Arhinful Radmehr 2023 The Impact of Financial Leverage On The Financial Performance of The Firms Listed On The Tokyo

Original Research
SAGE Open
October-December 2023: 1–22
Ó The Author(s) 2023
The Impact of Financial Leverage on the DOI: 10.1177/21582440231204099
journals.sagepub.com/home/sgo
Financial Performance of the Firms
Listed on the Tokyo Stock Exchange
Richard Arhinful1 and Mehrshad Radmehr1
Abstract
Japan is widely regarded as one of the world’s most developed nations. The country’s electronics industry, in particular, is
consistently ranked among the global leaders in innovatiion. Industries such as automotive, construction, electronics, metal,
and telecommunications, companies have traditionally leaned more heavily on debt financing for both their day-to-day opera-
tions and investment endeavors, rather than relying on equity financing. In Japan, debt financing is favored as cost-effective
source of capital compared to equity financing. The study selected 257 automotive, construction, electronic, metal, and tele-
communications companies between 2000 and 2021. To find the effect of financial leverage on financial performance, the
study used the random effect and the GMM to estimate the effect of the firms’ leverage on financial performance. The study
found that interest coverage has a positive and statistically significant effect on ROA, ROE, and Tobin’s Q. The study discov-
ered that cash coverage has a positive and statistically significant effect on ROE. The study found that debt service obligations
have a negative and statistically significant effect on financial performance.
Keywords
automobile companies, assets coverage ratio, cash coverage ratio debt service obligation, interest coverage ratio.
Introduction important management tool that can be used to increase

shareholders’ equity and get money to invest in the com-
Financial leverage entails companies borrowing money pany’s growth and value creation. Common equity
to support their operational activities. Debt financing financing strategies in Japan include going public, third-
offers numerous benefits for corporate operations, such party allotments, and rights offer (Kim & Song, 2020).
as a stable interest rate, enhanced financial maneuverabil- As stated by Hoshi and Kashyap (2004), if a Japanese
ity, and tax deductions (Santos et al., 2023). The appro- firm needs debt financing, it typically engages in colla-
priate level of debt a company employs to establish an boration with the Japanese government, other domestic
optimal capital structure significantly impacts its financial firms, and Japanese banks. Japanese businesses have a
performance (Akhtar et al., 2021). Also, the traditional strong dependence on bank loans to fulfill their opera-
capital structure encourages firms to use debt in their tional and capital expenditure requirements (Nobanee
capital structure to a specific limit because the use of debt et al., 2011). There are three primary categories of loans
leads to better business performance. Additionally, using and banks arrangements in Japan: loans provided by the
debt exposes a company to significant risk because failure Bank of Japan to commercial banks, short-term loans
to make debt payments results in the transfer of owner- extended by commercial banks, and long-term loans
ship from shareholders to bondholders or creditors
(Sahminan, 2021). Therefore, it has become important to
study the impact of debt on the financial performance of 1
Cyprus International University, Haspolat, Nicosia, Turkish Republic of
firms to enable various stakeholders to understand how Northern Cyprus
debt impacts financial performance.
Corresponding Author:
According to Krasnow (1993), using domestic stock
Richard Arhinful, Accounting and Finance Department, Cyprus International
issuance as a form of equity financing is a viable option University, Haspolat, Nicosia + 90, Turkish Republic of Northern Cyprus.
for Japanese companies. Equity financing is an Email: [email protected]
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2 SAGE Open
from long-term credit banks (Krasnow, 1993). Japanese Numerous studies have investigated the effect of the
companies utilize domestic corporate bonds issuances as firm’s financial leverage on financial performance
a means of securing debt financing for Japanese compa- (Akhtar et al., 2021; Ibrahim & Isiaka, 2020; Iqbal &
nies. Corporate debt can be broadly categorized into two Usman, 2018; Kenn-Ndubuisi & Joel, 2019). Many of
main types: Straight bonds and convertible bonds. these studies employed various proxies for financial
According to Brealey et al. (2018), the pecking order leverage, such as the long-term debt-to-total assets ratio,
theory encourages businesses to prioritize their sources the total debt-to-total assets ratio, the long-term debt-to-
of financing by putting internally generated funding first, capitalization ratio, and the total debt-to-capitalization
debt financing second, and equity financing third. ratio. These proxies have been utilized to evaluate how
Japanese companies have used debt financing, which is financial leverage influences a company’s financial per-
easier and cheaper than equity financing (Hoshi et al., formance. Using these variables to evaluate the impact of
1989; Weinstein & Yafeh, 1998), more than equity financial performance may not offer a comprehensive
financing in the past. Debt financing offered several understanding of how debt financing influence financial
advantages compared to equity financing, such as tax outcomes, as they do not account for the methods a cor-
benefits associated with interest payment and the pre- poration intends to employ to fulfill its obligations or
dictability of fixed monthly interest and principal assess whether its earnings will suffice for this purpose.
payment(Frydenberg, 2011; Glen & Pinto, 1994). In line The manner in which debt financing is repaid signifi-
with MM Proposition II, an increase in corporate debt cantly affects financial performance. Coverage ratios
financing leads to a reduction in the weighted average serve as a valuable tool for gauging a firm’s capacity to
cost of capital (WACC), providing additional rationale meet its debt obligations through debt financing. There
for Japanese firms’ preference for debt financing over has been a limited number of studies exploring the the
equity financing (Michalak, 2016). However, no limits application of coverage ratios to assess business risk by
are placed on the proportion of debt that can be included determining its ability to service its debt and the subse-
in a company’s capital structure. MM Proposition I, a quent effects of these ratios on financial performance.
