Study on the relationship between financial
performance and leverage: empirical evidence on
Bucharest Stock Exchange
Lector univ. drd. Floriniţa DUCA
Universitatea ARTIFEX, Bucureşti
Abstract
This paper seek to investigate the relationship between financial
performance of the companies and the companies debt to equity. The empirical
study was conducted on a sample of one hundred companies listed on the
Bucharest Stock Exchange. Financial performance of firms is analyzed by
return on equity. The dataset is obtained from annual reports for 2010. The
results indicate a positive and significant relation between return on equity
and debt to equity.
Key word: Return on equity, debt-to-equity ratio, size firm, corporate
governance
I. Introduction
Corporate governance, i.e. the system by which companies are
directed and controlled, has become a key topic for legislation, practice and
academia in all modern industrial states(Hopt, 2011). Furthermore, corporate
governance covers all the rules of and constraints on corporate decision-making.
Corporate governance is meant to respond to agency problems created by the
separation of ownership and control. Therefore, it defines the relationship
between shareholders and managers. Good corporate governance requires that
managers have the proper incentives to work on behalf of shareholders and that
shareholders are properly informed about the decisions of the managers. Thus, it
allows for a balance between managers’ and shareholders’ desires (Wells, 2010).
Corporate governance in Romania is at initial stages, so proper
application and practice of corporate governance is not present at this moment
in Romania. The objective of the study is to investigate the relationship
between return on equity and the debt-to-equity ratio in companies listed at
Bucharest Stock Exchange. Performance of the firms is affected by practicing
good corporate governance policies.
Literature review
The relationship between performance financial and debt to equity it
is a field of study both in academia and in policy makers in recent years.
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In 2012, Akhtar, et al. investigates the relationship between financial
leverage and financial performance. The result shows that there is a general
perception that a relationship exists between the financial leverage and the
performance of the firms. The financial performance indicators have positive
relationship among leverage and the financial performance.
Using a panel data analysis, Raza( 2013) examines the determinants
of capital structure of Karachi Stock Exchange listed none-financial firms for
the period 2004 through 2009. The regression statistical technique was used
for the research. The results indicated a negative relation between performance
leverage. Also, there was no significant relationship between leverage and
profitability.
In their study, Obradovich and Gill (2013) show 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
positive relationship the value of American firms.
III. Methodological framework
The panel data set covers a on year, with a sample of one hundred
firms listed at Bucharest Stock Exchange. The data were taken from the annual
reports of these firms. All financial data is nominated in terms of romanian
coin. The model used was multiple regressions (more than one independent
variables). I used to study Ordinary Least Squares (OLS) method for analysis
of hypotheses stated in a multiple form. That is, a pooled OLS equation will be
estimated in the form of: Return on Equity = β0 + β1 Debt-to-equity + β2Size
+ μ (1). , Where;

μit = Error term.
Description of variables:


Return on Equity (ROE): Return on equity measures a corporation’s
profitability by revealing how much profit a company generates
with the money shareholders have invested. Return on equity(ROE)
is expressed as a percentage and calculated as: Return on Equity =
Net Income/Shareholder’s Equity.

 The debt-to-equity ratio is a financial ratio show the relative proportion
of companies equity and debt used to finance an companies assets.
Debt-to-equity ratio is used as a standard for judging a company’s
financial standing. It is also a measure of a company’s ability to
refund its debts. A debt-to-equity ratio is calculated by taking the
total debts and dividing it by the shareholders’ equity.

 Firm size is measured by the log natural of total assets.
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IV. Results and discussion
The current section deals with the results of the study which include
the descriptive statistics, econometric results for the model.
The descriptive statistics are calculated and analysis mean and standard
deviation of all the variables have been presented in Table 1. The result relevant
to the descriptive statistics for the return on Equity is 0.2663. The value is
more than one, it indicates that the market value is higher than the total asset
value and that the company might be overvalued. Debt to equity and size have
positive mean value which to 0.8411 for debt to equity to 17.9487 for size.
Debt to equity have the highest standard deviation of 2.9221. This indicates
that the observations in the data set are widely dispersed from the mean. This
table above also shows that size has value of standard deviation of 1.6123.
Descriptive Statistics
Tabel 1
Mean
Median
Maximum
Minimum
Std. Dev.
ROE
0.2663
0.0426
17.5491
-0.1152
1.7554
Size
17.9487
18.0965
24.1899
13.8661
1.6123
Debt-to-equity
0.8411
0.3173
28.5904
-3.3318
2.9221
In this section the results of the inferential statistical techniques used
in the study are presented(Table 2).
Method of least squares
Dependent variable = Return On Equity(ROE)
Variable
Coeff.
Std. Error
t-Stat.
Size
-0.0845
0.0299
-2.8252
Debt-to-equity
0.5703
0.0165
34.5398
C
1.3040
0.5413
2.4089
R-squared
0.9282
Mean dependent var
Adjusted R-squared
0.9268
F-statistic
Durbin-Watson stat
1.9550
Prob(F-statistic)
Table 2
Prob.
0.0057
0.0000
0.0179
0.2663
627.34
0.0000
The table above shows that coefficient of multiple determinations
R-Square which explains the extent to which the independent variables affect
the dependent variable. In this case, 0.9282 or 92.82% of the variations in the
dependent variable were explained by the independent variables. Value for
F-statistic is 627.3477. Diagnosis suggests that the independent variables, level of
debt-to-equity ratio and size firm have a significant relationship with profitability
of the company. Firm size, on the other hand, has a negative and significant.
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The result shows that debt-to-equity ratio has a significant impact
on return on equity, the value of p-value = 0.0000 <0.05(Table 2). Company
size has a significant negative effect on return on equity, the value of p-value
= 0.0057 <0.05. The results presented in Table 2 show that firm size has a
negative and significant relationship with, on the other hand, the debt ratio has
a strong and positive correlation with return on equity. This result is confirmed
by research conducted by Abu-Tapanjeh (2006).
Conclusion
This paper examines the relationship between financial performance
measured by return on equity and debt to equity firm’s for a hundred firms
listed at Bucharest Stock Exchange. The result shows firm size is negatively
related with return on equity at 5 % significance level, indicating larger firms,
lower results than their smaller counterparts, and the debt ratio has a strong
and positive correlation with return on equity.
As for limitations, this study choice of debt ratio and firm size as the
only independent variables affecting profitability was dictated by the available
data sources. The database employed is unique and reliable consisting of the
public annual balance sheets and audit reports. The indicators return on equity
are consistent with those used in previous studies, using return on equity. Given
the limitations mentioned above, there are several lines of research which could
be undertaken as a follow up on this paper: adding more variables to study
the relationships between performance financial and debt to equity; improved
ways to measure profitability as well as investigate it in different time periods.
References
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leverage and financial performance: Evidence from fuel and energy sector of
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33(4), 2010, page numbers 1247- 1292-73, http://ssrn.com/abstract=1581478.
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