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

Author

Listed:
  • Evans Murithi Murombi

    (Department of Business Administration, Technical University of Mombasa)

  • Esha Shaban Mohammed

    (Department of Business Administration, Technical University of Mombasa)

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.

Suggested Citation

  • Evans Murithi Murombi & Esha Shaban Mohammed, 2025. "Balancing Risk and Return: The Influence of Leverage on Corporate Financial Performance," East African Finance Journal, East African Finance Journal, vol. 4(2).
    • Handle: RePEc:cwk:eafjke:2025-17
    DOI: 10.59413/eafj/v4.i2.6
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    References listed on IDEAS

    as
    1. Rajan, Raghuram G & Zingales, Luigi, 1995. "What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-1460, December.
    2. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    3. Joshua Abor, 2005. "The effect of capital structure on profitability: an empirical analysis of listed firms in Ghana," Journal of Risk Finance, Emerald Group Publishing, vol. 6(5), pages 438-445, November.
    4. Myers, Stewart C, 1984. "The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-592, July.
    5. Joshua Abor, 2005. "The effect of capital structure on profitability: an empirical analysis of listed firms in Ghana," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 6(5), pages 438-445, December.
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    Cited by:

    1. CRINGASU Oana Irina, 2025. "Liquidity And Leverage As Nonlinear Determinants Of Risk Of Default," Revista Economica, Lucian Blaga University of Sibiu, Faculty of Economic Sciences, vol. 77(3), pages 106-120, December.

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