company’s value is unaffected by whether or not it Also, corporations rely on assets and cash to meet their
receives funding from a combination of debt and equity debt obligations. Therefore, understanding the influence
(Robichek & Myers, 1966). Whether a company relies of cash and asset coverage on financial performance can
more heavily on equity financing or debt financing is a instill confidence in investors and creditors. It assures
matter left to the discretion of its shareholders and man- them that their investments in the corporation or the cor-
agement. The advantages of debt financing make it more poration’s debt financing contribute positively to its per-
beneficial for businesses to use it. However, the more formance and enhance its ability to meet debt obligations
corporations increase their debt in their capital structure, (Omollo et al., 2020).
the more they may be unable to make their loan pay- This study sought to address these key
ments and eventually go bankrupt. questions:Firstly, how do asset and cash coverage ratios
There is an inherent risk risk of financial loss associ- impactfinancial performance? Secondly, can the use of
ated with debt financing. A significant source of financial interest coverage and debt service obligations as indica-
risk arises the lack of cash flow needed to meet debt ser- tors of firms’ ability to meet debt obligations shed light
vice requirements is a major source of financial risk on the corporation’s financial performance? Thirdly, to
(Vanacker & Manigart, 2010). If a company has finan- what extent does the economic policy in Japan influence
cial difficulties, it cannot pay its debts (Ferris & Lawless, the financial performance of the corporations listed on
1999). When a company’s per-unit profits are low, its the Tokyo Stock Exchange? Furthermore, did the
breakeven point is high, or its sales are vulnerable to eco- COVID-19 pandemic impact the financial performance
nomic downturns, it may be highly leveraged, increasing of these corporations, and lastly, did the global economic
the likelihood of being unable to honor its debt obliga- policy uncertainty affect the corporation’s financial
tions. Before financial institutions approve any debt performance?
financing for a business corporation, they must assess its The study contributes to the literature in the following
ability to honor the debt obligation. The coverage ratio ways: Firstly, the study depends on the pecking order
determines whether a business can pay back its debts. theory, which advises firms to consider debt financing as
The interest coverage ratio determines if a company can their second priority when choosing or selecting the
make enough earnings to pay the interest on its debts. financial source of obtaining funding to finance business
The debt service obligation determines if the business activities, to investigate the effect of financial leverage on
corporation can make enough earnings to pay the inter- financial performance. Secondly, the study used the cov-
est and principal on the debt. Companies pay their debt erage ratios to assess the ability of the firms to pay off
obligations using their assets and immediate cash. their debt from their earnings and how the coverage
Arhinful and Radmehr 3
ratios affect financial performance, using firms listed in The issuance of bonds alone is the most common
the Tokyo stock market as a sample size. Thirdly, the method of bond financing, while trust structures are only
study contributes to the literature by finding the effect of sometimes employed. Unusual CBOs (collateralized
the COVID-19 pandemic on the financial performance of bond obligations) include trust beneficiary rights backed
firms listed in five sectors of the Tokyo Stock Exchange. by a pool of many different types of bonds, including one
Moreover, the study found the effect of economic policy that may be called a garbage bond. Hoshi and Kashyap
uncertainty in Japan and global economic policy uncer- (2004) and Petry et al. (2023) report that most Japanese
tainty on financial performance. Furthermore, the study debt transactions occur outside the regulated markets of
found a moderating effect of the coverage ratio on finan- securities exchanges. Japan has always relied on bank
cial performance. loan financing. Hence, the country’s public debt capital
markets have expanded more slowly than its public
equity capital markets. That is typical of Japan, which
Literature Reviews and Hypothesis relies heavily on bank loans for financing.
Development Most Japanese debt instruments are traded on the
Tokyo Stock Exchange (TSE). This market operates
Debt Capital Markets in Japan independently from the OTC market. There are fewer
Before beginning to solicit investors to purchase debt debt securities listed on the TSE than equity instruments.
securities, corporations in Japan are generally required to The Japanese government and convertible bonds are
file a securities registration statement to engage in a pub- among the instruments traded on the TSE (Greiner et al.,
lic offering of debt securities (Kelley, 1990). Before pur- 2002; Mollemans, 2002). The Financial Services Agency
chasing debt securities, investors must receive a copy of of Japan (FSA) regulates the debt securities markets in
the prospectus. The Financial Instruments and Exchange Japan. The FSA’s regional finance office oversees the
Act (FIEA) of Japan places limitations on a variety of bulk of this work. The TSE oversees the debt securities
transactions that have the potential to undermine the market and regulates listed securities. The Financial
integrity of the country’s financial markets. Insider trad- Institutions and Exchange Act primarily governs the debt
ing and market manipulation are the two broad cate- securities markets. The exchange’s rules bind all securities
gories that these regulations fall under. listed on the Toronto Stock Exchange.
