The Resilience of Central Bank Interest Rate on the Association of Financial Leverage and Firm Performance

Abstract

This study investigates the moderating effect of the Central Bank's interest rate on the relationship between financial leverage and firm profitability. The study uses panel data of Pakistani firms listed on Pakistan Stock Exchange for the period 2009-2016 with fixed effect regression analysis. Firm profitability is used as a dependent variable and is measured by EBIT and ROE while leverage andCentral Bank's Interest Rate (SBIR) are used as Independent variables. Results show that leverage isnegatively associated and statistically significant with firm performance (FP) while SBIR is negativelyrelated but this relation is statistically not significant. This imply that SBIR has no direct effect on firm performance. The important factor is the composite effect of leverage and SBIR on FP, which isnegative and statistically significant. These results imply that the central bank's policy of discountrates has an indirect effect on FP as this policy affects lending decisions of the firm. All these findings are consistent with previous studies. The study adds to the existing literature of banks interest rates and leverage in the sense that when government increases interest rates, it indirectly affects the firm performance as a firm may or may not be able to get credit from these financial institutions. Thus,government and policy makers are to take into account firms' performances and overall capitalmarket while changing he interest rates of the country. Keywords: Financial leverage; Central bank interest rate; Profitability; Moderating effect