EuroMed Journal of Business

Dynamic performance, financial leverage and financial crisis: evidence from GCC
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Rami Zeitun Ali Salman Saleh

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Dynamic performance, financial

leverage and financial crisis:
evidence from GCC countries
Rami Zeitun and Ali Salman Saleh
Department of Finance and Economics, Qatar University, Doha, Qatar

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Abstract

Financial
leverage and
financial crisis
147
Received 15 August 2014
Revised 3 November 2014
18 January 2015
Accepted 19 January 2015

Purpose The purpose of this paper is to investigate the effects of financial leverage on firms
performance in Gulf Cooperation Council (GCC) countries. Additionally, this paper investigates the
impact of recent financial crisis on GCC firms.
Design/methodology/approach The authors argue that the firms performance has a dynamic
relationship that cannot be measured in cross-sectional data. Hence, the authors use a panel data to
examine the effect of financial leverage on firms performance using the dynamic Generalised Method
of Moments (GMM) estimator.
Findings The results from the GMM estimator show that companies leverage is a significant
determinant of firms performance in GCC countries. The authors also found that financial crisis had a
negative and significant impact on firms performance in GCC countries.
Research limitations/implications First, the data used in this paper rely on information
published by the firms, and therefore, the robustness of the results were limited by the accuracy of the
data provided. Second, failed firms were excluded from the study sample which may affect the results.
Third, macroeconomic variables could be used in future research to investigate their impact on
companies performance before and after the global financial crisis. Fourth, some other important
variables (such as firm age and firm ownership) could be used in future studies to examine the effects
of the 2008 financial crisis on companies performance.
Practical implications This research provides initial guidelines for policy makers in GCC
countries to understand how to enhance the performance of their firms using financial leverage and
other firm-specific factors.
Originality/value This is a first comprehensive study to investigate the effect of capital structure
and financial crisis on firms performance in GCC countries.
Keywords GMM, Financial crisis, Dynamic performance, Financial leverage
Paper type Research paper

1. Introduction
This paper deals with an important topic in finance, the financial leverage and its
relationship to a firms performance. The importance of this issue in finance stands for
the fact that understanding such issue assists companies in assessing their financial
needs, their borrowing capacity and their ability in generating returns and maximising
performance. Hence, this topic is of considerable importance, not only to understand
a firms financial and borrowing needs, but also for policy makers. Theoretically, firms
with a higher level of leverage should focus more on improving their financial
performance, since a higher leverage indicates that firms suffer from agency costs.
Therefore, there is a negative relationship between financial leverage and firms
performance (Jensen and Meckling, 1976; Myers, 1977). However, some researchers argue
that a positive relationship exists between firm performance and leverage because debt
financing places a burden on managers to maximise a firms value (Anderson et al., 2003;
Jensen, 1986). Nevertheless, profitable firms are less concerned on their debt level (Myers
and Majluf, 1984).

EuroMed Journal of Business

Vol. 10 No. 2, 2015
pp. 147-162
Emerald Group Publishing Limited
1450-2194
DOI 10.1108/EMJB-08-2014-0022

