The Effect of Financial Leverage and Market Size on Stock Returns on the Karachi Stock Exchange: Evidence from Selected Stocks in the Non-Financial Sector of Pakistan

Abstract

This paper studies the effect of financial leverage and market size of selected stocks on stock returns. Ordinary Least Square (OLS) regression models were used to test the relationship between the dependent and independent variables. The leverage of the selected sector was estimated from the Annual Financial reports covering a period of twelve years from 2014 to 2015 non-financial sectors listed in Karachi Stock Exchange. Furthermore, stock index prices of the selected stocks between 2004-2015 for non-financial sector are used to calculate stock return. Capital structure decisions are very important for any firm because they have a direct impact on firm value as well as shareholder’s wealth. The positives or negatives of these decisions determine the future value of any business. Some studies discussed multiple outcomes or relation between stock return and leverage. Some studies reveal positive relationship between them, some review show negative outcomes and some has blended results. The study concluded that there is statistically significant direct relationship between size which is proxy of market capitalization and stock return (100 index prices). However, there is feeble and inverse relationship between financial leverage and stock return, and this relationship is not significant, so there is no statistically significant relationship between financial leverage and shareholders return.

Keywords: financial leverage, market capitalization, ordinary least square, non-financial sector