corporate resources to large proportion of companies in developing countries. This
escalate production capacity. In case of gaining huge profits, survey examines whether urban resource settlers reflect
a company is able to withstand high costs because it has a variances between small, medium and large enterprises, and
high potential to achieve financial performance from debt examines whether capital settlers are same listed companies.
acquisition, which means that the profitable company adds Booth et al. (2001) examined the financial structure of
more. Financial performance is critical to a company’s companies in 10 developing countries: Malaysia, India,
economic success because of the way the company achieves Turkey, Zimbabwe, Pakistan, Thailand, Mexico, Jordan,
its financial goals and objectives of economic growth (Xu & South Korea and Brazil. They ponder those decisions for
Wanrapee, 2014). investment and their impact vary from country to country and
also whether the type of capital structure predicts better if the
Financial Gearing and Financial Performance company is a citizen.
Many clear and concise descriptions seek to describe
the interaction and performance of a company. In principle, The researchers determined that models of financial
the roll-by-roll system emphasizes that companies have a structure have forecasting power in under developed and
system to choose from when they receive funding. The developed countries. They noted that the small companies
provision of funds depends on the debt and availability of this having large tangible assets, which are paying tax and are
type of loan (Mukras and Mule, 2015). Raza (2013) stated profitable, have less debt in total apart from more debt in long
that trade data show that a good financial structure can only term. In the end apart from ratio of market value, financial
be achieved in case of equilibrium in connection with variables at least are affected by the dynamics of the country.
capital’s cost and the company’s cost. Jafari and Moghaddam
(2015) examine the need for job placement. The outcomes Empirical Literature of Pakistan
depicted that a positive relation exists in between the Mostly Pakistan’s pragmatic research studies examined
financial performance and company’s investment. The study only financial structure’s direct effect on performance of the
also explored that companies are more profitable which firm with the help of different samples of Pakistan’s
having higher capital gains as compared to companies which industries. Tauseef et al (2015) studied the efficiency and
are less profitable. gearing relation by taking Pakistani 95 registered firms’
sample for time span from 2002 to 2008. Financial
Financial Structure and Financial Performance performance was measured through ROE where the capital
The relation between performance and capital gains / structure is calculated with cost reduction. The results show
profits is an ongoing topic among academic researchers. The an unrelated relationship between high returns and equity.
documents state that real equity and fees are required when This means that with increased leverage, the company’s
developing a business-to-business strategy because it is a key performance increases to its best capital level and then starts

