Debt Capital, Default Risk and Financial Performance of Firms

Abstract

This research aimed to examine the effect of debt capital on firms’ performance in Pakistan. For the purpose of analysis, the study selected a sample of 220 firms from 05 sectors listed at Pakistan Stock Exchange. Debt capital was measured in terms of short term and long term debt to assets ratio. The financial performance was measured through return on assets. Certain other firm level variables were taken as the control variable. Secondary data of the firm level variables were extracted from the annual audited reports and the official website of Pakistan Stock Exchange. The study covered the time span of 2011-2017, examined the effect of debt capital on overall sample firms and then across the firms of different default risk level. For placing the firms in relevant default risk class, the study applied Z-score model. The firms were placed in safe, gray and distress zone on the basis of low, indeterminate and high default risk level, respectively. Panel regression model was used to examine the effect of debt capital on firms’ performance in each scenario. The study only observed the significant effect of long term debt capital for overall firms and the firms placed in safe zone while in other scenarios, it remained negative but insignificant. The study suggested the officials of the firms for taking care in determining the proportion of short term and long term debt capital in the capital structure.