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148

The ambiguous results related to the relationship between a firms performance

and leverage have motivated researchers to conduct further empirical studies in
order to investigate this relationship. However, the majority of the prior evidence
on such a relationship stems from the determinants of capital structure in both
developed and developing countries. Empirical evidence on such a relationship is
lacking, particularly in the case of Gulf Cooperation Council (GCC) countries regarding
the effect of the 2008 financial crisis on firms performance at the micro level (see
Dolenc et al., 2012; Twairesh, 2014; Zeitun, 2014).
The GCC financial markets are small in size and less developed by international
standards and its emerging peers. For instance, GCC countries market volume is
only about 0.8 per cent of the global financial markets and is lagging behind Latin
America and Asia. Additionally, the proportion of GCC equity markets is very low in
comparison to the global equity market capitalisation. For example, the GCC financial
markets accounted for 1.3 per cent of the global equity market capitalisation in 2010
(Kern, 2012). Furthermore, the total number of listed firms in the GCC stock markets
accounted for 707 firms in 2013, although this was comparable with other stock
markets in newly emerging economies such as Poland. It is important to note, that
the first stock market in GCC countries was established in 1977 in Kuwait, followed by
the Saudi stock market which was established in 1984, even though the trading was
effectively launched in 2001. Recent developments in the GCC newly emerging
economies including the opening of the Abu Dhabi Securities Exchange and the Dubai
Financial Market in 2000. This indicates that the stock markets in GCC countries are
considered young in comparison with other stock markets worldwide. Additionally,
there are various barriers to entry to these markets by foreigners, due to restrictions on
the maximum percentage of ownership permitted to foreigners. Moreover, low tax rate,
ownership concentration, high public ownership, and weak market competition were
also some distinctive characteristics of GCC financial markets.
Amongst the GCC stock markets, Kuwait had the largest number of listed
companies, 210, followed by Saudi Arabia, 163 and Qatar had the lowest number of
listed companies, 42. The capitalisation in the GCC stock markets was approximately
$800 billion USD in 2011 with a growth rate of 21 per cent per year (Kern, 2012).
Prior to the 2008 financial crisis and over the last decade, GCC economies expanded
at a higher rate in comparison with some other developing and developed countries.
The high income from oil and gas had resulted in easing the effect of the 2008 financial
crisis and had stimulated the economic growth in GCC countries. Furthermore, non-oil
industries have contributed significantly to this growth. Nevertheless, the financial crisis
negatively affected the global liquidity which in turn affected banks and other financial
instructions ability to offer credit facilities. Therefore, the cost of borrowing increased
tremendously as the accessibility of liquidity decreased and banks created tighter credit
policies which affected firms performance negatively (Ellaboudy, 2010).
Hence, this research provides sundry contributions to the current literature. First
of all, this study presents a comprehensive analysis of a large representative sample of
400 companies listed in the stock markets of six GCC countries. Second, this study
uses the advanced Generalised Method of Moments (GMM) estimation technique. To our
knowledge, this technique is used for the first time in these countries to examine such a
relationship. Additionally, various econometrics measures were also used to confirm the
consistency and robustness of the results. Third, this research emphasises on other
factors (such as risk, size, and growth) that affect firms performance during the financial
crisis within GCC countries. Precisely, this study examines how a firms financial leverage

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affects firms performance using both accounting and market measures of performance.
The studys importance stems from some unique characteristics of GCC economies such
as the low tax rate and the high liquidity. Therefore, this study argues that in GCC
countries, debt financing is not motivated by the benefits of shielding profits from taxes.
The GCC market is also very liquid, thereby lowering the cost of borrowing. Hence, the
results would assist directors and business managers who are regularly interested to
understand the determinants of firms performance and their ability to borrow and
generate high returns for their stakeholders.
The remainder of the paper is organised as follows: Section 2 reviews the literature
related to the area of financial leverage and a firms performance, Section 3 presents the
data, variables, and hypotheses. Section 4 describes the methodology, and Section 5
presents the descriptive analysis. Finally, Section 6 discusses empirical the results, and
Section 7 concludes.
2. Literature review
The relationship between corporate performance and capital structure has been
examined by numerous prominent scholars from a broad range of perspectives (Jensen
and Meckling, 1976; Modigliani and Miller, 1958, 1963; Harris and Raviv, 1991; Myers,
1977; Margaritis and Psillaki, 2007, among many others). Modigliani and Miller (1958)
argued that a firms capital structure is irrelevant to its value. In contrast, according to
the trade-off theory, the relationship between a firms performance and capital
structure exists because of the tax benefits of using debt financing and the cost of
bankruptcy (Scott, 1977). Management devoted a lot of resources to find an optimal
capital structure that maximises each firms value. A study by Harris and Raviv (1991)
concluded that a firms capital structure was associated with the trade-off between the
benefit and cost of liquidation for both shareholders and managers. Therefore, many
firms are interested to increase the level of debt financing, since it generates higher
returns and increases firms value.
Earlier empirical studies had focused on examining the relationship between a
companys performance and financial leverage. For instance, some studies found a positive
relationship between profitability and debt financing (Oke and Afolabi, 2011; Abor, 2005).
However, other studies indicated a significant and negative relationship between financial
leverage and firms performance (for instance see Twairesh, 2014; Mumtaz et al., 2013;
Chinaemerem and Anthony, 2012; Pratheepkanth, 2011; Gleason et al., 2000; Majumdar
and Chhibber, 1999). Krishnan and Moyer (1997) concluded that the ratio of total debt to
total equity significantly and negatively impacts the return on equity (ROE). Hence,
empirical studies were inconclusive with regard to the relationship between profitability
and debt financing (see Ebaid, 2009; Phillips and Sipahioglu, 2004).
Although there is a limited number of studies in the area of financial leverage and
firms performance in GCC countries, there is some literature on such a relationship in
many other parts of the world (for instance see Zeitun and Tian, 2007; Muritala, 2012;
Ojo, 2012; Rehman, 2013; Vithessonthi and Tongurai, 2014; Raza, 2013). Twairesh
(2014) examined the impact of financial leverage on firms performance for 74 firms
from Saudi Arabia using a panel data analysis. He found that debt negatively and
significantly affected firms performance. Recently, Zeitun (2014) used both the fixed
and random effects models to examine the relationship between corporate governance,
capital structure, and firms performance in five selected GCC countries for a relatively
small sample data set of 203 firms. He found that capital structure had no impact on
firms performance. Mumtaz et al. (2013) found that a firms financial leverage

