Financial Leverage and Profitability of PDF

INTERNATIONAL JOURNAL OF RESEARCH IN ECONOMICS AND SOCIAL
SCIENCES(IJRESS)
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VOL. 8 ISSUE 9, SEPTEMBER- 2018
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FINANCIAL LEVERAGE AND PROFITABILITY OF QUOTED FOOD AND

BEVERAGE COMPANIES IN NIGERIA
Joseph I. Onyema
Department of Banking and Finance,
Rivers State University, Port Harcourt
Joy U. Oji,
Department of Banking and Finance,
Rivers State University, Port Harcourt
Abstract
This study examined financial leverage and profitability of quoted food and beverage firms in
Nigeria. It is aimed at studying the relationship between measures of financial leverage and
profitability. Time series data were sourced from the financial statements of the selected food
and beverage firms and were subjected to rigorous statistical analysis such as the Augmented
Dickey Fuller test, co-integration test, granger causality test and vector error correction
models. They were used to examine the dynamic relationship that exists between the
dependent and the independent variables. The level series result in model one found that total
liability ratio relates negatively with return on equity (ROE) and return on assets (ROA)
which were used as the dependent variables in the models while long term debt, equity ratio,
debt ratio and debt equity ratio relate positively with the dependent variables. Model two
found that total liability ratio, long term debt ratio, debt equity ratio and debt ratio have a
negative relationship while equity ratio has a positive with return on equity. The Augmented
Dickey Fuller test found that the variables are stationary at first difference; the co-integration
test found the presence of long run relationship while the Granger causality test found a bi-
directional relationship to exist between the independent and independent variables.
The study concludes and recommends that firms going for debt financing should adopt debt
financing mix of debt ratio, equity ratio and total liability ratio. Of these, debt ratio should be
more vigorously pursued for its profound salutary effect on the profitability of quoted food
and beverage firms in Nigeria.
Keywords: Financial Leverage, Profitability, Food and Beverage Firms, Debt Equity Ratio,
Total Debt Ratio.
Introduction
Financial leverage is traditionally viewed as the use of debt component of capital structure,
through the use of fixed income securities, such as loans and bonds. It has a significant
influence on the company’s ability to achieve its ultimate goal, such as maximizing the
shareholders wealth (Taani, 2012). Increased leverage results in increased return and risk
(Tally, 2014). However, the use of leverage is associated with two different possible
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outcomes either positive such as maximizing the profit or negative such as minimizing the
losses. Financing leverage is determined by profitability, corporate size, liquidity, cash flows,
tax and dividend policy (Rajin, 2012). It is measured in terms of debt equity ratio, long term
debt to total debt, total debt as percentage of total asset and short term debt to total debt
(Rehman, 2013). Financial leverage is intended to earn more on the fixed charges funds than
their costs (Tally, 2014). The effect of financial leverage in maximizing the return of the
shareholders is based on the assumptions that the fixed- charges funds such as the loan and
debentures can be obtained at a cost lower than the firm’s rate of return on net assets
(Damouri, Khanagha, & Kaffash, 2013).
The finance management functions of determining the capital structure of the firm is very
important to the short and the long run sustainable growth of corporate entities. The
separation of ownership from management means that owners’ investment must generate
return which depends on corporate policies such as the financing policy, the dividend policy,
the investment policy and the capital structure policy. How well a firm achieves its
operational objective has a lot to do with these policies. Financial leverage is an important
component in capital structure along with equity and retained earnings. One of the main
debates in corporate finance is the impact of financial leverage on a firm’s investment.
Determining the capital structure mix that will improve a firm’s value is a contentious topic in
financial literature. The literature shows that what might be suitable for one firm in one region
might not be suitable for firms in other industries or regions. Thus, studying the effect of the
capital structure mix in a specific environment helps determine the mix that will improve
firms’ performance in that environment (Graham & Harvey, 2001). In Nigeria, there are
limited studies of citable significance which have dealt on the problem of financing leverage
on profitability of quoted firms. Existing studies such as Ujah and Brusa (2012)
Akinmulegun, (2012) failed to capture measures of financing leverage such as debt equity
ratio and also failed to capture measures of corporate profitability such as return on
investment, return on assets, and return on capital employed. This creates a knowledge gap on
the relationship between financing leverage and profitability of quoted firms. Therefore, this
study intends to examine the relationship between measures of financing leverage and
profitability of food and beverage companies in Nigeria.
Literature Review
Conceptual Framework
Financial Leverage
Leverage refers to the extent to which firms make use of their financial indebtedness such as
debts financing to increase profitability and is measured by total liabilities to equity.
Leverage is a major component of the financial structure of firms, and unlike other causes of
risk, the management has complete control over the risk resulting from leverage. It exists
whenever a company has fixed costs whether in the firm’s operational or financial activities,
meaning, having operational leverage or financial leverage (Graham, 2000). Both types of
leverage affect the profitability of the firms. However, in this research we will be examining
the effect of financial leverage on the profitability of firms. It is concerned with the
structuring of the funds obtained through the capital structuring of the firm, including both
equity & short/long term liabilities.
International Journal of Research in Economics & Social Sciences 47