The FIEA and related regulations provide several
requirements for securities businesses, including those
registered with the FIEA as financial instrument business Financial Leverage
operators, due to the essential role securities firms play Leverage in the financial markets occurs when a bor-
in the market. Bonds issued by the Japanese government rower uses borrowed funds to purchase an asset, expect-
and conventional bonds make up the majority of the ing a larger return than the cost of the loan itself
country’s marketable debt securities (McCauley & (Adenugba et al., 2016). Therefore, financial leverage is
Remolona, 2000). A public offering is used for transac- an investment strategy that promotes business expansion
tions when securities are distributed to individual retail and growth. Financial leverage is borrowing debt to
investors. When stocks are distributed to professional expand one’s asset base. Leverage is a way to get a
investors, a public offering or a private placement may be higher rate of return on money that has been invested
utilized, depending on the particular circumstances and (Demiraj et al., 2023). There is a higher chance of failure
the adherence to specified regulations. It is normal to use if too much financial leverage is used, as servicing the
shelf registrations concerning the public issue of corpo- loan becomes more challenging. The financial leverage
rate bonds. In that instance, the issuer will submit a pre- formula is a valuable indicator of a company’s borrow-
liminary shelf registration statement to the relevant local ing capacity as a ratio of total debt to total assets. The
finance bureau and provide ongoing disclosure about the debt-to-assets ratio is a standard indicator of financial
issuer and its corporate group. The issuer will subse- leverage. Financial leverage is beneficial when interest
quently submit a supplement to the shelf registration payments are less than the profits from the debt’s utiliza-
statement when it is time to issue the securities. On the tion (Nissim & Penman, 2003). Instead of selling new
other hand, when it comes to private placements, debt shares of stock to raise money, many companies use
securities are only made available to a select group of financial leverage, which can lower the value of each cur-
institutional investors or a small group of accredited indi- rent shareholder’s stake (Ghosh & Jain, 2000). Debt
vidual investors. In this particular instance, a shelf regis- financing makes the most sense when stable cash flow is
tration or a declaration on securities registration is not expected. This makes it much easier to budget for debt
necessary (subject to certain conditions under the FIEA). repayment. Cash flow stability is typical in markets with
4 SAGE Open
few competitors, considerable entry barriers, and few legal obligation to return the funds they raise. When a
game-changing product innovations. business issues bonds or takes out a loan to pay for its
There are two main benefits to using financial lever- operations, it must pay back the principal plus interest
age. It can improve a company’s profit margin (Js to its investors (Christie et al., 2021).
Ramalho & da Silva, 2009). Second, interest is tax Therefore, debt holders such as banks and investors
deductible in many tax systems, lowering the borrower’s are concerned with whether or not a company is making
debt cost (Cole, 2017). However, financial leverage also enough money to pay off its debts and what will happen
carries the risk of disproportionate losses, as the result- if earnings fall short of projections. One example of a
ing interest expense can be prohibitive if the borrower solvency ratio is the asset coverage ratio. Asset coverage
cannot generate adequate returns to cover it. This determines whether or not a corporation has sufficient
becomes a severe issue when interest rates increase, or assets to satisfy its current short-term debt obligations.
asset returns fall. A similar dilemma faces an investor Even if a company is not making enough money to pay
considering taking on debt to boost his or her purchase its debts, a high asset ratio reassures a creditor that it will
of assets. An investor could lose all of their money if the be repaid (Hernandez-Canovas & Martinez-Solano,
security’s market price drops and the lender demands 2006). The frequency with which a company’s income
repayment of the lent funds. can cover its debt is measured using asset coverage. A
company with a high asset coverage ratio can pay off its
debt quickly. According to the research of Alessi et al.
Financial Performance
(2022), businesses with a higher asset coverage ratio are
How well a company can profit from its primary business safer than those with a lower ratio. If the company’s
activity is a gauge of its financial performance (Gofwan, earnings are insufficient to meet its financial commit-
2022). The financial performance of a company over a ments, it may be forced to liquidate some or all of its
specific time period can be seen as a broad indicator of assets to raise the necessary capital. Creditors and inves-
its overall financial health. Trade creditors, bondholders, tors commonly look at a company’s asset coverage ratio
investors, employees, and management are all stake- to see how reliably its assets cover its debt. Asset cover-
holders interested in the business. All of these stake- age determines if the company’s earnings are insufficient
holders keep an eye on the company’s bottom line. Its to cover its debts.
financial performance shows how well a company makes
money and uses its resources to meet the needs of its H1: Asset coverage has a statistically significant effect
investors and other stakeholders (Man & Wong, 2013). on financial performance.
There are a number of indicators that can be used to
assess the financial health of a business. Cash flow from
Cash Coverage Ratio. A company’s liquidity and ability
operations, operating income, and other similar metrics
to meet its debt commitments using cash on hand can be
can all be employed. The number of units sold could also
be used (Griffin & Mahajan, 2019). The analyst or inves- evaluated using the cash coverage ratio (Berrada, 2022).
tor also wishes to dig further into the financial statement The cash coverage ratio is a way to determine if a com-
to find information that leads to higher profits or declin- pany has enough cash flow to pay its interest payments.
ing debt. The cash ratio measures a company’s liquidity, determin-
ing how quickly it can pay its current liabilities using cash
(Faruk & Habib, 2010). Due to its stricter nature, many
Hypotheses Development creditors check the cash ratio rather than the current or
Asset Coverage Ratio. The asset coverage of a company quick ratio (Ertugrul & Karakasoglu, 2009). This is
can indicate its financial health. The ratio quantifies how because only cash may be utilized to pay off current debt.
well an organization can pay its obligations (Okunev, Investors care about a company’s solvency since they
2022). Asset coverage ratios provide helpful insight into have debts to pay. The creditor also likes it if inventories
a company’s capacity to meet its financial obligations to and accounts receivable are not included in the cash ratio
creditors, investors, and analysts (Ogachi et al., 2020). calculation because these assets are not always reliable
Lending organizations and creditors look for a minimum for paying off debt. Collecting receivables could take a
asset coverage ratio when choosing whether or not to few weeks, whereas selling stock could take months or
extend credit. Creditors and investors can gauge the years.