Financial
leverage and
financial crisis
149

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150

was negatively correlated to its market value. Pontoh and Ilat (2013) used a sample of
247 firms listed on the Indonesian stock exchange. They found a negative correlation
between both return on assets (ROA) and ROE and debt.
As indicated earlier, the 2008 financial crisis had a negative impact on global
liquidity and increased the cost of borrowing. This in turn affected the firms ability to
borrow and affects firms performance. Despite the importance of the effect of the
financial crisis on firms performance, only few studies attempted to examine such a
topic in both developed and developing countries in various sectors. For instance,
Lucky and Minai (2011) examined the effect of external factors (e.g. economic factors),
individual determinants, and firm characteristics on small companies performance
during the economic downturn. They indicated that the relationship among external
factors, firm characteristics, individual determinants, and firm performance remained
significant during the economically turbulent period. Dolenc et al. (2012) also found
that a firms performance had worsened during the financial crisis. Fosberg (2012)
found that firms market-debt ratio increased on average by 5.5 per cent and only by
5.1 per cent during the financial crisis when the effect of the recession on companies
capital structure was removed.
3. Data, variables, and hypotheses
3.1 Data
The data set was collected based on secondary data provided by the Bloomberg database.
The panel data included accounting and financial information from companies listed on
the stock exchanges of six countries in the GCC: Qatar, Kuwait, United Arab Emirates,
Kingdom of Saudi Arabia, Oman, and Bahrain. International financial reporting standards
constitute a set of accounting standards used in preparing the financial statements in
GCC countries.
The sample consist of 400 firms listed on the stock exchanges from 18 industrial
sectors for the period of 2004-2012. The sample excluded financial firms, banks, and
insurance companies, because their capital structure and characteristics are different
from other businesses. Additionally, utility firms and firms that underwent mergers
and acquisitions were also excluded from our sample. Following suggestions from
previous studies (Flannery and Rangan, 2006; Lemmon et al., 2008; Dang et al., 2012;
Sobrinho et al., 2012), this research also excluded negative and extreme values for some
firm-specific variables in order to eliminate or at least minimise the impact of outliers
on firm performance. This study includes companies that disclosed more than five
years of financial statements with the aim of upholding the reliability of observations
for each company.
3.2 Description of variables and hypotheses
This study investigates firms performance from two different angels: the firm perspective
using the ROA as an accounting-based measure and the market perspective using Tobins
Q as a market-based measure. These measures (ROA and Tobins Q) were commonly used
in earlier studies (for instance see Ebrati et al., 2013; Sufian and Habibullah, 2009;
Kosmidou, 2008; Anderson et al., 2003). The ROA is the ratio of net income to average total
assets. The Tobins Q is expressed as the ratio of market value (year-end stock prices) of
total equity plus book value of total debt to book value of total assets. Accounting and
market measures of performance are used to investigate whether the independent
variables including the financial leverage have a similar impact on the two measures
of performance.