Measurements of Financial Performance

Return on Equity (ROE)
Debt is an important component of the capital structure of a firm. Debt provides needed
resources to take advantage of profit opportunities. When used productively, debt can
leverage equity capital in a way that is very beneficial financially. But financial leverage is
impartial and unforgiving. Debt works just as well to the detriment of a business when it is
used unproductively, as it works to benefit a farm that is managed wisely. A firm needs to
know whether and to what extent financial leverage is working either for or against their
business. The rate of return on equity (ROE) provides useful information about the
performance of debt in the capital structure. ROE is calculated by dividing net income by
shareholder’s equity. ROE should exceed ROA for firms that borrow money. If ROE doesn’t
exceed ROA, it means that borrowed capital isn’t earning enough to pay its cost.
Alternatively, ROE may be way higher than ROA and may indicate potential to benefit from
additional investments in the firm.
Return on Assets (ROA)
Capital employed must be used productively. Capital is mobile and if not used productively,
will eventually move to where it can generate a competitive return. ROA provides a measure
for assessing the overall efficiency with which the assets are used to produce net income from
operations. It is also indicative of management’s effectiveness in deploying capital, because it
is certainly possible to be efficient and yet poorly positioned in terms of how capital is
utilized. Return on assets is calculated by dividing profit after tax (PAT) and interest returns
by total assets. Return on assets is probably the single best overall measure of operating
performance. It ties together the results of operations with the resources used to produce those
results. It is also relatively easy to interpret
Theoretical Framework
2.2.1 Irrelevance and Relevance Theory
These theories as propounded by Modigliani and Miller (1963) state that under perfect capital
market conditions, a firm’s value depends on its operating profitability rather than its capital
structure, that is, value irrelevant (Modigliani and Miller, 1963). But, in their tax-corrected
paper, Modigliani and Miller (1963) showed that when corporate tax laws permit the
deductibility of interest payments, the market value of a firm is an increasing function of
leverage. With corporate income tax rate tc, and  on an after tax basis, the equilibrium
market value of levered firm is given by:

VL= X (1-tc)/+tcDL 2.1

(4) Where, X equals expected earnings before interest and taxes,

X (1-tc)/  = Vu, value of the firm of all-equity-financed, and tcDL is the present value of

the interest tax-shield, the tax advantage of debt. Given X , VL increases with the leverage,
because interest is a tax-exempt expense. But while this theory successfully introduced the
potential effects of corporate taxes into the capital structure theory, it only leads to an extreme
corner effect as the firm’s value is maximised when 100 percent debt finance is used.

