Balancing Risk and Return: The Influence of Leverage on Corporate Financial Performance

Evans Murithi Murombi and Esha Shaban Mohammed
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Evans Murithi Murombi: Department of Business Administration, Technical University of Mombasa
Esha Shaban Mohammed: Department of Business Administration, Technical University of Mombasa

East African Finance Journal, 2025, vol. 4, issue 2

Abstract: This study investigates the impact of leverage on corporate financial performance, with a particular focus on financial, operating, and combined leverage. Leverage plays a critical role in influencing profitability, risk exposure, and long-term sustainability. Despite extensive academic inquiry, the relationship between leverage and firm performance remains contested, with findings often diverging across industries and economic contexts. This paper employs a literature review and synthesis methodology to explore theoretical perspectives—such as Modigliani and Miller's theorem, trade-off theory, pecking order theory, and agency theory—alongside empirical insights into how leverage influences financial outcomes. The study highlights that while moderate levels of leverage can enhance profitability through tax advantages and investment expansion, excessive reliance on debt increases financial vulnerability, particularly during economic downturns. The paper concludes by recommending that firms adopt balanced capital structure strategies, grounded in contextual industry analysis, to optimize financial outcomes and mitigate risk.

Keywords: Leverage; Financial Performance; Operating Leverage; Capital Structure; Corporate Finance; Agency Theory; Trade-off Theory; Pecking Order Theory; Modigliani and Miller Theorem (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:cwk:eafjke:2025-17

DOI: 10.59413/eafj/v4.i2.6

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