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to decline. The study also determined that the best debt level uses SDR, LDR and TDR as predictors of change because
is around 56 per cent in Pakistan’s textile provinces. company performance is measured by asset returns. Survey
Moreover, the company’s market growth predicts a return to consequences reflected the adverse relation between whole
company size does not reflect the company’s performance. financial structure and corporate performance.
Ahmad & Mohsin (2016) described financial structure effect
on the firm’s performance related to Pakistani cement There is dire need to research those effects which affect
industry by taking 18 registered firms for time span from in determining the optimum financial structure regarding
2009 to 2015. Performance was calculated with help of total financial performance of the company. For professionals and
asset’s return in which debt was incurred to calculate gearing. academic analysts, financial structure is the key subject in
The outcomes reflected an adverse and costly relation corporate finance. The best ratio of debt and equity which can
between debt and profit. Similarly, Uwais et al. (2016) minimize the cost of capital along with risk of insolvency
demonstrated the capital influence on company’s called the optimum financial structure of the company. In
performance by taking 100 registered non-financial Pakistani conjunction with this study, these studies were nominated
firms having time span from 2004 to 2012. Surveys show that because they are meticulously interrelated with one another
total debt improves the performance of all companies, such as and have influence in making the decisions about financial
ROA, ROE, and Tobin’s Q measures and earns in long and performance and financial structure.
short run. Debt settlement can make a company performance
better. V. FINDINGS, RESULTS ANALYSIS AND
DISCUSSIONS
Habib & others (2016) expanded the available
document by analyzing the relations between gearing and The purpose of overall review descriptive analysis is to
performance by taking sample of 340 registered Pakistani test the hypothesis framed earlier for accomplishment the
companies having time span from2003 to 2012. This study relation among the stated variables.
Table – 5.1 Overall Descriptive Statistics of Variables
Table 5.1 is expressed overall statistics report of all fluctuated from profitability and the minimum value 42.74%
study variables. The mean of ROA showing sample average demonstrates loss for some companies. The said figures show
of respective variable as overall is 4.135%, this depicted that the difference in profitability among the companies. Hence,
Rs. 0.04135 earnings will be produced against investment of the under-review firms describe the outcome and discloses
each rupee one in assets. The other variables like return on that higher %age in ROE’s value than the value of ROA is
equity have higher average upto 9.39% while return on evidenced that companies are prefer to use more equity than
investment average as whole is highest at 15.86% for the the use of debt. Companies less depend on debt financing. In
sample used. the table 5.1 ROI at maximum value is 48.95% shows the
difference fluctuates from profitability while the minimum
The maximum value of ROA has 22.75% shows value of 21.82% is displaying high loss for some specific
difference of range profitability. While the minimum value of companies. The value ROI at 15.86% is evidenced that have
15.35% displays a loss for some companies. While the low value of %age. While gearing measurement reflects in
maximum value of ROE is 44.97% shows the difference high mean value of 55.57%. That thing indicates that

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companies’ liabilities in total on average amount are performance. At the significance level of 0.01 ROE as
appraised upto 55.57% the value of total assets. dependent variable has positive correlation (0.0256) with
ratio of debt using as independent variable, accordingly at
Matrix of Correlation 0.05 levels financial gearing have positive correlation
In table 5.2 outcomes of the tests applied explained (0.0722) with ROE. This reflects that debt has less risk in the
negative correlation among interest coverage as independent sample having positive effect on owners’ equity. On the
variable and ROA (-0.1816), ROE (-0.1518) and ROI (- contrary, at the level of 0.01 of significance the ratio of debt-
0.0114) as dependent variables and also ratio of debt (- equity independent variable has negative correlation (0.020).
0.1954) along with ratio of debt-equity (0.2251) upto the Accordingly at 0.05 level interest coverage also has negative
level of 0.01 significant correlations exists. While financial correlation (-0.152) with ROE. This shows that debt amounts
gearing at 0.5816 is favorable upto level of 0.05 which are high as compare to equity. It reflects that debt financing
reflects theory of agency and show the conflict in between has inverse effect on ROE. Hence, lower debt financing
owners and management executives which may cause the low makes the high return on equity.
Table-5.2 Overall Correlation Statistics of variables
On the same way, at the significance level of 0.01 Hausman Test

returns on investment using as dependent variable also have For implication of policy and for analytical purpose,
positive correlations with ratio of debt and debt-equity by the another Hausman test is employed to determine the most
correlation coefficient of 0.2735 and 0.2227 using as appropriate model to accept in each under discussion periods.
explanatory variables. This reflects that in case if companies’ This test analyzes in clarifying having the disparity or not
debt increased, it will provide opportunity to permit surety for among the three models. In the research study, basically, this
more borrowings for funds investment in better projects. test is applied to determine the most appropriate and best
Conversely, significant correlations are also existed among model among them for acceptance. The following hypothesis
the explanatory variables. At the level of 0.01 of significance is verified through this test to choose the model to accept.
ratio of debt and interest coverage both independent variables
have positive correlations (0.335) between each other. Hypothesis of Hausman Test:
Accordingly, ratio of debt-equity explanatory variable is also H0: represents the suitability for Random effect model
having positive correlations with other two independent H1: represents the suitability for fixed effect model
variables ratio of debt and interest coverage by correlation
coefficient of .3066 and 0.9375 respectively at same said Notable: Statistically significance value of probability
significance level. These positively correlated variables like decides to select the fixed effect or
debt structure and interest coverage reflects company’s Random effect model that which one of the
capability to permit surety for more borrowings. Hence, models will be used in the research study.
companies have much ability to pay the finance cost results in
more debt can use.