The Pecking Order Theory

In the theory of firm's capital structure and financing decisions, the pecking order was first
suggested by Donaldson in 1961 and it was modified by Myers and Majluf (1984). It states
that companies prioritize their sources of financing (from internal financing to equity)
according to the principle of least effort, or of least resistance, preferring to raise equity as a
financing means of last resort. Hence, internal funds are used first, and when that is depleted,
debt is issued, and when it is not sensible to issue any more debt, equity is issued. Pecking
Order theory tries to capture the costs of asymmetric information. It states that companies
prioritize their sources of financing (from internal financing to equity) according to the law of
least effort, or of least resistance, preferring to raise equity as a financing means “of last
resort. Hence: internal financing is used first; when that is depleted, then debt is issued; and
when it is no longer sensible to issue any more debt, equity is issued. This theory maintains
that businesses adhere to a hierarchy of financing sources and prefer internal financing when
available, and debt is preferred over equity if external financing is required (equity would
mean issuing shares which meant 'bringing external ownership' into the company). Thus, the
form of debt a firm chooses can act as a signal of its need for external finance. The pecking
order theory is popularized by Myers (2001) when he argues that equity is a less preferred
means to raise capital because when managers (who are assumed to know better about true
condition of the firm than investors) issue new equity, investors believe that managers think
that the firm is overvalued and managers are taking advantage of this over-valuation. As a
result, investors will place a lower value to the new equity issuance.
The Agency Cost Theory
This is a theory concerning the relationship between the principal (shareholders) and the agent
of the principal (company’s managers). This suggests that the firm can be viewed as a nexus
of contracts (loosely defined) between resource holders. An agency relationship arises
whenever one or more individuals, called principals, hire one or more other individuals, called
agents, to perform some service and then delegate decision-making authority to the agents.
The agency theory concept was initially developed by Berle and Means (1932), who argued
that due to a continuous dilution of equity ownership of large corporations, ownership and
control become more separated. This situation gives professional managers an opportunity to
pursue their interest instead of that of shareholders (Jensen and Runback, 1986). In theory,
shareholders are the only owners of a company, and the task of its directors is merely to
ensure that shareholders’ interests are maximized. More specifically, the duty of directors is
to run the company in a way which maximizes the long term return to the shareholders, and
thus maximizes the company’s profit and cash flow.
Cash Flow and Free Cash Flow Theory
The free cash flow (FCF) theory considers the internal source of a firm’s funds. However,
FCF has costs associated with the way firms’ managers’ deal with FCF. The focus of the FCF
theory is how to balance cash flow and the costs of FCF. Scott (1981) stated that if a firm has
enough cash flow to pay for their expenses, particularly debt, it will be able to survive. He
argued that firms’ managers will be able to use the firm’s history of cash flows to predict the
firm’s health and future performance. He linked this with the ability of current cash flows to
predict future financing status.

Empirical Review
Akhtar, et al (2012) examines the relationship between financial leverage and financial
performance, evidence from fuel and energy sector of Pakistan. The result shows that there is
a general perception that a mixed relationship exists between the financial leverage and the
performance of the companies. Most of the financial performance indicators have positive
relationship among leverage and the financial performance when compared with debt to
equity ratio while the gearing ratio indicates negative relationships with the leverage
indicators. The gearing ratio also takes into account the effect of capital with return numerator
which not only accommodates the debt but also the outstanding shares of preferred stock. The
result adds that gearing ratio may differ from that of debt to equity ratio while debt equity
ratio takes into account the long term debt.
Rehman (2013) studies the relationship between financial leverage and financial performance
in listed sugar companies of Pakistan. The result shows positive relationship of debt equity
ratio with return on asset and sales growth, and negative relationship of debt equity ratio with
earning per share, net profit margin and return on equity. This negative relationship between
debt equity ratio and earnings per share (EPS) support the fact that as debt increases, the
interest payment will also rises, so EPS will decrease.
Akinmulegun (2012) examines the effect of financial leverage on selected indicators of
corporate performance in Nigeria. This shows that financial leverage significantly affects
corporate performance in Nigeria. Rajin (2012) investigates the influence of financial
leverage on shareholders return and market capitalization, evidence of telecommunication
sector companies in India. He found out that the nature of relationship and the state of
influence of the financial leverage on shareholder’s return and market capitalization
individually indicates positive relationship between financial leverage and shareholder return
but negative relationship between financial leverage and market capitalization. Ujah and
Brusa (2013) suggest that financial leverage and cash flow impact the degrees to which firms
manage their earnings. They continue that it depends on economic group or industry a firm
belongs to their degree and extent of managed earnings varies.
Obradovich and Gill (2013) indicates that larger board size negatively impacts the value of
American firms and CEO duality, audit committee, financial leverage, firm size, return on
assets and insider holdings positively impact the value of American firms. Pandey (2010)
says that the variance and covariance and therefore beta depend on three fundamental factors
such as; the nature of business, the operating leverage and financial leverage. Nasrollah et al
(2013) studies effect of financial leverage and investment diversification on income-
increasing earning management. The results show that financial leverage coefficient is
meaningful at level of 95% of confidence, consequently, it can be concluded that financial
leverage has an influence on income-increasing earnings management.
Enuju and Soocheong (2005) examine the effect of financial leverage on profitability and risk
of Restaurant firms. They find that financial leverage does not influence the restaurant firms’
profitability. It is noteworthy that the sign of financial leverage is positive meaning that more
leveraged firms had more profits on average even though it was not statistically significant.
Nazir and Saita (2013) studies financial leverage and agency cost, an empirical evidence of
Pakistan. The study found out that general and admin expense into to sales ratio is negatively

