Financial leverage and stock returns: evidence from an emerging economy¹

¹"This work has been fully supported by the Croatian Science Foundation under the project number 9481 Modelling Economic Growth – Advanced Sequencing and Forecasting Algorithm". "Any opinions, findings, and conclusions or recommendations expressed in this material are those of the author(s) and do not necessarily reflect the views of Croatian Science Foundation". Authors are thankful to anonymous referees for valuable comments.

Figures & data

Table 1. YoY Sample Size 2001 to 2013.

Year	No. of Firms
2001	430
2002	452
2003	473
2004	500
2005	500
2006	480
2007	480
2008	475
2009	475
2010	508
2011	508
2012	512
2013	512

Source: Authors’ estimates.

Table 2. Portfolio construction procedure.

Market Capitalisation	Book to Market	Leverage	Portfolios
Big MV	High B/M	Low Leverage	BHLL
		High Leverage	BHHL
	Medium B/M	Low Leverage	BMLL
		High Leverage	BMHL
	Low B/M	Low Leverage	BLLL
		High Leverage	BLHL
Small MV	High B/M	Low Leverage	SHLL
		High Leverage	SHHL
	Medium B/M	Low Leverage	SMLL
		High Leverage	SMHL
	Low B/M	Low Leverage	SLLL
		High Leverage	SLHL

Source: Authors’ estimates.

Table 3. Distribution of factors sorted portfolios (using financial leverage).

Year	BHLL	BHHL	BMLL	BMHL	BLLL	BLHL	SHLL	SHHL	SMLL	SMHL	SLLL	SLHL	Total
2001	31	30	35	37	42	35	45	40	45	35	30	25	430
2002	36	37	38	42	40	39	41	38	42	36	33	30	452
2003	38	40	38	42	40	39	43	42	45	42	35	29	473
2004	41	40	40	38	44	43	46	48	50	45	36	29	500
2005	41	40	40	38	44	43	46	48	50	45	36	29	500
2006	39	41	40	40	42	42	44	46	42	38	36	30	480
2007	39	41	40	40	42	42	44	46	42	38	36	30	480
2008	38	40	39	38	41	40	42	45	40	40	40	32	475
2009	38	40	39	38	41	40	42	45	40	40	40	32	475
2010	43	46	42	44	44	44	43	42	44	42	42	32	508
2011	43	46	42	44	44	44	43	42	44	42	42	32	508
2012	44	47	40	43	44	45	42	44	42	42	44	35	512
2013	44	47	40	43	44	45	42	44	42	42	44	35	512
Total	515	535	513	527	552	541	563	570	568	527	494	400

Source: Authors’ estimates.

Table 4. Distribution of factors sorted portfolios (using probability of default).

Year	BHLL	BHHL	BMLL	BMHL	BLLL	BLHL	SHLL	SHHL	SMLL	SMHL	SLLL	SLHL	Total
2001	35	32	34	39	40	32	46	37	43	37	34	21	430
2002	32	37	42	40	38	35	47	37	40	36	33	35	452
2003	37	38	36	40	38	37	45	45	47	44	36	30	473
2004	45	39	38	42	48	46	40	41	53	46	34	28	500
2005	45	39	38	42	48	46	40	41	53	46	34	28	500
2006	36	41	40	42	45	40	42	44	46	38	35	31	480
2007	36	41	40	42	45	40	42	44	46	38	35	31	480
2008	36	42	37	36	40	35	45	48	36	40	44	36	475
2009	36	42	37	36	40	35	45	48	36	40	44	36	475
2010	40	42	40	44	40	47	47	45	47	40	40	36	508
2011	40	42	40	44	40	47	47	45	47	40	40	36	508
2012	40	46	42	43	41	44	46	45	43	41	46	35	512
2013	40	46	42	43	41	44	46	45	43	41	46	35	512
Total	498	527	506	533	544	528	578	565	580	527	501	418

Source: Authors’ estimates.

Table 5. Descriptive statistics: firm size based on market capitalisation (PKR in millions).

	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013
Median	69.38	86.06	87.76	98.86	115.80	132.64	107.76	125.52	178.22	151.40	148.72	161.69	182.77
Average	382.15	379.95	434.07	429.54	548.81	848.87	685.61	550.39	681.93	782.26	894.78	850.20	1059.53
Std Dev	237.21	266.68	284.18	283.07	383.60	601.39	681.60	751.61	629.13	819.86	672.23	527.01	619.95

Source: Authors’ estimates.

Table 6. Descriptive statistics: book to market ratio.

	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013
Median	0.42	0.38	0.43	0.45	0.52	0.42	0.51	0.47	0.43	0.33	0.39	0.34	0.42
Average	0.55	0.47	0.55	0.57	0.62	0.47	0.59	0.57	0.54	0.43	0.50	0.46	0.53
Std Dev	1.01	0.62	0.46	0.39	0.42	0.28	0.41	0.52	0.45	0.45	0.47	0.46	0.47

Source: Authors’ estimates.

Table 7. Descriptive statistics: net debt to total assets (%).

