Impact of Debt Financing on Performance: Evidence from Textile Sector of Pakistan

Abstract

This research study aimed to determine the impact of capital structure mainly debt financing on firm performance incorporating panel data of 70 textile companies in Pakistan from year 2010-2015 respectively. Balance Sheet Analysis issued by State Bank of Pakistan was used for data collection. Variables for political uncertainty and sub sector/industrial effect is also incorporated in order to identify their impacts on firm performance. Fixed Effects Model was used to find the relationship between firm performance (ROA) and capital expenditure (DTA, LDA and STD). Statistical results present a positive relationship among return on assets and debt-to-asset ratio. This suggests that firms mainly rely on financial leverage for their performance. As the debt-to-asset ratio increases, the return on assets increase. Almost 64.4% of firm’s assets are financed through debt either short term (39.2%) or long term (23.8%). Further it holds a negative relation between short term debt and firm performance measure (ROA) still resulting more short term borrowing because of lower interest rate. The results also showed positive relationship between Long-term debt to assets and Return on assets. These results imply that the textile firms which are heavily trapped in debt must bear huge interest costs. Firm’s sales growth and interest rates have positive and significant effect whereas the firm size has negative but significant impact on its return on assets. It was proved that capital structure has impact over firm performance so managers should adopt necessary carefulness while taking decisions regarding capital structure.

Keywords: Financial leverage, Panel data, Return on Assets, Textile, Pakistan, Capital structure, Debt policy