related to all four leverage ratio. Taani (2012) investigates impact of working capital
management policy and financial leverage on financial performance. The study shows that
firm’s working capital management policy, financial leverage and firm size have significant
relation to net income and also no significant impact on return on equity (ROE) and return on
Assets (ROA).
Akbarian (2013) examines the investigation effect of financial leverage and environment risk
on performance of firms of listed companies in Tehran stock exchange. The result shows that
there is a negative relation between financial leverage and dividend per share and between
market risk and economic risk with free cash flow per share positive significant. It also
indicates that financial leverage, market risk and economic risk with return of equity have
positive significant relationship. Huang and Song (2006) studies on Chinese companies found
a negative relationship between long-term debt and return on assets, as well as between all the
liability and return of assets.
Methodology
Since there are so many types of research design, the one that was used in this study is the ex-
post factor research design. This is because, it involves events that have already taken place in
the past. The records that was observed are from 1990-2016 a period of twenty six years. The
population of this study is all the firms producing food and beverages on the Nigeria Stock
Exchange (NSE). However, because of unavailability of data, the study used only 10 firms’
selected using random sampling technique. The study used only secondary data that were
extracted from the Annual Reports and statements of Account of the selected manufacturing
companies. The data from the Annual Report are assumed to be reliable, because according to
section 11, chapter one of the companies and Allied Matters Act 1990, companies are
required to keep accounts and to produce accounts that give true and fair view of the
company.
The method of data analysis used in this study is the multiple linear regressions using
ordinary least square method. This approach, which is a quantitative technique, includes
statistical test of hypotheses formulated by using ordinary least square with Econometric
View regression analysis at 5% level of significance. Moreover, in order to undertake a
statistical evaluation of our model, so as to determine the reliability of the result obtained and
the coefficient of correlation (r) of the regression, the coefficient of determination (r2), the
student T-test and F-test where employed.
3.5 Model Specification
CP = ƒ (FL) ………………………………………….. (1)
Where CP = Corporate Profitability
FL = Financial Leverage
Disaggregating equation (1) to achieve the objective of the study, we have the following
regression models
ROE = f (DER, DR, ER, TLR, LTDR) `
ROA = f (DER, DR, ER, TLR, LTDR)
Transforming the equations above, to a testable form, we have the following equation
ROE =  0  1DER   2 DR  3 ER   4TLR  5 LTDR  

ROA =  0  1 DER   2 DR   3 ER   4TLR   5 LTDR  

Where
ROE = Return on equity
ROA= Return on assets
DER = Debt equity ratio
DR = Debt ratio
ER = Equity ratio
TLR = Total liability ratio
LTDR = Long term debt ratio
0 = Regression intercept
 = Error term
Estimation Method
Unit Root
It is possible that many series that you would have thought were stationary based on OLS
regression were in fact generated by random walks (Cochrane, 2005) we shall therefore
subject all the variables to unit root test using the augmented Dickey Fuller (ADF) test
specified in Gujarati (2004) as follows.
m
yt  1  2yt 1  i  yt 1  Et
i 1
Where:
yt = change time t
yt 1 = the lagged value of the dependent variables

t = White noise error term
If in the above  = 0, then we conclude that there is a unit root. Otherwise there is no unit
root, meaning that it is stationary. The choice of lag will be determined by Akaike
information criteria.
Co-integration Test
In order to avoid spurious estimates, we intend to establish long-run relationship between the
variable included in the model and Engle-Granger Approach to co-integration will be
adopted. This approach is based on conducting unit root test on residual obtained from the
estimated regression equation. If the residual is found to be stationary at level, we conclude
that the variables are co-integrated and as such long-run relation sip exists among them.
Granger Causality Test
The main objective of this study is to investigate the causality between financial leverage and
profitability of quoted food and beverage firms. Granger (1996) proposed the concept of
causality and exogeneity: a variable Yt is said to cause Xt, if the predicted value of Xt is
ameliorated when information related to Yt is incorporated in the analysis.

