Profitability And The Corporate Leverage Policy Of Firms

Profitability And The Corporate Leverage Policy Of Firms

Corporate Leverage Policy. This study attempts to determine the relationship between the profitability and leverage policy of firms of Fuel and Energy sector of Pakistan. The analysis was implemented on 27 firms in the Fuel and energy sector listed at the Karachi Stock Exchange for the period 2003-2008.

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Regression was used to find out the relationship between the independent variable (Profitability) and dependent variable (Leverage). We expect the negative relationship between the Profitability and the Leverage Policy of firms in the Fuel and Energy sector of Pakistan, confirming the pecking order theory of capital structure. The results found in our study were not as expected.

The results showed that there is inverse relationship between profitability and leverage but our results were not that much significant to accept our hypothesis. So we rejected our pecking order theory hypothesis.

Therefore we conclude that because of certain factors such as economic situation of the Pakistan, rising prices of oil all around the world, interests rates and reliance of firm’s financing needs mostly on bank financing, pecking order theory model becomes insignificant in the Energy and Fuel sector of Pakistan…………..

Capital structure involves different decisions taken by a firm in financing its assets. Generally, a firm can solve this issue through different mixes of debts, equity, or other financial arrangements. It can also combine bonds, TFCs, lease financing, bank loans or many other options with equity in order to boost the market value of the firm.
1.1 Importance of the topic:

Optimal capital structure plays a vital role in the overall value maximization of a firm. The strategic management of capital structure ensures access to the capital needed to fund future growth and enhance financial performance.

Our focus in this study is to correlate the profit of the firm with its leverage. Importance of the study is to find out that which source of funds either retained earnings, debt or equity, a firm in the Fuel and Energy sector should prefer in order to optimize the profit and the value of the firm.

In Pakistan, firms usually prefer short-term borrowing, because commercial banks are the major lenders and they do not encourage long-term loans. Up to 1994 firms did not rely on market based debt; in mid 1994 the government amended the Company Law to help companies to raise debt directly from the market in the form of TFCs (Term Finance Certificates).
1.2 Background of the study:

Various capital structure theories had been discussed b