THE IMPACT OF LEVERAGE ON FIRM’S PROFITABILITY
ABSTRACT
This study investigates the impact of financial leverage on firm profitability, and it also specifically examine to determine the relationship between financial leverage and firm profitability in Nigeria and to examine the impact of financial leverage on firm profitability in Nigeria.
The population consist of firms listed in the Nigerian stock exchange. The sample size consists of 14 listed companies from the oil and gas sector of the economy. Descriptive, Correlation analysis and Regression analysis was used for the data analysis and the sample period is five (5) year ranging between 2010 and 2014.
The research find out that debt equity ratio does not significantly determine the profitability of the firms in the oil and gas sector of Nigerian economy and it also discovered that total asset which is a component of firm size significantly determines the profitability of the firms in the oil and gas sector of the Nigerian economy.
TABLE OF CONTENTS
CHAPTER ONE:    INTRODUCTION
1.1    Background of the Study    
1.2    Statement of Research Problem    
Research Questions    
1.4    Objectives of the Study    
1.5    Research Hypotheses    
1.6    Scope of the Study    
1.7    Significance of the Study    
1.8    Limitations of the Study    
CHAPTER TWO:    LITERATURE REVIEW
2.1 Introduction
2.2 Conceptual Review
2.3 Financial Leverage Theories
2.3.1 Net Income Approach----------
2.3.2 Net Operating Income Approach
2.3.3 Traditional Approach
2.3.4 Modigliani and Miller Theory
2.3.5 The agency cost theory
2.3.6 The pecking order theory
2.4 Review of Empirical Studies
2.4.1 Firm’s Size
2.4.2 Firm Leverage
2.4.3 Firm’s Asset Structure
2.4.4 Firm’s Growth
Firm`s Profitability
CHAPTER THREE:    METHODOLOGY
3.1     Introduction
3.2    Population and Sample Size
3.3    Sources of Data Collection
3.4    Research Design and Data Estimation Technique
3.5    Sources of Data
3.6    Operationalization of Variables
3.7    Methods of Data Estimation and Analysis
3.8     Model Specification
CHAPTER FOUR:    PRESENTATION AND ANALYSIS OF DATA
4.1    Introduction
4.2    Presentation and Analysis of Descriptive Statistics
4.3    Presentation and Analysis of Correlation Results
4.4    Regression Results for examining the Statistical Significance of the
Variables
CHAPTER FIVE:    SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1    Summary of Findings
5.2     Conclusion
5.3  Recommendations
BIBLIOGRAPHY
APPENDIX
APPENDIX II:    REGRESSION RESULTS
LIST OF TABLES
4.2     Descriptive statistics for the variables
4.3    Correlation result for the variables    
4.4     Relationship between firm profitability and leverage
4.5     The relationship between the firm profitability and
financial leverage with correlation or seria correlation
CHAPTER ONE
INTRODUCTION
Background of the Study
It is general concept that financial leverage and financial performance has positive relationship. The objective of the current study is to investigate the influence of financial leverage on financial and to investigate whether financial leverage has an effect on financial performance with evidences from the oil and gas sector of the Nigerian economy.
Excessive leverage by banks is widely believed to have contributed to the global financial crisis (FSB 2009; FSA 2009). As a result, the G-20 and the Financial Stability Board have proposed the introduction of a leverage ratio to supplement risk-based, measures of regulatory capital Leverage allows a financial institution to increase the potential gains or losses on a position or investment beyond what would be possible through a direct investment of its own funds.
There are three types of leverage: balance sheet, economic, and embedded and no single measure can capture all three dimensions simultaneously. The first definition is based on balance sheet concepts, the second on market-dependent future cash flows, and the third on market risk. Balance sheet leverage is the most visible and widely recognized form. Whenever an entity’s assets exceed its equity base, its balance sheet is said to be leveraged. Banks typically engage in leverage by borrowing to acquire more assets, with the aim of increasing their return on equity (Adrian & Shin, 2008).
Embedded leverage refers to a position with an exposure larger than the underlying market factor, such as when an institution holds a security or exposure that is itself leveraged. A simple example is a minority investment held by a bank in an equity fund that is itself funded by loans. Embedded leverage is extremely difficult to measure, whether in an individual institution or in the financial system. Most structured credit products have high levels of embedded leverage, resulting in an overall exposure to loss that is a multiple of a direct investment in the underlying portfolio. Two-layer securitizations or re-securitizations, such as in the case of a collateralized debt obligation that invests in asset-backed securities, can boost embedded leverage to even higher levels. (Andritzky, et al. 2009).
Over the years, the proportionate mix of equity and debt in financing a firm’s investment proposals has been the subject of intensive theoretical modelling and empirical examination having its tenet in the implication of such a mix on corporate performance. The mix has been defined in terms of capital structure in the literature (Grinblatt & Titman, 2003).
Capital structure is seen as the mix of debt and equity. The capital structure decision reflects judgment and the assessment of a highly uncertain future management degree of risk aversion and may affect the firm’s financial policy. Thus, the change in capital structure that is caused by an increase or decrease in the ratio of debt to equity is referred to as financial leverage. When a firm includes debt as a proportion of funds employed to finance its project, financial leverage is brought into being.