Error Correction Model (ECM)

Co-integration is a prerequisite for the error correction mechanism. Since co-integration has
been established, it is pertinent to proceed to the error correction model. The VECM is of this
form:
j 1
yt  yt 1    j yt 1     t , t  1,....., T
i 1
Where Yt is a vector of indigenous variables in the model. α is the parameter which measures
the speed of adjustment through which the variables adjust to the long run values and the β is
the vectors which estimates the long run cointegrating relationship among the variables in the
model.  is the draft parameter and is the matrix of the parameters associated with the
exogenous variables and the stochastic error term.
Testing for Unit Root (Stationarity Test)
The Augmented Dickey Fuller (ADF) unit root test was used to test whether the variables are
stationary .and their order of integration. The ADF was preferable as it corrects for possible
autocorrelation in the model. The result of the ADF unit root test is shown in table 4.3 below:
Table 2: Unit Root Test Summary Results at Level
VARIABL ADF MACKINNON PROB. ORDER OF
E STATISTICS 1% 5% 10% INTR.
ROE -4.434979 -3.724070 -2.986225 -2.632604 0.0019 1(1)
ROA -5.250419 -3.724070 -2.986225 -2.632604 0.0003 1(1)
TLR -1.429812 -3.724070 -2.986225 -2.632604 0.5515 1(0)
LTDR -7.242512 -3.752946 -2.998064 -2.638752 0.0000 1(1)
ER -4.883301 -3.808546 -3.020686 -2.650413 0.0010 1(1)
DR -8.335527 -3.752946 -2.998064 -2.638752 0.0000 1(1)
DER -4.883301 -3.808546 -3.020686 -2.650413 0.0010 1(1)
Unit Root Test Summary Results at First Difference
ROE -6.525659 -3.752946 -2.998064 -2.638752 0.0000 1(1)
ROA -6.633322 -3.752946 -2.998064 -2.638752 0.0000 1(1)
TLR -5.694478 -3.737853 -2.991878 -2.635542 0.0001 1(1)
LTDR -4.885579 -3.724070 -2.986225 -2.632604 0.0006 1(1)
ER -5.137565 -3.857386 -3.040391 -2.660551 0.0007 1(1)
DR -5.740597 -3.737853 -2.991878 -2.635542 0.0001 1(1)
DER -5.137565 -3.857386 -3.040391 -2.660551 0.0007 1(1)
Source: Extracts from E-view
The ADF unit root test indicates that all the variables except total liability ratio were
stationary, at level and first difference. However, following Harris (1995) and Gujarrati
(2003), both I(1) and I(0) variables could be carried forward to test for co-integration which
forms the basis of the next section. The Johansen co-integration test was used to test for the
existence or not of a long run relationship among the variables. The Johansen methodology
was preferable for the study because it has the advantage amongst others of allowing for more
than one co-integration vector. The result of the Johansen co-integration test is shown in the
table below:

Table 3: Johansen Co-Integration Test Results: Maximum Eigen

Hypothesized Maximum- 0.05 Decision
No. of CE(s) Eigen value Eigen Critical Value Prob.**
None * 0.888894 136.8820 95.75366 0.0000 Reject H0
At most 1 * 0.696700 84.14747 69.81889 0.0024 reject H0
At most 2 * 0.646632 55.51471 47.85613 0.0081 reject H0
At most 3 * 0.565107 30.54880 29.79707 0.0409 Accept H0
At most 4 0.339389 10.56508 15.49471 0.2397 Accept H0
At most 5 0.025296 0.614905 3.841466 0.4329 Accept H0
Trace Statistics
None * 0.888894 52.73452 40.07757 0.0012 Reject H0
At most 1 0.696700 28.63275 33.87687 0.1858 reject H0
At most 2 0.646632 24.96591 27.58434 0.1044 reject H0
At most 3 0.565107 19.98372 21.13162 0.0717 Accept H0
At most 4 0.339389 9.950174 14.26460 0.2152 Accept H0
At most 5 0.025296 0.614905 3.841466 0.4329 Accept H0
Model II
Hypothesized Maximum- 0.05 Decision
No. of CE(s) Eigen value Eigen Critical Value Prob.**
None * 0.857480 134.6115 95.75366 0.0000 Reject H0
At most 1 * 0.725779 87.85291 69.81889 0.0010 reject H0
At most 2 * 0.679500 56.80122 47.85613 0.0058 reject H0
At most 3 0.588311 29.49225 29.79707 0.0542 Accept H0
At most 4 0.272476 8.192537 15.49471 0.4450 Accept H0
At most 5 0.022979 0.557939 3.841466 0.4551 Accept H0
Trace Statistics
None * 0.857480 46.75863 40.07757 0.0077 Reject H0
At most 1 0.725779 31.05168 33.87687 0.1048 reject H0
At most 2 0.679500 27.30898 27.58434 0.0542 reject H0
At most 3 * 0.588311 21.29971 21.13162 0.0474 Accept H0
At most 4 0.272476 7.634598 14.26460 0.4171 Accept H0
At most 5 0.022979 0.557939 3.841466 0.4551 Accept H0
The trace statistics from model I indicate no co-integrating equation while the maximum
Eigen from the model one indicates at list 3 co-integrating equation. The maximum Eigen in
model 2 proved 2 co-integrating equations while the trace statistics prove 1 co-integrating
equation. In conclusion, there is the presence of long run relationship between financial
leverage indicators and profitability of the selected food and beverage manufacturing firms.
However, the above result failed to indicate the direction of long run relationship that exists
between the dependent and the independent variables, this enable us to test for normalized co-
integrating equation in the table below.