ISSN No:-2456-2165
Table 5.6 Results of the Hausman Test
Source: Using E-Views – 10 software Computation of Author
In table 5.6 while closely observing the values of Chi- 5%. Lastly, the values of Probability for both cross-section
Square of above three models where period random, cross and period random are 0.66, 0.29, 0.52 respectively here one
section random or both cross-section and period random value is also below 5%. Hence, cross section Random is
values are in comparison of dependent variables ROA, ROE suitable because in this case null hypothesis cannot reject.
and ROI. Firstly, the values of Probability for cross-section The reason is that all the values are higher than 5%.
random are 0.95, 0.52, and 0.74 respectively which shows Therefore, Suitable model is Random effect model to accept
that all of these values are greater than 5%. Secondly, the for analytical purposes.
values of Probability for period random are 0.73, 0.44, and
0.94 respectively which shows that one value is below than Random Effects Test Analysis
Table 5.5 Random Effects Models Regression Results Excerpt
Source: Using E-Views – 10 software Computation of Author
Econometric form of Projected Random Effects Models ROI = -0.04646 + (-0.05488) X1 + (0.501361) X2 + (-2.58E-
ROA = 0.0442 + (-0.0249) X1 + (0.056639) X2 + (3.92E-05) 08) X3 + (0.017761) X4
X3 + (0.006174) X4
ROE = 0.0072 + (-0.05418) X1 + (0.300962) X2 + (1.20E- The above table 5.5 is displaying the results of all the
04) X3 + (0.000825) X4 three random effect models in order to compare each of them.
Evidently, all the explanatory variables, Debt-equity ratio,