safety of their investments in a company by comparing The cash coverage ratio is the ratio of the available
the asset coverage ratio to the debt-to-equity ratio (Nini cash to the interest that needs to be paid. It gives organi-
et al., 2009). Once the coverage ratio is calculated, indus- zations a fundamental notion of how their businesses will
try averages can be compared. When seeking financing, pay off their obligations, which is helpful. When a com-
companies that issue stock or equity have a moral or pany calculates its cash coverage ratio, it can see where
there are gaps in its operations and where there is poten- use it to assess a company’s creditworthiness and pros-
tial for improvement. Most of the time, the shareholders pects because it helps analyze its potential to finance
use these ratios to predict how the company’s finances future expansion. Lenders look to the ratio as a primary
will be in the future. indicator of whether a company can fulfill its interest
and principal payment obligations (Yenni et al., 2021).
H2: Cash coverage has a statistically significant effect Shareholders, potential investors, and buyers of a firm
on financial performance. use the ratio to gauge the company’s financial health and
dividend prospects before deciding whether to purchase
Interest Coverage Ratio. A company’s ability to make the business. It displays the amount of money that is
interest payments on bank loans is evaluated using a available for shareholders or investors. Companies can
ratio known as the interest coverage ratio (Strahan, use the ratio to assess their capacity for expansion and
1999). It is also sometimes referred to as interest earned their potential to secure further funding. If all the money
over time. The ratio determines how often a company’s were to go toward repaying the firm’s debt, there would
operating income can cover the interest costs on its be no funds left for the company to reinvest. If the
debts. This information is used to make financial deci- DSCR calculation exceeds 1, it suggests there is just
sions. The interest coverage ratio measures a company’s enough operational revenue to pay the annual debt obli-
ability to meet its interest payments out of earnings gen- gations. In contrast, less than one calculation indicates
erated by the business. It indicates how much of a buffer that there may be possible concerns with solvency
the company has available to pay its interest expenses, (Vishwanath, 2009).
which are a fixed obligation. The ratio can proxy the
company’s ability to meet its interest obligations and H4: Debt service obligations have a statistically signif-
remain in operation. The fact that the rating reflects the icant effect on financial performance.
company’s capacity to meet its repayments gives rise to
the significance of interest coverage in assessing a firm’s Debt-to-Equity Ratio. As a measure of leverage, the
creditworthiness (S. Kim et al., 2013). The company debt-to-equity ratio looks at how much debt and finan-
must generate sufficient revenue to cover its interest pay- cial liabilities equal how much equity shareholders have
ments. Companies are more likely to be able to meet invested in a corporation (Ofulue et al., 2022). This ratio
their obligations if their interest coverage ratio is high shows how much debt versus equity financing is in a
(Palomino et al., 2019; Suhaila & Wan Mahmood, company’s capital structure. Companies that are stable
2008). The business’s profitability, level of gearing, and and generate substantial cash flow benefit from a high
cost of borrowings all play a role in determining whether debt-equity ratio (Dirman, 2020), while a declining com-
or not the company can meet its interest expenses. When pany should aim for a lower ratio (Dirman, 2020).
it comes to companies with an inherently low-profit mar- However, when the ratio decreases, it indicates that the
gin level, a high-interest burden may negatively affect company is using less leverage and moving closer to
their rating. This high-interest burden could result from being entirely equity-financed. A high debt-to-equity
a high gearing level, a high cost of financing, or both of ratio might be beneficial if the company can pay its debts
these factors. on time and leverage to increase equity returns. A high
debt-to-equity ratio indicates that a firm may struggle to
H3: Interest coverage has a statistically significant repay its debts in the event of a fall in business
effect on financial performance. performance.
When the D/E ratio is high, the business is more pre-
Debt Service Coverage Ratio. A company’s ability to carious. Companies that are just getting started or busi-
meet its debts with operating cash flow is measured by nesses that want to expand rapidly may have a higher D/
the debt service coverage ratio (Delele, 2021; Okunev, E ratio. However, they may also have more potential
2022). The payment covers both the interest and the prin- upside if everything goes according to plan. The debt-to-
ciple of the loan. When a corporation obtains a loan equity ratio is a standard that investors refer to when
from a bank or other financial organization that pro- evaluating the risk associated with an investment
vides loans, the computation is performed at the time of (Witkowska et al., 2019). D/E is very important for a
acquisition. The debt service coverage ratio (DSCR) is a company when that company employs creditor financ-
crucial measure of a company’s financial health, accounting. Lenders and investors generally prefer that a com-
ing for interest payments, principal payments, and divi- pany maintain a low debt-to-equity ratio. However, a
dend payments (Firouzi & Meshkani, 2021). The debt low debt-to-equity ratio might signal that the company
service coverage ratio indicates a company’s financial may need to leverage its assets more adequately, limiting
health (Toton, 2002). Bankers and investors extensively its profitability.
6 SAGE Open
H5: Debt to equity has a statistically significant effect Table 1. Summary of Selected Companies.
on financial performance.