Table 4 Normalized Co-integrating Equation

Model I
ROA TLR LTDR ER DR DER
1.000000 2.029858 2.164663 -1.827818 -18.24363 -3.655920
(1.49957) (1.36371) (0.61710) (3.93908) (0.36065)
Model II
ROE TLR LTDR ER DR DER
1.000000 3.450163 11.35920 -0.349133 -25.16481 -3.058048
(2.63086) (2.38827) (1.08244) (6.94474) (0.62769)
From model I, the study found that total liability ratio and long term debt ratio has positive
long run relationship with return on assets while equity ratio, debt ratio and debt equity ratio
has negative long run relationship with the dependent variable. Model II also found that total
liability ratio and long term debt ratio has positive impact while equity ratio, debt ratio and
debt equity ratio has negative impact on return on equity. The existence of a least one co-
integrating equation permits the estimation of the parsimonious (preferred) Error Correction
mechanism (ECM) which forms the next section.
Table 5 Parsimonious Error Correction Results
VARIABLE COEFFICIENT STD ERR. T-STATISTICS PROB.
C -1.752106 7.112959 -0.246326 0.8104
D(ROA(-1)) -0.247365 0.320317 -0.772251 0.4578
D(ROA(-3)) 0.195531 0.225709 0.866296 0.4066
D(TLR(-1)) 1.186950 12.11612 0.097965 0.9239
D(TLR(-2)) -11.00729 9.575840 -1.149486 0.2771
D(TLR(-3)) -7.496930 9.944184 -0.753901 0.4683
D(LTDR(-1)) 1.555029 3.462005 0.449170 0.6629
D(LTDR(-2)) -1.646124 3.374336 -0.487836 0.6362
D(LTDR(-3)) -1.544766 2.846272 -0.542733 0.5992
D(DER(-3)) 0.177672 0.768943 0.231060 0.8219
D(DR(-1)) 8.747593 6.293686 1.389900 0.1947
ECM(-1) -0.803511 0.533448 -1.506260 0.1629
C -1.752106 7.112959 -0.246326 0.8104
R2 0.763639
ADJ. R2 0.503641
F-STATISTICS 2.937100
F-PROB. 0.050300
Durbin-Watson 1.829373

Model II
VARIABLE COEFFICIENT STD ERR. T-STATISTICS PROB.
C 36.65052 65.08917 0.563082 0.5830
D(ROE(-1)) -0.221317 0.580465 -0.381275 0.7092
D(ROE(-2)) -0.417148 0.371179 -1.123848 0.2814
D(ROE(-3)) -0.171188 0.363566 -0.470859 0.6455
D(TLR(-1)) 7.231347 14.34097 0.504244 0.6225
D(TLR(-2)) -20.86438 15.91257 -1.311188 0.2125
D(TLR(-3)) -11.20444 12.55134 -0.892689 0.3883
DER -0.875238 1.366586 -0.640456 0.5330
ECM(-1) -0.653594 0.627691 -1.041268 0.3167
R2 0.592309
ADJ. R2 0.341422
F-PROB. 0.041369
Durbin-Watson 1.892795
The Parsimonious ECM result highlighted the significance of the effect of financial leverage
on the profitability of the selected food and beverage firms. The result indicates that the
relationship between financial leverage and profitability has mixed result, while some of the
variables have positive impact at lag I it will record a negative impact at lag II. For instance,
total liability ratio has positive but insignificant effect on return on assets in lag I but have
negative and insignificant effect on return on assets at lag II. However, the none of the
variable is statistically significant in model I. The insignificant impact of the variables could
be traced to internal and external factors that affect the operational efficiency of the selected
firms. Model II found that long term debt, debt ratio and equity ratio was drawn from the
model due to the insignificant impact of the variables within the period covered in this study.
The mixed result enables us to test for causality between the dependent and the independent
variables as contained in the table below.
Table 6 Pair Wise Causality Test
TLR does not Granger Cause ROA 24 0.30579 0.7401
ROA does not Granger Cause TLR 0.48857 0.6210
LTDR does not Granger Cause ROA 24 0.95500 0.4025