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In line with earlier studies (for instance see Ebrati et al., 2013; Sufian and Habibullah,
2009; Kosmidou, 2008; Anderson et al., 2003), this paper uses the following independent
variables: firm leverage, size, growth, risk, and tangibility to examine the determinants
of firms performance.
Leverage was measured as the ratio of the total debt to total assets (TDTA).
Additionally, the change in leverage in this paper is defined as the current year
leverage minus the last year leverage over the last year leverage. This variable is used
to examine the effect of change in leverage on the firms performance.
Modigliani and Miller (1963) argued that using debt to finance companies activities
may increase their value. The trade-off theory also argued that profitable firms are
likely to have higher debt because of the associated tax benefits. However, in the case of
GCC countries, debt financing is not affected by tax benefits as the tax rate in these
countries is low. Jensen (1986) stated that profitable firms use more financial leverage to
solve the agency problem between shareholders and managers.
Earlier empirical studies on this issue supported the existence of a positive relationship
between leverage and firms performance (for instance see Oke and Afolabi, 2011; Salteh
and Ghanavati, 2012). In contrast, the pecking order theory argues that profitable firms
tend to rely more on internal financing than outside debt financing, because more cash
flow is generated (Myers and Majluf, 1984). Other studies also indicated an inverse
relationship between profitability and companies leverage (for instance see Ebrahim et al.,
2014; Mumtaz et al., 2013; Zeitun and Tian, 2007). Thus, it is hypothesised that financial
leverage will affect firms performance negatively.
This study measures company size (SIZE) by the logarithm of total assets (for
instance see Chen, 2004; Pasiouras and Kosmidou, 2007; Zeitun and Tian, 2007; Pontoh
and Ilat, 2013). Larger firms have the ability to diversify their investment, lower their
default risk, have more access to capital markets, lower their financing costs, and have
higher profits (see Ebrahim et al., 2014; Fama and French, 2002). Earlier studies found
that a companys size has a significant impact on its performance (for instance
Pasiouras and Kosmidou, 2007). Thus, this study expects a positive relationship
between a firms size and performance (see Adewale and Ajibola, 2013; Pontoh and Ilat,
2013; Jermias, 2008; Zeitun and Tian, 2007; McConnell and Servaes, 1990; Frank and
Goyal, 2003).
This paper defines growth as growth in sales (measured by sales which in current
year minus the sales in last year over the sales in last year). Growth is also used
as a proxy for growth opportunity (GROWTH). It is hypothesised that a company with
a more growth opportunity will have a better performance, because it generates
additional income from new investment projects. Myers (1977) found that companies
with a high growth rate relied more on internal financing and less on debt funding,
which in turn leads to a higher performance. Thus, we expect a positive relationship
between growth opportunities and companys performance.
This study measures risk as the standard deviation of a companys cash flow over
the last three years (RISK). This paper also uses the operating cash flow as a net
income plus depreciation to total assets. This definition of this cash flow was used in
earlier studies (for instance see Gombola and Ketz, 1983; Bowen et al., 1986, Zeitun and
Tian, 2007). In accordance with the classic risk-return trade-off theory, companies with
higher risk should are expected to have higher profit. Therefore, the higher the risk the
higher the expected return in order to compensate the investors for taking more risk (e.
g. see Zeitun and Tian, 2007). Therefore, it is hypothesised that there is a positive
relationship between profits and risk.

Financial
leverage and
financial crisis
151

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152

This study measures tangibility as the ratio of net fixed assets to total assets
(TANGIBILITY). Tangible assets could increase companies ability to have higher debt
at lower cost because tangibility serves as a collateral (for instance see Frank and
Goyal, 2009; Zhang and Kanazaki, 2007; Chen, 2004; Scott, 1977). However, extensively
investing in tangible assets without improvement in a companys profitability may
negatively affect firms performance. Thus, it is hypothesised that tangibility may affect
firms performance positively.
As indicated earlier, the 2008 financial crisis decreased global liquidity which in turn
increased the cost of borrowing as the accessibility of liquidity decreased and banks had
tighter credit policies. During the downturn firms demand on finance increased due to the
need to finance their activities. However, increasing the cost of borrowing limited firms
opportunity to have access to external funds which affected firms performance negatively
(for instance see Ellaboudy, 2010; Sufian and Habibullah, 2010; Dolenc et al., 2012). In order
to capture the effect of the financial crisis on companies performance, this study uses a
dummy variable equal to one during the period 2008-2012 is included. Therefore, it is
hypothesised that the 2008 financial crisis could affect firms performance negatively.
4. Methodology
Much of the earlier research in the area of financial leverage and firms performance used
the traditional econometrics techniques such as descriptive and correlation analysis,
pooled ordinary least square (OLS) regression, random and fixed effects regressions,
instrumental variable and two-stage least square estimation, and Vector Auto Regression
models (for instance see Ojo, 2012; Hidayat and Abduh, 2012; Raza, 2013; Rehman, 2013).
However, this paper uses a GMM dynamic panel which is a more advanced estimation
technique. This method has become more popular, because standard econometric
techniques such as OLS do not provide unbiased estimates, due to the presence of the
lagged dependent variable among the explanatory variables (for instance see Fan et al.,
2011; Wintoki et al., 2012; Masoud, 2014). Additionally, the existence of correlation
between the lagged dependent variables and the error term denotes the presence of
endogeneity, which biases the estimated coefficient of the lagged dependent variable
when using OLS estimation. The GMM estimation method could resolve this issue (for
instance see Alvarez and Arellano, 2003). The unbalanced panel data consist of a small T
(time series) and a large N (cross-section) which is suitable to use the system GMM
estimator (Nickell, 1986; Arellano and Bover, 1995; Blundell and Bond, 1998; Bond, 2002).
This study assumes that a firms performance could be affected by the prior years
performance as well as financial leverage, size, growth, risk, and tangibility. The GMM
estimator is of the following form:
yit dyit1 xit bi wit bi eit ;

i 1; . . .; N ; t 1; . . .; N ;