Sectors Number of firms Percentage (%)
Construction and materials 121 47.08

Methodology Automobile and parts 83 32.30
Electronic 23 8.95
Sample and Data Metal 18 7.0
Telecommunication 12 4.67
The study focused on non-financial institutions listed on Total 257 100.00
the Tokyo stock market, encompassing diverse sectors
such as automobile, construction, electronic, metal, and
telecommunications companies. Japan, chosen as the Our selection comprised 121 companies from the con-
study’s backdrop, merits attention as one of the world’s struction and materials sectors, 83 firms from the auto-
most advanced nations. Its prominence extends from its mobile and parts sectors, 23 from the electronic sector,
sizable and highly educated labor force to its extensive 18 from the metal sector, and 12 from the telecommuni-
consumer market (Rodrik, 2014). Notably, the bedrock cations sector. It is essential to note that our study relied
of Japan’s economic prowess lies in manufacturing solely on secondary data sourced from publicly available
(Johnson, 1982). annual reports of the selected companies. As our research
Within the domain of manufacturing, Japanese firms did not involve the study of human subjects, we did not
have honed their strengths globally, spanning optical seek Institutional Review Board (IRB) approval. Table 1
and precision equipment, electrical and electronic goods, provides a detailed overview of the companies and their
machinery tools, automobiles, ships, chemicals, and food corresponding data.
and agricultural products (Dore, 2013; Farrell, 2008 ).
These enterprises play a vital role in Japan’s economic
landscape by employing its citizens, contributing to Variables (Dependent, Dependent, and Control
national tax revenue, and attracting foreign capital Variables)
(Posen, 1998). Some established and emerging businesses Dependent Variables. The study used three dependent
in Japan have grown in recent years due to globalization variables as proxies for financial performance. The first
and intense competition (Zysman, 1996). Japanese com- dependent variable was the return on assets (ROA).
panies are very active in expanding overseas for several ROA reveals to shareholders how efficiently a business
reasons, such as taking advantage of global demand, turns its assets into net capital (Bansal, 2014), making it
making products that fit the needs of specific markets, a crucial metric for any organization. As a result, the
and taking advantage of economies of scale (Castley, higher the percentage of ROA, the better it is for the
2016; Ohno, 2016). The expansion allows firms to business’s management. When a company’s return on
increase their presence at their overseas bases. While assets (ROA) index is poor, it could be due to a number
some companies could finance their expansions intern- of factors (Alexopoulos et al., 2018). Managers can use
ally, most looked to outside sources. To finance their this metric to assess internal performance and spot where
growth and expansion, Japanese corporations rely on the company’s investments may be lacking so that they
equity and debt financing (Chang, 2003; Jarallah et al., can be improved. The ROA was calculated as net profit
2019). after tax/total assets 3 100.
We sourced our data from Thomson Reuters Eikon The second dependent variable was return on equity
DataStream, a reputable data provider widely utilized (ROE). ROE is a profitability indicator used to calculate
for similar research purposes (Amin & Cek, 2023; the return on shareholders’ investment in a company
Arhinful & Radmehr, 2023; Mensah & Bein, 2023). Data (Wahjudi, 2019). It demonstrates the efficiency with
from DataStream is renowned for its reliability and which shareholders’ funds have been used. ROE is deter-
accuracy. For our study, we examined data from 257 mined by dividing net income by total equity. The com-
companies operating in various sectors including auto- pany’s low ROE means the shareholders’ funds could be
motive and parts, construction and materials, electronic, better used. ROE is a vital indicator of a company’s suc-
metal, and telecommunications. Our dataset spans a sub- cess. A higher value indicates that the company effec-
stantial period, encompassing the years from 2000 to tively turns fresh investment into profit. Before investing,
2022, amounting to 22 years and yielding a total of 5,654 investors look at the ROE of various companies in the
firm-years of observations. To ensure a representative market.
sample, we employed the purposive sampling method, as The final dependent variable was Tobin’s Q. Tobin’s
not all firms had data available in Thomson Reuters Q ratio calculates a company’s worth by dividing its total
Eikon for the entire 22-year period. assets by market value (Tahir & Razali, 2011). The
Table 2. Variable and Measurements.
Variables Abbreviations Measurements
Return on assets ROA Net profit after tax/average total assets 3 100
Return on equity ROE Net profit after tax/average total equity 3 100
Tobin’s Q TOB Total market value/total assets
Asset coverage ratio ACR EBIT + depreciation/total interest expense
Cash coverage ratio CCR Tangible assets 2 (current assets 2 short term debt)/total debt
Interest coverage ICR EBIT/Interest expense
Debt service obligation DSCR Earnings before interest and tax/(interest expense on debt + short term
debt & current portion of long-term debt
Debt-to-equity ratio DEBEQT Total debt/total equity
Age AGE The year the firms were incorporated on the Tokyo Stock Exchange up to
2022
Size of firm SZE Log of total assets
COVID-19 COVD19 A dummy variable (if the firms reported their financial statements during
the COVID-19 pandemic from 2019 to 2021, then ‘‘1’’; otherwise, ‘‘0’’).
Economic policy uncertainty of Japan EPUJ Economic Policy Uncertainty Index for Japan (DISCONTINUED), Index,
Annual, Not Seasonally Adjusted
Global economic policy uncertainty GEPU Global Economic Policy Uncertainty Index: Current Price Adjusted GDP,
Index, Annual, Not Seasonally Adjusted
market value of a company should be equal to its outbreak, it was marked ‘‘1’’ and otherwise marked ‘‘0.’’
replacement cost, according to Tobin’s Q ratio. Tobin’s The COVID-19 pandemic affects financial performance
Q ratio assesses how close an asset’s current market price (Santos et al., 2023). Economic policy uncertainty for
is to its replacement price. Tobin’s Q ratio describes how Japan and global economic policy uncertainty are
market value compares to the actual value of an asset. macroeconomic variables that reflect financial, price,
This ratio makes it simple to determine whether a com- and economic stability and can also affect the financial
pany, sector, or market is priced appropriately performance of firms.
