Leveraging and Profitability: A Study of Public Companies in the Context of an Emerging Economy

Abstract

Extant research on Financial Leverage and Capital Structure Policy has ignored emerging markets as research contexts. This study attempts to investigate the effects of debt and equity mix, as measured by financial leverage, on a firm’s financial performance in an emerging market like Saudi Arabia. This study was developed to extend understandings in the literature of how financial leverage operates in a zero-interest financial system, and how it may affect financial performance. This research examined 57 publicly trading firms listed in the Saudi Arabian Stock Market between 2002 and 2010. It also extends the understandings previously reported in the literature of how financial performance is linked to financial structure, zakat and the ages and sizes of Saudi Arabian firms in a zero-interest financial system.

The overall results of this study were that, in the long term, in the absence of acute economic downturns, lower leverage levels tend to lead to higher profit margins and returns on both assets and equity. It also provides evidence to recommend that, under normal economic conditions, Saudi Arabian firms could attempt to improve their financial performance by balancing their zakat liabilities with their leverage borrowing levels. Another recommendation made by this study is that more studies are needed to examine zakat calculation standards and zakat’s effect on firms’ capital structure and society.

Keywords: Financial leverage, financial performance, Saudi Arabia Companies

JEL Classification: G2, 05, 016