(1)

where i is for the countrys specific and time-varying characteristics, X is for the
independent variables, W captures time dummies and the financial shocks time-specific
heterogeneity, eit is the idiosyncratic error, and d is the autoregressive coefficient. The
Arrellano and Bonds autocorrelation test is used in this study to test for the second-order
serial correlation. Sargan test is also used to test the significance of the models.
5. Descriptive statistics
Table I reports the summary statistics for the variables used in the study. The average
ROA for the sample period 2004-2012 is about 6.1 per cent, this is low compared to the

value of Tobins Q (about 131 per cent). On average, the leverage using TDTA is about
24.4 per cent.
Table II presents the correlation between companys performance measures (ROA
and Tobins Q) and the firms specific variables for the whole period as well as for
sub-periods both pre- and post-crisis periods. Table II shows that a companys
performance (ROA) is negatively correlated with the leverage ratio TDTA
but positively correlated with GROWTH and SIZE variables for both the whole

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Variable

Observation

Mean

SD

Min.

ROA
2,677
0.06095
0.101368
0.67812
TOBINQ
2,525
1.314124
1.001097
0.00602
TDTA
2,196
0.243791
0.191566
0.000584
GROWTH
2,380
13.93276
38.80271
157.388
RISK
2,677
0.0473
0.050512
0.000109
SIZE
2,678
5.312076
0.753469
2.512462
TANGIBILITY
2,544
0.428155
0.253917
1.78E-05
Note: See Section 3.1 description of variables for variables definitions

Variables

ROA

TOBINQ

TDTA

2004-2012
ROA
TOBINQ
TDTA
GROWTH
SIZE
RISK
TANGIBILITY

1
0.284*
0.313*
0.201*
0.087*
0.148*
0.088*

1
0.140*
0.064*
0.049*
0.007
0.002

2004-2007
ROA
TOBINQ
TDTA
GROWTH
SIZE
TANGIBILITY
RISK

1
0.259*
0.346*
0.102*
0.200*
0.161*
0.161*

1
0.163*
0.033
0.271*
0.013
0.053

Financial
leverage and
financial crisis
153

Max.
0.661269
6.896239
0.956735
214.9823
0.755788
7.955408
1.090462

GROWTH

SIZE

RISK

TANGIBILITY

1
0.046*
0.102*
0.005
0.263*

1
0.050*
0.046*
0.001

1
0.117*
0.0413*

1
0.127*

1
0.103*
0.087*
0.032
0.312*

1
0.093*
0.011
0.007

1
0.108*
0.073*

1
0.079*

2008-2012
ROA
1
TOBINQ
0.244*
1
TDTA
0.283* 0.093*
1
GROWTH
0.194*
0.059*
0.038
1
SIZE
0.094* 0.068*
0.191*
0.075*
1
TANGIBILITY 0.321* 0.043
0.006
0.090*
0.117*
1
RISK
0.018
0.007
0.228*
0.021
0.079* 0.150*
1
Notes: See Section 3.1 description of variables for variables definitions. *Statistically significant at
5 per cent level

Table I.
Summary statistics
2004-2012

Table II.
Correlation
coefficients
2004-2012 and
sub-periods

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154

period and the sub-periods. The firm performance (ROA) also has a negative
correlation with TANGIBILITY and RISK variables for both the whole period and
the sub-periods.
6. Discussion of results
6.1 Dynamic performance and financial leverage
Arrellano and Bonds zero autocorrelation test suggested that the residuals were not
affected by the second-order serial autocorrelation. The findings are robust because the
system GMM estimator produces consistent estimates; this is confirmed by Arrellano and
Bonds zero autocorrelation tests statistic. Thus, the moment conditions were valid as this
study could not find a second-order serial correlation in the idiosyncratic errors in the
regressions with both variables in leverage and changes in leverage (see Tables III and IV).
These findings also suggest strong evidence in favour of the null hypothesis that there is
no autocorrelation in higher orders. Furthermore, this research also conducts Sargan test.
This test shows that the instruments used in the GMM models are not correlated with
the residuals. For all models, the value of the Wald 2 is insignificant using ROA and
Tobins Q measures of performance.
Table III indicates that the estimated coefficient for the lagged dependent variables,
Performancet1 (ROA) and Performancet1 (TOBINQ), is significant. This significance
implies that the previous years performance for the GCC firms has a positive and