(Setyawan, 2011). It also quantifies the gap between a
company’s replacement cost and market value. The stock
of a corporation is considered overvalued if its market Model Specification
price exceeds the cost of replacing the company’s assets. We used eight model models to find the effect of finan-
When a company’s or market’s Tobin’s Q ratio is greater cial leverage on financial performance and tests for the
than one, the market is considered overvalued. hypotheses formulated.
Model 1
Independent Variables. The study used five independent
variables, which are proxies for financial leverage. The FP = b0 + b1ACR + b2CCR + b3ICR
variables measure the leverage of the firm. The variables
+ b4DSCR + b5DEBEQT + b6AGE
were cash coverage, asset coverage, interest coverage,
debt service obligation, and debt-to-equity ratio. The + b7SZE + e
cash coverage, assets coverage, interest coverage, and
debt service obligation were outliers, and we used the Model 2
winsor2 command in Stata to Winsor them at their 10th
and 90th quantiles. The variables and their definitions FP = b0 + b1ACR + b2CCR + b3ICR
are summarized in Table 2. + b4DSCR + b5DEBEQT + b6AGE
+ b7SZE + b8S COVD19 + e
Controlling Variables. The firm’s size was obtained by
logging total assets, and its age is the number of years
Model 3
the firm has been on the stock market since its year of
incorporation. The COVID-19 pandemic is a dummy;
FP = b0 + b1ACR + b2CCR + b3ICR
the financial reports reported by the firms during the
COVID-19 pandemic were used as a base. If the corpo- + b4DSCR + b5DEBEQT + b6AGE
ration reported a financial report during the pandemic + b7SZE + b8 EPUJ + e
8 SAGE Open
Model 4 denotes interest coverage ratio, ‘‘DSCR’’ denotes debt

service obligation, ‘‘DEBEQT’’ denotes debt to equity
FP = b0 + b1ACR + b2CCR + b3ICR ratio, ‘‘AGE’’ denotes the ages of the firm, ‘‘SZE’’
+ b4DSCR + b5DEBEQT + b6AGE denotes the size of the firm, ‘‘COVD19’’ denotes the
COVID-19 pandemic, ‘‘EPUJ’’ denotes economic policy
+ b7SZE + b8GEPU + e
uncertainty for Japan, ‘‘GEPU’’ denotes global economic
policy uncertainty, and ‘‘ã’’ denotes an error term.
Model 5
FP = b0 + b1ACR + b2CCR + b3ICR Estimation Method

+ b4DSCR + b5DEBEQT + b6AGE We employed both the random and the fixed effect mod-
+ b7SZE + b8 ACR DSCR + e els to estimate the effect of financial leverage on financial
performance. To ensure the robustness of our findings,
Model 6 we conducted Hausman specification tests, which
allowed us to determine the consistency of the results
FP = b0 + b1ACR + b2CCR + b3ICR The results from the Hausman specification tests
show that the random effect model is inconsistent under
the alternative hypothesis (p . .05) but efficient under
+ b7SZE + b8CCR DSCR + e the null hypothesis. Therefore, our results were discussed
based on the random effect models. We also dealt with
Model 7 the endogeneity problem using the robust two-step
Generalized Method of Moments (GMM). We chose
FP = b0 + b1ACR + b2CCR + b3ICR two-step over one-step GMM because the one-step
+ b4DSCR + b5DEBEQT + b6AGE GMM subtracts the current value from the past, and it
+ b7SZE + b8CR DSCR + e will result in a problem if some of the values are missing
(Roodman, 2009). The two-step robust GMM, instead
of subtracting the current values from the past values,
Model 8
instead found the average of the future available obser-
vations and subtracted it from the past values, which
FP = b0 + b1ACR + b2CCR + b3ICR
gives efficient results (Roodman, 2009).
+ b7SZE + b8COVD19 + b9EPUJ
Empirical Results and Discussions
+ b10GEPU + b11ACR DSCR
+ b12CCR DSCR + b13CCR DSCR + e Table 3 shows the descriptive statistics for all the vari-
ables (dependent, independent, and control variables).
The dependent variables are used as proxies for the
Where ‘‘FP’’ is the financial performance, which is ROA, firm’s financial performance in Japan: ROA, ROE, and
ROE, and Tobin’s Q. ‘‘ACR’’ denotes asset coverage Tobin’s Q. The average return on using the corporation’s
ratio, ‘‘CCR’’ denotes cash coverage ratio, ‘‘ICR’’ assets was 2.311%, while the average return on using
Table 3. Descriptive Statistics.
Variable Obs Mean Std. dev. Min Max
ROA (%) 5,654 2.311 4.238 242.62 65.87

ROE (%) 5,654 5.204 5.801 25.78 13.96
TOB 5,654 0.036 0.028 0.001 0.675
ACR 5,654 1.472 0.822 0.534 3.117
CCR 5,654 1.507 0.832 21.585 5.43
ICR 5,654 1.247 0.879 21.678 5.277
DSCR 5,654 0.246 0.928 24.526 5.014
DEBEQT 5,654 1.426 1.019 0.354 3.547
AGE 5,654 64.021 16.74 1 131
SZE 5,654 7.773 0.704 6.164 10.792
COVD19 5,654 0.136 0.343 0 1
EPUJ (%) 5,654 103.94 19.281 63.505 137.132
GEPU (%) 5,654 136.644 63.286 62.676 320.044
Table 4. Matrix of Correlations.