It has been claimed by many finance researchers that financial leverage is the top most factor among the other factors that can affect the firm’s profitability. It comprises the capital structure management concepts. Manager choice of making debt intensive or equity intensive company that formulate the financing of the company assets leads to the concept of capital structure formulation. It has been observed that most of the times managers of the company use some extent of debt and some extent of equity to finance their assets. Therefore right choice of the combination of debt and equity is very important for the manager of any company. Those companies who dislike to borrow funds for the financing of their assets have to rely completely on equity financing therefore they are free from any fixed amount of charges to pay which means there is no financial leverage associated with that company. It is obligatory that every individual organization have to give a special focus towards the most important questions of amount of financial leverage, associated cost of capital and their impact on the firm’s profitability.
Mostly firms take money from lenders in order to increase sales volume which leads to higher earnings, such money which company have taken from the lender show the financial leverage associated with that company. Generally financial leverage is measured by the ratio of total debts which company owe and total assets which a company own. Financial leverage ratio tells the extent to which company has used borrowed money in order to finance its capital structure. If company use more borrowed money in order to finance its capital structure. If company use more borrowed money than company have to pay more fixed cost associated with that money. If firm use less amount of debt than have to pay less amount of fixed cost associated with that borrowed money. Such fixed cost associated with the borrowed money is the cost of debt which is generally called as interest amount. If firm borrowed more money from creditors than firm has to pay more amount of cost of debt to the creditors which is called interest rate which leads to the less net income for the firm which means lower profitability.
In economic boom period, higher financial leverage gives benefits to the firm but on the other hand, in economic recession this financial leverage have adverse impact on firms profitability. It can cause cash flow problems in economic recession period for the firm and firm might not be able to meet its interest charges. This could be happen because there will be less sale volume in economic recession which make the firm unable to cover the interest payments to the creditors. In the past numerous studies have been conducted on the market and book value measured of leverage as (Jnag, 2005; Titman and Wessels, 1998; Rajan and Zingales, 1995).
Statement of Research Problem
The relationship between financial leverage and firm profitability is a subject of intense debate in financial literature, where several theories posit that financial leverage affect firm profitability and hence, the existence of an optimal leverage according to the traditional view approach, Miller and Modigliani (1958) argued that financial leverage is irrelevant. They posits that it is capital budgeting decision (Investment) that adds value to the firm and not how such investment is financed or appropriated. The extent of this literature is replete with ample empirical evidences on the subject matter in developing economies with robust capital markets evidences. However, to the best of our knowledge, there is scarcity of empirical evidences from some developing countries like Nigeria. More so, the result from available evidences is mixed. Hence this study is an attempt to help solve this controversy in knowledge. To proceed, we address our minds to the following questions;
1.3    Research Questions
The research questions for the study are as follows:
What is the impact of financial leverage on the firm profitability?
What is the impact of financial leverage on firm performance?
Objectives of the Study
The main objective of this study is to investigate the impact of financial leverage on firm profitability. Related to the main objective, the research is committed to specifically examine the following on Nigeria listed firms.
To determine the relationship between financial leverage and firm profitability in Nigeria
To examine the impact of financial leverage on firm profitability in Nigeria.
Hypothesis of the Study
Hypothesis is a tentative answer to a research question therefore, the hypothesis of this study includes
there is no significant relations between financial leverage and firm profitability
financial leverage does not have any significant  impact on firm profitability in Nigeria.
1.6 Scope of the study
 The firms listed on the Nigerian stock exchange (NSE) shall serve as area of coverage for this study. Data of twenty (20) firms quoted on the Nigeria stock exchange (NSE) between 2010 and 2014, representing 70 firm year observation would be used for the study. Based on this, and conclusion, referencing and recommendations arising from the study may be applicable to other companies in Nigeria.
1.7    Significance of the Study
This research study tends to identify the benefits and contributions of financial leverage to firm profitability on the Nigeria quoted firms by proffering solutions to the impending problems.
The research study will aid management in ascertaining the best method of finance given the paucity of research in the oil and gas sector of the Nigerian economy
Just as some firms uses financial leverage to meet their financing needs little do these firms know concerning its effect their financial performance and hence the firms shareholder’s funds This research will be very helpful for the firms to analyse their financial needs, capacity to borrow and how it is helpful for generating returns for shareholders and ultimately for economic growth.
 (debt and equity) to be employed to achieve minimum cost
It will aid management in making different decisions on the specific mixture of long-term debt and equity capital that will yield substantial profit.
It will help to enlighten the investors on the need to invest in a well leveraged firm with efficient and effective policy.
 To help the firm determine what impact its age has on the performance of the firm.
1.8    Limitations of the Study
    The study like many others is constrained by inconsistent and unreliable data which most often render research work biased and consistent.
 In addition to the problem of poor and unreliable data, one would agree that the chosen sample size is not enough when compared to the total firms quoted on the Nigerian stock exchange. The justification for this can be the time and financial constraint. All these factors together with other subjective factors serve as limitation of this study.