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Financial leverage and firm efficiency: the mediating role of cash holding

Author

Listed:
  • Haifeng Guo
  • Tenkir Seifu Legesse
  • Jiqiang Tang
  • Zhen Wu

Abstract

Agency cost theory suggests that a firm’s financial leverage is important to improve organizational efficiency. Using data of industrial companies of three biggest economies, this study analyzes how debt-financing decision affects firm efficiency and the mediating role of cash holding. We find inverted U-shape relationship between the level of financial leverage and firm efficiency. This implies that firms with optimum capital structure achieve high efficiency. The cash-holding level of the companies negatively relates to the efficiency. We also document that the firms’ that apply more financial leverage are less likely to hold excess cash balances and that the cash holding partially mediates the relationship between the financial leverage and the firms’ efficiency. This suggests that the use of debt financing has the potential to enhance firm efficiency by effectively tapping the free cash flow that would have been misused by the management. The results have important implications for corporate finance since it highlights how financial decisions determine corporate productivity.

Suggested Citation

  • Haifeng Guo & Tenkir Seifu Legesse & Jiqiang Tang & Zhen Wu, 2021. "Financial leverage and firm efficiency: the mediating role of cash holding," Applied Economics, Taylor & Francis Journals, vol. 53(18), pages 2108-2124, April.
    • Handle: RePEc:taf:applec:v:53:y:2021:i:18:p:2108-2124
    DOI: 10.1080/00036846.2020.1855317
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    Cited by:

    1. Ploypailin Kijkasiwat & Anwar Hussain & Amna Mumtaz, 2022. "Corporate Governance, Firm Performance and Financial Leverage across Developed and Emerging Economies," Risks, MDPI, vol. 10(10), pages 1-20, September.
    2. Guangchun Jin & Jian Xu, 2022. "Does Intellectual Capital Affect Financial Leverage of Chinese Agricultural Companies? Exploring the Role of Firm Profitability," Sustainability, MDPI, vol. 14(5), pages 1-14, February.
    3. Wen‐Min Lu & Qian Long Kweh & Irene Wei Kiong Ting & Chunya Ren, 2023. "How does stakeholder engagement through environmental, social, and governance affect eco‐efficiency and profitability efficiency? Zooming into Apple Inc.'s counterparts," Business Strategy and the Environment, Wiley Blackwell, vol. 32(1), pages 587-601, January.
    4. Ioannis E. Tsolas, 2021. "Efficiency and Determinants of Capital Structure in the Greek Pharmaceutical, Cosmetic and Detergent Industries," JRFM, MDPI, vol. 14(12), pages 1-13, December.
    5. Muh. Sabir Mustafa & Ubud Salim & Nur Khusniyah Indrawati & Siti Aisjah, 2023. "Implementation of Hulontalo Ethnic Values in Small and Medium Businesses (SMEs) Financial Decision-Making," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 7, pages 139-157.
    6. Xiang Zhang & Zongyi Zhang & Han Zhou, 2023. "Grabbing hand or financial constraint mitigation effect? A reexamination of the relationship between institutional development and cash holdings," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(1), pages 631-655, March.
    7. Guoen Xia & Zenghui Yu & Xuwu Peng, 2023. "How Does Enterprise Digital Transformation Affect Total Factor Productivity? Based on the Information Intermediary Role of Analysts’ Attention," Sustainability, MDPI, vol. 15(11), pages 1-22, May.

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