Variables

0.172
0.123
0.189
0.037
0.485
0.591
(0.006)***
(0.005)***
(0.044)***
(0.042)
(0.036)***
(0.043)***
TDTA
0.260
0.861
0.223
1.748
0.206
0.403
(0.007)***
(0.053)***
(0.041)***
(0.571)*** (0.034)***
(0.223)*
GROWTH
0.0002
0.0002
0.0002
0.0004
0.0002
0.0004
(0.00001)*** (0.00008)*** (0.0001)**
(0.001)
(0.00007)** (0.0006)
SIZE
0.109
0.062
0.038
0.159
0.081
0.216
(0.003)***
(0.02)***
(0.013)
(0.143)
(0.037)**
(0.092)**
RISK
0.358
0.893
0.318
0.284
0.199
0.888
(0.009)***
(0.098)***
(0.087)***
(1.42)
(0.183)
(0.337)***
TANGIBILITY 0.110
0.015
0.071
1.349
0.062
0.307
(0.004)***
(0.0323)
(0.031)***
(0.452)**
(0.028)**
(0.339)
F_SHOCK
0.052
0.597
X
X
X
X
(0.001)***
(0.015)***
Constant
0.382
1.12
0.42
0.72
0.438
1.56
(0.017)***
(0.108)***
(0.072)***
(0.320)**
(0.362)
(0.469)***
Arellano-Bond
test for Ar(2) (pvalue)
(0.0873)
(0.065)
(0.067)
(0.072)
(0.6184)
(0.9223)
Sargan test
(p-value)
(0.1443)
(0.0989)
(0.1188)
(0.0985)
(0.7899)
(0.1275)
Observations
1,843
1,788
554
520
1,038
1,030
Notes: Robust standard errors are in parentheses except p-values for Sargan test and Arellano-Bond
test. Industrial and country dummy variables are included in the regression. See Section 3.1 description
of variables for variables definitions. *,**,***Significant at 10, 5, 1 per cent level, respectively

Performancet  1

Table III.
Firms performance
in GCC for the full
sample and the
sub-sample periods
(2004-2007,
2008-2012)

Full sample 2004-2012

Pre-crisis 2004-2007
Post-crisis 2008-2012
Performance Performance Performance Performance Performance Performance
(ROA)
(TOBINQ)
(ROA)
(TOBINQ)
(ROA)
(TOBINQ)

Variables

Full sample 2004-2012

Pre-crisis 2004-2007
Post-crisis 2008-2012
Performance Performance Performance Performance Performance Performance
(ROA)
(TOBINQ)
(ROA)
(TOBINQ)
(ROA)
(TOBINQ)

0.163
0.153
0.08
0.048
0.454
0.743
(0.025)***
(0.045)***
(0.046)*
(0.008)*** (0.036)***
(0.043)***
TDTA
0.136
0.48
0.177
2.749
0.079
0.048
(0.032)***
(0.044)***
(0.055)***
(0.733)*** (0.034)**
(0.035)
Change_TDTA 0.128
0.352
0.061
1.259
0.153
0.233
(0.035)***
(0.041)
(0. 763)**
(0.035)***
(0.242)
(0.025)***
GROWTH
0.0002
0.00006
0.00028
0.0013
0.0002
0.0004
(0.0001)**
(0.223)
(0.00007)** (0.00049)
(0.00004)*** (0.000)***
SIZE
0.112
0.073
0.0087
0.049
0.078
0.182
(0.017)***
(0.011)***
(0.012)
(0.828)
(0.013)***
(0.082)**
RISK
0.373
0.785
0.348
0.121
0.199
0.825
(0.051)***
(0.072)***
(0.089)***
(0.951)
(0.169)
(0.506)
TANGIBILITY 0.135
0.259
0.065
1.124
0.034
0.302
(0.025)***
(0.023)*
(0.033)*
(0.492)**
(0.019)*
(0.362)
F_SHOCK
0.059
0.427
X
X
X
X
(0.005)***
(0.008)***
Constant
0.407
1.114
0.351
1.599
0.361
1.125
(0.091)**
(0.068)***
(0.074)***
(0.187)*** (0.297)
(0.492)**
Arellano-Bond
test for Ar(2)
(p-value)
(0.0905)
(0.078)
(0.079)
(0.089)
(0.1568)
(0.9718)
Sargan test
(p-value)
(0.1950)
(0.1033)
(0.1285)
(0.1093)
(0.6419)
(0.0827)
Observations
1,709
1,706
489
486
999
999
Notes: Robust standard errors are in parentheses except p-values for Sargan test and Arellano-Bond
test. Industrial and country dummy variables are included in the regression. See Section 3.1 description
of variables for variables definitions. *,**,***Significant at 10, 5, 1 per cent level, respectively