ROA does not Granger Cause LTDR 0.01219 0.9879
ER does not Granger Cause ROA 24 6.05143 0.0093

ROA does not Granger Cause ER 0.08970 0.9146
DR does not Granger Cause ROA 24 5.05280 0.0174

ROA does not Granger Cause DR 2.31631 0.1258
DER does not Granger Cause ROA 24 1.02594 0.3775

ROA does not Granger Cause DER 0.68275 0.5172

Model II
TLR does not Granger Cause ROE 24 0.49362 0.6180
ROE does not Granger Cause TLR 0.35995 0.7024
LTDR does not Granger Cause ROE 24 0.81989 0.4555

ROE does not Granger Cause LTDR 0.50324 0.6124
ER does not Granger Cause ROE 24 1.28596 0.2994

ROE does not Granger Cause ER 1.38180 0.2752
DR does not Granger Cause ROE 24 0.36944 0.6960

ROE does not Granger Cause DR 1.84804 0.1848
DER does not Granger Cause ROE 24 0.37199 0.6943

ROE does not Granger Cause DER 2.02582 0.1594
In the granger causality test, model I shows no causality between total liability ratio and
return on assets and no causality between return on assets and total liability ratio, therefore we
accept the null hypothesis. No causality between long term debt and return on assets and no
causality between return on assets and long term debt, therefore we accept the null hypothesis.
There is causality between equity ratio and return on assets we reject the null hypothesis but
no causality between return on assets and equity ratio, we accept the null hypothesis. There is
causality between debt ratio and return on assets we reject the null hypothesis but no causality
between return on assets and debt ratio. Debt equity ratio have no causality on return on assets
we accept the null hypothesis. The results found no causality among the variables in model II;
we therefore accept the null hypothesis.
Descriptive Analysis
The descriptive analysis involves the use of trends and graphs in analyzing the data within the
time frame of the study. For the purpose of this study, the annual time series data was trend
using the excel model.
Prior Expectation of the Result
The a-priori expectation of the variables proposes that an increase in a unit of each of the
explanatory variables leads to increase in the dependent variables (profitability). Therefore it
can be mathematical stated as follows: β1, β2, β3 β4, β5>0.
Data Presentation, Analysis and Discussions of Findings
The results of the multiple regression are presented in Table 1 where the analysis of ROE and
ROA are shown in models I and II respectively. The interpretation of both results is presented
after the Table.

Table 1
Model I: Financial Leverage and Return on Equity (ROE)
VARIABLE COEFFICIEN STD ERRS. T-STATISTICS PROB.
T
TLR -3.258475 5.334941 -0.610780 0.0082
LTDR 0.245602 2.905691 0.084524 0.9335
ER 0.213678 2.161991 0.098834 0.9223
DR 4.419539 8.915582 0.495710 0.0055
DER 0.555764 0.799324 0.695293 0.0449
C 242.0315 146.4079 1.653132 0.1139
2
R 0.777896
2
ADJ. R 0.552630
F-PROB 0.000890
Durbin-Watson stat 2.401563
Model II: Financial Leverage and Return on Assets (ROA)
VARIABLE COEFFICIEN STD ERRS. T-STATISTICS PROB.
T
TLR -2.863955 6.262371 -0.457328 0.0024
LTDR -5.373764 3.410818 -1.575506 0.0000
ER 1.673838 2.537833 0.659554 0.5171
DR -2.661039 10.46547 -0.254268 0.0019
DER -0.061226 0.938279 -0.065253 0.9486
C 568.9057 171.8595 3.310295 0.0035
2
R 0.838681
2
ADJ. R 0.6 76648
F-PROB 0.000047
Durbin-Watson stat 1.991373
Discussion of Findings
Model I on ROE above shows the adjusted R2 of 0.552 which suggests that 55.2% of the
variation in return on equity is attributable to the variations in the identified components of
financial leverage. This is a fairly good fit. Also, the calculated F- value of 4.337 has
probability value of 0.000890 which points to the overall reliability of the model utility. All
the explanatory variables such as LTDR, ER, DR and DER are positively signed and conform
to theoretic expectations except TLR that is differently signed and runs contrary to a priori
expectation. None of them however, is statistically significant.
Model II has an adjusted coefficient of determination (r²) value of 0.677 which shows that the
model has a good fit. Also, the calculated F- value of 6.644 and probability value of 0.000047
implies a good reliability of the entire model. All the independent variables except ER are all
negatively signed and do not correspond to a priori expectation. Again, none of them is
statistically significant.