	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013
Median	42.75	44.57	46.00	48.01	46.26	44.12	42.87	41.90	40.86	41.60	40.55	38.55	41.38
Average	44.10	45.72	47.01	48.54	47.89	46.04	45.23	45.97	45.54	47.60	44.01	41.63	43.78
Std Dev	25.66	25.04	25.72	26.75	27.62	26.84	26.09	27.64	32.47	31.78	29.65	28.40	31.31

Source: Authors’ estimates.

Table 8. Descriptive statistics: probability of default (%).

	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013
Median	1.52	2.03	1.51	1.97	1.77	1.56	2.13	1.77	1.58	1.87	1.53	2.26	1.95
Average	2.02	1.86	1.98	2.70	2.12	2.38	3.27	3.46	3.71	2.80	2.39	2.16	2.65
Std Dev	0.05	0.59	0.63	0.81	0.24	0.85	0.97	0.45	0.95	0.09	0.44	0.19	0.59

Source: Authors’ estimates.

Table 9. Four factor regression on portfolios sorted for size, book to market and leverage (net debt to total assets).

	α	β1	β2	β3	β4	t(α)	t(β1)	t(β2)	t(β3)	t(β4)	R^2	D-W Stats
BHLL	-0.175	-0.852	-0.602	0.732	-0.811	-0.441	-1.627	-4.811	7.916	-4.040	0.424	2.083
BHHL	-0.166	-0.374	-0.751	0.810	0.858	-0.470	-0.637	-5.348	7.802	3.808	0.598	2.097
BMLL	0.111	-0.514	-0.625	-0.058	-0.265	0.298	-0.920	-4.679	-5.858	-2.538	0.302	1.992
BMHL	-0.011	-0.244	-0.676	-0.166	0.661	-0.029	-0.426	-4.939	-5.109	3.771	0.383	2.042
BLLL	0.312	-0.126	-0.631	-0.943	-0.831	0.818	-0.231	-4.840	-9.790	-3.975	0.478	2.089
BLHL	-0.037	-0.276	-0.751	-0.684	0.549	-0.103	-0.483	-5.483	-6.757	4.401	0.517	2.049
SHLL	-0.042	-0.146	0.092	0.910	-0.710	-0.118	-0.251	6.639	8.854	-3.184	0.596	2.031
SHHL	0.336	-0.428	0.143	0.860	0.674	0.917	-0.754	2.498	8.580	3.099	0.402	2.037
SMLL	0.065	0.020	0.030	-0.066	-0.857	0.186	0.034	2.125	-6.229	-3.743	0.350	2.000
SMHL	-0.003	-0.435	0.026	-0.024	0.822	-0.009	-0.788	1.944	-2.444	3.883	0.372	2.035
SLLL	-0.237	-0.769	0.025	-0.884	-0.780	-0.690	-1.271	1.737	-8.276	-3.363	0.284	2.088
SLHL	-0.085	-0.628	0.238	-0.658	0.922	-0.234	-1.094	3.635	-6.488	4.186	0.280	1.997

β₁, β₂, β₃ and β₄ refer to factor loadings on market risk, size, value and leverage premium respectively Level of Significance refer to 99% for |t| > 2.33 and 95% for |t| > 1.96.

Source: Authors’ estimates.

Table 10. Four factor regression on portfolios sorted for size, book to market and financial distress.

	Α	β1	β2	β3	β4	t(α)	t(β1)	t(β2)	t(β3)	t(β4)	R^2	D-W Stats
BHLL	0.246	-0.234	-0.924	0.691	-0.562	0.727	-1.329	−23.331	12.920	-14.387	0.551	2.053
BHHL	0.265	-0.092	-0.901	0.616	0.677	0.982	-0.539	-23.604	11.958	17.999	0.652	2.048
BMLL	-0.109	-0.064	-0.967	-0.585	-0.209	-0.400	-0.449	-30.377	-13.607	-6.664	0.549	1.994
BMHL	0.415	0.025	-1.014	-0.694	0.326	1.581	0.181	-32.969	-16.718	10.759	0.610	2.048
BLLL	-0.423	0.115	-0.968	-0.208	-0.194	-1.509	0.789	-29.465	-4.690	-5.981	0.497	2.092
BLHL	0.334	0.183	-0.912	-0.335	0.338	1.163	1.223	-27.121	-7.381	10.188	0.572	2.058
SHLL	0.069	0.237	0.031	0.478	-0.415	0.253	1.665	9.645	11.071	-13.148	0.597	2.017
SHHL	-0.435	-0.121	0.238	0.706	0.650	-1.230	-0.656	5.738	18.997	15.918	0.419	1.985
SMLL	0.215	-0.225	0.346	-0.736	-0.726	0.740	-1.151	7.878	-18.682	-16.785	0.456	2.039
SMHL	-0.341	0.054	0.078	−-0.803	0.960	-0.991	0.302	2.638	-22.231	24.194	0.536	1.987
SLLL	0.766	0.104	0.096	-0.216	-0.518	0.660	0.692	2.843	-4.741	-15.564	0.465	2.088
SLHL	0.489	0.116	0.125	-0.439	0.425	1.573	-0.713	3.424	-2.793	11.832	0.361	1.995

β₁, β₂, β₃ and β₄ refer to factor loadings on market risk, size, value and financial distress premium respectively Level of Significance refer to 99% for |t| > 2.33 and 95% for |t| > 1.96.

Source: Authors’ estimates.