Financial
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Performancet  1

significant impact on firms current performance. These empirical results show that, a
companys performance in the current year is significantly affected by previous years
performance in these countries. This could be explained by the fact that the last year
performance provides information to investors and encourage them to invest in that
company, which in turn affects the firms current year performance positively. This
finding may suggest that investors in GCC countries based their investment decisions
on the firms last year performance.
The negative and significant coefficient for leverage, TDTA, suggests that
companies with a higher percentage of debt in their capital structure have lower
performance in GCC countries (in terms of the ROA measure). This finding supports
our hypothesis that leverage affects companies performance. Moreover, this significant
and negative relationship between leverage and companies performance may suggest
that profitable firms in GCC countries depend on internal financial sources more than
on borrowed funds (Myers and Majluf, 1984). This finding could also reveal that firms
in GCC countries borrow more than they need, which in turn affects their performance
negatively. Therefore, firms in GCC countries need to find their optimal capital
structure that maximises their performance. This finding is in line with earlier studies
(for instance see Krishnan and Moyer, 1997; Gleason et al., 2000; Pratheepkanth, 2011;
Chinaemerem and Anthony, 2012; Pontoh and Ilat, 2013, among others).

155

Table IV.
Firms performance
and change in
financial leverage
in GCC for the full
sample and the
sub-sample periods
(2004-2007,
2008-2012)

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156

Even though leverage was found to have a negative and significant impact on
companies performance, a change in leverage could also affect companies performance
because investments during the current year may be impacted by a change in leverage.
Table IV presents the results of firms leverage and the change in leverage for both the
full period as well as the sub-sample periods (2004-2007 and 2008-2012). For the change in
leverage, the coefficient is negative and significantly affects the companys performance
ROA for the period of 2004-2012 as well as post-crisis period. This could indicate
that firms in GCC countries are not efficiently utilising the financial leverage in
improving firms performance ROA. This is due to the extra cost of debt which in turn
decreases firms profitability. Interestingly, this study finds that the change in leverage
has a positive and significant impact on a companys performance Tobins Q for
the period 2004-2012 as well as for the pre-crisis period. This finding suggests that, the
increase in firms leverage improves firms market performance Tobins Q.
Tables III and IV indicate that, the firm size has a significant and positive impact on
firms performance (ROA) in GCC countries for the period 2004-2012. This finding is
consistent with both our expectation and earlier studies (for instance see Pontoh and
Ilat, 2013; Adewale and Ajibola, 2013; Pasiouras and Kosmidou, 2007; Zeitun and Tian,
2007; Jermias, 2008; Frank and Goyal, 2003, among others). With regard to growth
opportunities, this research finds that there is a positive and significant effect on
companies performance (ROA). This result suggests that companies in GCC countries
with better investment opportunities could have a higher performance. This finding
also reveals that growth opportunity (GROWTH) improves performance during
both pre-crisis and post-crisis periods. Additionally, growth opportunities have a
positive but insignificant impact on firms performance (reported by the Tobins Q
ratio). The significant and negative coefficient of tangibility suggests that companies
in GCC countries have a sizable amount of fixed (tangible) assets that affect
companies performance (ROA). This also indicates that a higher tangibility ratio
reduces firms performance (ROA). This finding suggests that companies in GCC
countries could decrease their investment in fixed assets or use their fixed assets
more efficiently. This finding is inconsistent with expectations; hence, the
hypothesis was rejected. As shown in Tables III and IV, companies risk (RISK)
had a negative and significant effect on firm financial performance (ROA). This
result is not in line with our expectations and therefore does not support the
classic risk trade-off theory.
6.2 The effect of the 2008 financial crisis
The impact of the 2008 financial crisis on firms performance had been a matter of
concern in many developed and developing countries. However, to our knowledge,
there were no prior studies which had investigated this issue on companies
performance in GCC countries. This is the first comprehensive study that investigates
the effect of the 2008 financial crisis on companies performance in GCC countries. This
paper also investigates the effect of the crisis on firms performance and whether the
current debt and change in debt affects firms performance similarly for pre- and postcrisis periods.
This study uses a dummy variable to capture the effect of the financial crisis on
companies performance in the full sample. The findings based on the GMM
estimator strongly support the hypothesis that, the financial crisis has a negative
and significant impact on companies performance (Tables III and IV). Therefore, the
negative coefficient of the financial shock (F_SHOCK) shows that GCC firms