From the t-values in the regression summary, it is evident that financial leverage in selected
food and beverage firms has no significant effect on return on equity (ROE) and return on
assets (ROA). Of all the explanatory variables in model I, namely, total liability ratio (TLR),
long term debt ratio (LTDR), equity ratio( ER), debt ratio (DR) and debt equity ratio (DER),
only TLR is negative with a coefficient of 3.258 such that its unit increase drops return on
equity (ROE) by 3.258 units. Firms should rather be encouraged to increasingly adopt DER as
a policy since if this increases by one unit, ROE increases by as much as four times the
increase in DR. LTDR, ER, and DER have minimal increases on ROE of 0.245, 0.213 and
0.556 respectively with a unit increase in each of them. The negative relationship between
ROE and TLR could be traced to the high cost of debt in the financial market.
The positive relationship between ROE and the rest of the independent variables conforms to
a-priori expectations and validates the theories reviewed above.
Model II found that total liability ratio (LTR) has a negative coefficient of 2.86, long term
debt ratio (LTDR) has a negative coefficient of 5.37 while equity ratio (ER) has a negative
coefficient of 2.66 and debt equity ratio (DER) has a negative coefficient of 0.06. From these
results, firms should be wary of using TLR, DR and especially LTDR to finance their
operations since they act to reduce the profitability of firms. As far as ROA is concerned,
firms should rather opt for ER since it contributes positively to firms’ profitability.
Conclusions
In accordance with the research findings, the study concludes that firms going for debt
financing should adopt debt financing mix of debt ratio, equity ratio and total liability ratio.
Of these, debt ratio should be more vigorously pursued for its profound salutary effect on the
profitability of quoted food and beverage firms in Nigeria.
Recommendations
In line with the findings of this study, firms going for debt financing should adopt debt
financing mix of debt ratio, equity ratio and total liability ratio. Of these three, debt equity is
the most preferable of them all.
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INTERNATIONAL JOURNAL OF RESEARCH IN ECONOMICS AND SOCIAL

FINANCIAL LEVERAGE AND PROFITABILITY OF QUOTED FOOD AND

International Journal of Research in Economics & Social Sciences

International Journal of Research in Economics & Social Sciences 47

Measurements of Financial Performance

International Journal of Research in Economics & Social Sciences 48

The Pecking Order Theory

International Journal of Research in Economics & Social Sciences 49

International Journal of Research in Economics & Social Sciences 50

International Journal of Research in Economics & Social Sciences 51

ROA =  0  1 DER   2 DR   3 ER   4TLR   5 LTDR  

yt 1 = the lagged value of the dependent variables

International Journal of Research in Economics & Social Sciences 52

Error Correction Model (ECM)

International Journal of Research in Economics & Social Sciences 53

Table 3: Johansen Co-Integration Test Results: Maximum Eigen

International Journal of Research in Economics & Social Sciences 54

Table 4 Normalized Co-integrating Equation

International Journal of Research in Economics & Social Sciences 55

LTDR does not Granger Cause ROA 24 0.95500 0.4025

ER does not Granger Cause ROA 24 6.05143 0.0093

DR does not Granger Cause ROA 24 5.05280 0.0174

DER does not Granger Cause ROA 24 1.02594 0.3775

International Journal of Research in Economics & Social Sciences 56

LTDR does not Granger Cause ROE 24 0.81989 0.4555

ER does not Granger Cause ROE 24 1.28596 0.2994

DR does not Granger Cause ROE 24 0.36944 0.6960

DER does not Granger Cause ROE 24 0.37199 0.6943

International Journal of Research in Economics & Social Sciences 57

International Journal of Research in Economics & Social Sciences 58

International Journal of Research in Economics & Social Sciences 59

International Journal of Research in Economics & Social Sciences 60

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