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debt ratio, F.L. ratio and ratio of Interest cover have 4. The outcomes demonstrate that the ratios related to debt
significantly favorable influence on firm’s performance in all and equity has favorable but irrelevant influence on
the three models except one variable (debt-equity) which has company’s performance in case when it is measured with
negative effect on ROA, ROE, and ROI. Therefore, Debt- help of ROA. The ratio related to debt and equity has
Equity ratio has negative effect by -0.025, -0.054 and -0.055 adverse and substantial relation with performance of the
respectively on said explanatory variable while Debt ratio, FL company. Equity returns display favorable and important
ratio (except on ROI significant but negative), and interest relation with ratios of debt and equity. Ratio of equity has
cover ratio have positive effect by 0.056, 3.92, 0.006 on adverse and irrelevant relation with performance of the
ROA, 0.300, 1.20, and 0.0008 on ROE and lastly 0.50, -2.58, company. ROCE or ROI with ratio of debt display adverse
and 0.018 on ROI respectively. and irrelevant relation and debt /equity has favorable and
substantial relation.
All the models regarding overall significance implies 5. Any Enhancement in financial gearing is caused to reduce
the relationship’s direction and behavior of dependent the equity value in contrast assets’ value rise. The reason
variables can be explain with help of explanatory variables is that gearing negatively affect ROE while positively
which is the integral part for models used in the study. This affect ROA. In case where gearing value does not enhance
research study displayed that autocorrelation of Durbin the equity value then gearing has positively affect overall
Watson test (1.97, 2.24, and 1.99), regarding the criteria of firm’s performance.
econometric, is free from autocorrelation’s problem in all the
three models. RECOMMENDATIONS
VI. CONCLUSIONS Based on above said conclusions, the study endorses the
following recommendations:
This study has proven positive relationship among most
of the variables. The result depicts that the Textile Sector 1. The companies related textile sector should associate the
might increase financial gearing by reviewing its better use of concepts of financial gearing and the firm’s value along
internal and external sources of funds upto upper debt with try to combine both in that manner which is
threshold estimate level keeping in view its optimum reproduced on earnings.
financial structure. By applying the pooled regression 2. Companies might have to accomplish an optimum mixture
technique, the results illustrate the positive relationship exists of internal and external funds, for endurance in the long
between financial gearing and performance (ROA, ROE, run towards the company’s growth.
ROI) while adverse relationship with ROE. It emphasizes that 3. While using retained earnings to finance their projects,
increasing of external borrowings declines the financial Companies have to develop fresh strategies in order to
performance which measured with help of Return on Equity. enhance the firm’s financial performance.
The study outcomes described the adverse relation in 4. External borrowings which are an integral part of gearing
concerning nominated firm’s financial gearing as well as should less depend but more concentrate to develop
financial performance. Hence, profit of the firm’s decreases strategies internally in order to enhance the firm’s
when financing in debt increases. Research results explained financial performance.
the adverse relation among ratio of debt, ratio of debt to 5. The regression outcomes demonstrated the unfavorable
equity along with ratio of return on assets. Thus, a firm can relation between financial gearing and financial
produce more profits if it reduces external borrowings which performance of textile industry. Large organizations
are using in the financial structure of the firm. produce maximum earnings with respect to organizations
small in size. Liquidity and profitability both are
The researcher extracts and concludes the following on positively interrelated. Hence, there may be a vital motive
the basis of above said results: for healthier performance of Pakistani textile companies is
the decrease in cost of capital.
1. By examining the study reveals that a favorable relation 6. The authorities of regulatory bodies like SECP and SBP
exists among the financial gearing with Return on should notice the appropriate level of financial gearing of
Investment, Return on Equity and Return on Assets. listed companies of textile as well as banks related sectors
Hence, decisions related to mixture of financing and towards national level. Keeping in view the international
operating expenses fixed in nature favorably affect the standards the ratio of debt-to-equity should set upto the
earning capacity and ability of the company to generate mark at 40:60. The State Bank of Pakistan may direct the
revenue. In case when revenues of the company are commercial banks to consider said ratio during the
greater than fixed financial charges payable to investors / issuance of new loans to the textile industrial sector.
creditors, the gearing as a whole positively affect the 7. Some companies face unstable environment during
revenue. business operations. Because macro-economic variables
2. Large organizations increase the confidence of the are uncontrollable, it is highly probable that firms will be
investor in order to add value of the company. operating in an unstable environment. Either way gearing
3. Any enhancement in the structure of the assets, keeping in is recommended. In a stable environment, high gearing is
view its importance with the help of strategic decisions, is recommended. In an unstable environment, lower gearing
a positive sign for the stakeholders. levels are recommended.

ISSN No:-2456-2165
8. By utilizing external sources, with smart planning to companies. Another way to study future research is to check
finance the company’s operations, companies might invest the firm’s financial performance in comparison of Islamic and
surplus funds in the financial market with help of non-Islamic financing, which can add the knowledge in
repurchase agreements to get high returns with respect to literature.
cost of investment.
09. Management of the companies should take counteractive REFERENCES
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Volume 6, Issue 9, September – 2021 International Journal of Innovative Science and Research Technology

Effect of Financial Gearing and Financial Structure on

M. Naeem Iftikhar Dr. Salman Masood

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Hence, knowledge of the researcher which differentiates III. LITERATURE REVIEW

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Empirical Review of Financial Structure and

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Financial Performance Corporate Financial Structure in Developing Countries

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Table – 5.1 Overall Descriptive Statistics of Variables

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Table-5.2 Overall Correlation Statistics of variables

On the same way, at the significance level of 0.01 Hausman Test

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Source: Using E-Views – 10 software Computation of Author

Table 5.5 Random Effects Models Regression Results Excerpt

Source: Using E-Views – 10 software Computation of Author

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