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performance measures (ROA and Tobins Q) were negatively and significantly

affected by the global financial crisis. These findings are in line with our
expectations as well as with prior studies such as Opler and Titman (1994),
Asgharian (2003), Sufian and Habibullah (2010), and Dolenc et al. (2012).
This study also captures the firm performance differences measured by
Performancet1 (ROA), Performancet1 (TOBINQ), and leverage (TDTA) between the
two sample periods, the pre-crisis and post-crisis periods. Tables III and IV indicate
that the financial leverage (TDTA) has a significant and negative impact on firms
performance during the pre-crisis period but was insignificant during the post-crisis
period. Additionally, the last year Performancet1 was insignificant during the
pre-crisis period but significant during the post-crisis period. Hence, observations of
the estimated coefficients of leverage across the full period 2004-2012 reveal that
companys performance was affected by leverage and financial crisis in GCC countries.
This study uses dummy variables to control for the industry, country, and year effects,
but the results for these dummy variables were not reported in these tables.
7. Conclusion and implications
This study investigates the effects of financial leverage on companies performance of
400 firms in GCC countries using the GMM estimation method during the period
2004-2012. This paper also examines the effects of the recent financial crisis on
companies performance in these countries. The results indicate that companies
leverage was a significant determinant of firms performance in these countries. Firms
leverage affects their performance significantly and negatively, showing that higher
financial leverage in GCC companies capital structure decreased their performance (in
terms of the ROA). This finding is in line with some earlier studies that have examined
the relationship between financial leverage and firms performance (for instance see
Twairesh, 2014; Mumtaz et al., 2013; Chinaemerem and Anthony, 2012; Pratheepkanth,
2011; Gleason et al., 2000; Majumdar and Chhibber, 1999). Furthermore, firms in GCC
countries need to find their optimal capital structure that maximises their performance.
These results could suggest that companies in GCC countries might be more
conservative when using debt financing in order to maximise their performance. The
changes in leverage also have a negative and significant effect on firms performance.
Hence, firms in GCC countries should use their debt financing more efficiently in order
to maximise their returns and performance. Additionally, companies growth and size
variables are found to have a positive and significant effect on firms performance.
However, tangibility and risk variables have a negative and significant impact on the
firms performance. Therefore, the firms decision makers should increase the efficiency
in using the tangibles assets to generate income.
The empirical results indicated that the financial leverage was the most important
determinant of companies performance after the crisis (2008-2012). Moreover, financial
leverage had affected companies performance significantly and negatively for both,
before and after the crisis periods. The increase of debt financing during the financial
crisis period implied that the debt financing made firms more susceptible to refinancing
risks and borrowing at higher costs which in turn decreases their performance.
This paper is one of the most extensive studies to investigate the effects of debt
funding (leverage) and the 2008 financial crisis on firms financial performance in six
GCC countries. In this respect, the study has several limitations. First, the data used in
this paper rely on information published by the firms (through Bloomberg), and
therefore, the robustness of our results were limited by the accuracy of the data

Financial
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financial crisis
157

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provided. Second, failed firms were excluded from the study sample which may affect
the results. Third, macroeconomic variables could be used in future research to investigate
their impact on companies performance before and after the global financial crisis.
Fourth, some other important variables (such as firm age and firm ownership), among
other company-specific factors, could be used in future studies to examine the effects of
the 2008 financial crisis on companies performance.

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158
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About the authors
Dr Rami Zeitun received his PhD in Finance from the University of Western Sydney in 2007. His
research interests include ownership and capital structures, corporate governance, firm
performance, investment decisions, stock market performance, risk management, credit
management, default risk modelling, Islamic banking and financing, and economic growth. His
works have been published in Journal of Education for Business, Review of Middle East
Economics and Finance, Int. J. Financial Services Management, Global Economy and Finance
Journal, Banks and Bank Systems, Journal of World Economics Review, Australasian Accounting
Business and Finance Journal, International Research Journal of Finance and Economics,
Corporate Governance, International Journal of Corporate Finance in Business Society, and Review
of Islamic Economics. Dr Rami Zeitun is the corresponding author and can be contacted at: rami.
zeitun@qu.edu.qa

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162

Dr Ali Salman Saleh is an Associate Professor of Economics at the College of Business and
Economics, Qatar University. Prior to this appointment, he was an Associate Professor of
Economics at the Faculty of Business Administration and Economics, Notre Dame University,
Lebanon. He completed his Honours, Masters in Commerce and PhD in Economics at the
University of Wollongong, Australia. He has made significant contributions to research in
the areas of applied economics, efficiency performance of SMEs, and economic modelling.
Dr Saleh has published in highly ranked journals such as International Journal of Tourism
Research, Tourism Analysis, Journal of Policy Modeling, Singapore Economic Review, Australian
Economic Papers, Applied Economics Letters, Studies in Economics and Finance, among others.
Additionally, Dr Saleh has served as a business consultant on a number of occasions to various
private businesses in Australia and abroad in the Gulf region. He is currently working on a
number of external and internal projects on improving export performance (with the Ministry
of Planning and Investment in Vietnam) and exploring market opportunities for Australian
organisations.

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