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)
(1) ROA 1.000

(2) ROE .754 1.000
(3) TOB .320 .322 1.000
(4) ACR .175 .010 .360 1.000
(5) CCR .508 .440 .287 .522 1.000
(6) ICR .532 .511 .316 .487 .643 1.000
(7) DSCR .145 .057 .262 .467 .536 .570 1.000
(8) DEBEQT –.230 –.119 –.368 –.689 –.591 –.553 –.415 1.000
(9) AGE .057 .087 .025 .038 .098 .095 .050 –.064 1.000
(10) SZE .101 .151 .129 –.123 .032 .017 –.076 .115 .350 1.000
(11) COVD19 .084 .071 .029 .126 .199 .189 .115 –.168 .225 .059 1.000
(12) EPUJ –.037 –.070 –.159 .042 .011 –.016 .029 –.043 .118 .004 .112 1.000
(13) GEPU .155 .152 .021 .163 .269 .260 .153 –.216 .307 .064 .594 .455 1.000
shareholder equity was 5.204%. The average TOB was

Table 5. Variance Inflation Factor.
0.036, indicating that the firms are undervalued
(Humphery-Jenner, 2014; Vuong, 2022). The ACR was VIF 1/VIF
1.472, meaning the firm can use its assets to pay off its
debt since it is greater than 1. The CCR was 1.506. The CCR 5.772 0.102
ICR 5.732 0.103
results for the average CCR show that the firm could use GEPU 4.779 0.209
its available cash to pay off its debt obligations. The aver- COVD19 3.498 0.286
age ICR shows that the firm can make enough earnings DEBEQT 3.056 0.327
to pay off the interest component of its debt. The average ACR 2.853 0.351
DSCR shows that the company does not earn enough to EPUJ 1.678 0.596
DSCR 1.618 0.618
pay the interest and principal on its debt financing. AGE 1.264 0.791
The average DEBEQT ratio shows that the firm is SZE 1.194 0.837
highly leveraged; it uses more debt in its capital structure Mean VIF 3.144 .
than equity (Welch, 2011). Each firm’s average age was
64 years old, and the average size of the firm was 7.773.
Out of the total firm observations of 5,654, of which the
Table 6. Cross Sectional Dependence Test.
firms report their annual financial reports for 22 years,
769 years of the observations were for the period where Variable CD-test p-Value Corr Abs (corr)
the firms reported the annual report during the COVID-
19 pandemic, which is 0.136; the average EPUJ was ROA 42.180 .000 .173 .180
102.94%, and the average GEPU was 136.64%. ROE 41.910 .000 .172 .197
TOB 132.910 .000 .546 .546
Table 4 presents the outcomes of the matrix correla- ACR 195.350 .000 .802 .802
tion analysis, a critical step in examining the assumptions CCR 138.520 000 .569 .569
of multiple regression analysis. One fundamental ICR 129.270 .000 .531 .531
assumptions is that the independent and controlling vari- DSCR 116.990 .000 .480 .480
DEBEQT 176.270 .000 .724 .724
ables should not exhibit strong correlation. To rigor- AGE 243.490 .000 1.000 1.000
ously assess and mitigate the issue of multicollinearity, SZE 236.880 .000 .973 .973
our study employed both matrix correlation analysis and
the Variance Inflation Factor (VIF). The findings stem-
ming from the correlation analysis reveal that the finan- the VIF values surpassed the critical threshold of 10,
cial leverage variables do not exhibit strong correlations, consistent with the guidelines outlined by J. H. Kim
as evidenced by coefficients between these variables not (2019) and Senaviratna and Cooray (2019). The results
exceeding the threshold of 0.80. This aligns with the find- confirmed that the dataset is not suffering from the prob-
ings of prior studies (Arhinful et al., 2023; Detthamrong lem of multicollinearity.
et al., 2017; Elshabasy, 2018). Table 6 shows the results for the cross-sectional
Moreover, we scrutinized the VIF results, as illu- dependence. We also used a method Pesaran (2015) pro-
strated in Table 5 for each variable. Importantly, none of posed for dependent cross-sectional tests. The alternative
10
Table 7. The Effect of Financial Leverage on Financial Performance (ROA).
Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Mode 8
ACR –0.129 –0.141 –0.13 –0.125 –0.065 –0.04 –0.048 –0.185*

(0.095) (0.095) (0.095) (0.095) (0.097) (0.093) (0.093) (0.095)
CCR 0.487*** 0.452*** 0.494*** 0.471*** 0.541*** 0.971*** 1.071*** 0.874***
(0.173) (0.173) (0.173) (0.173) (0.173) (0.173) (0.175) (0.18)
ICR 2.828*** 2.921*** 2.824*** 2.823*** 2.827*** 2.825*** 2.697*** 2.859***
(0.163) (0.163) (0.163) (0.163) (0.163) (0.16) (0.16) (0.168)
DSCR –0.96*** –0.971*** –0.959*** –0.96*** –0.663*** 0.322*** 0.068 0.104
(0.063) (0.063) (0.063) (0.063) (0.117) (0.106) (0.095) (0.143)
DEBEQT 0.167*** 0.153* 0.164** 0.176** 0.268*** 0.566*** 0.531*** 0.423***
(0.079) (0.079) (0.079) (0.079) (0.086) (0.082) (0.082) (0.084)
AGE –0.007** –0.004 –0.006** –0.008*** –0.007** –0.008*** –0.008*** –0.008***
(0.003) (0.003) (0.003) (0.003) (0.003) (0.003) (0.003) (0.003)
SIZE 0.435*** 0.427*** 0.431*** 0.44*** 0.429*** 0.306*** 0.312*** 0.29***
(0.071) (0.072) (0.072) (0.072) (0.071) (0.071) (0.071) (0.07)
COVID-19 –0.181 –1.54***
(0.141) (0.266)
EPUJ –0.004 –0.003
(0.003) (0.003)
GEPU 0.002** 0.009***
(0.001) (0.002)
ACR 3 DSCR –0.173*** –0.512***
(0.058) (0.071)
CCR 3 DSCR –0.609*** –1.459***
(0.041) (0.25)
ICR 3 DSCR –0.553*** –0.616***
(0.039) (0.236)
Constant –5.177*** –5.276*** –4.785*** –5.36*** –5.337*** –5.202*** –5.181*** –4.168***
(0.574) (0.574) (0.642) (0.58) (0.576) (0.563) (0.564) (0.623)
Number of observations 5,654 5,654 5,654 5,654 5,654 5,654 5,654 5,654
R-square 0.328 0.328 0.328 0.328 0.329 0.354 0.352 0.366
F-tests (p-value) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Year dummies Yes Yes Yes Yes Yes Yes Yes Yes
Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes
Hausman specification tests 0.345 0.357 0.431 0.451 0.460 0.471 0.491 0.531
***p\.01. **p\.05. *p\.1.

SAGE Open
hypothesis for all the variables is accepted, indicating the and statistically significant impact of COVID-19 pan-
presence of cross-sectional dependence among the demic on ROA, supporting previous studies (Jin et al.,
variables. 2022; Katusiime, 2021; Rahmi & Sumirat, 2021). The
Table 7 shows the results of the random effect estima- results show that EPUJ has a negative and statistically
tion. The study used the random effect estimation insignificant effect on ROA, which matches previous
method to find the effect of financial leverage, the studies’ findings (Akron et al., 2020; Demir & Ersan,
COVID-19 pandemic, EPUJ, and GEPU on ROA. The 2017; Garcı́a-Gómez et al., 2022). Conversely GEPU has
study relied on the Hausman specification tests to see a positive and statistically significant effect on ROA, and
which results for the random and fixed effect models the results align with a study by Quddus et al. (2022) but
were consistent. The results from the Hausman specifica- contradict the findings by W. Li et al. (2022). The results
tion tests show that the random effect estimation is imply that the improvement in GEPU will result in a
inconsistent under the alternative hypothesis but efficient positive ROA for the firms. The moderating effect of
under the null hypothesis (p . .05). DSCR on the relationship between ACR, CCR, and
In terms of specific findings, the study revealed that ICR shows a negative and statistically significant effect
ACR exerts a negative and statistically insignificant on ROA.
effect on ROA. This suggest that increasing the ACR of Table 8 provides an overview of the impact of finan-
the firms is associated with a decrease on ROA, signaling cial leverage, the COVID-19 pandemic, EPUJ, and
potential financial distress, in line with the findings of GEPU on ROE. The study revealed several noteworthy
Kuncoro & Agustina (2017) and Mesak & Imade (2019). findings. Firstly, ACR exhibited a negative and statisti-
On the other hand, the study found that the CCR has a cally significant effect on ROE. This negative impact
positive and statistically significant impact on ROA, aligns with the arguments put forth by Han Kim et
consistent with the research by Rehman et al. (2015) and al(1979) and Salehi et al (2017), suggesting that an aver-
supporting Miller and Orr’s (1966) trade-off theory, sion to debt arises due to the increased likelihood of
which emphasizes the optimization of cash holdings to bankruptcy and the associated costs. Consequently, an
balance the benefits and costs of maintaining liquid increase in ACR is associated with a decrease in ROE,
assets. Businesses use cash to finance initiatives if alter- consistent with the findings of Restianti and Agustina
native funding is unavailable or expensive (Stulz, 2000). (2018).
The results imply that higher CCR is linked with Secondly, the results unveiled a negative and statisti-
increased ROA. cally significant effect of CCR on ROE, indicating that
Additionally, the study found that the ICR has a posi- an increase in the CCR of the firms leads to a decrease
tive and significant effect on ROA, aligning with prior in ROE. This outcome contracts with the findings of
research by Ong and Phing Phing (2012) and Enekwe Amahalu and Beatrice (2017), who suggested that hold-
et al. (2014). This suggests that firms utilizing external ing cash for business activities positively impacts ROE.
debt financing are better positioned to meet interest obli- Thirdly, ICR was found to exert a positive and statisti-
gations and enhance their performance (Aziz & Abbas, cally significant effect on ROE, consistent with prior
2019; Pham & Nguyen, 2020). The findings support research (Ayoush et al., 2021; Capraru & Ihnatov, 2014;
M&M proposition II: as a firm increases its debt, its Kirimi et al., 2017). This implies that firms using external
financial performance improves (Miller, 1995). The study debt financing are well-positioned to meet their interest
found that DSCR has a negative and statistically signifi- obligations and enhance their ROE..
cant effect on ROA. According to Jensen (2019), a firm Fourthly, DSCR had a negative and significant effect
must be able to pay off its debt and provide a good on ROE, indicating that the firms with higher leverage
return to equity owners. After the firm pays off all its are under constant pressure to repay debt, and have an
debt, nothing remains for the equity owners, which elevated likelihood of defaulting on their obligations.
would create an agency problem (DeAngelo & This scenario may lead to panic or even a disruption in
DeAngelo, 2007). The results of DSCR indicate that the the financial market, in line with the perspectives ofBean
excessive use of debt poses a risk to the firm as they may (2010) and Holmstrom (2015). The study also examined
struggle to repay it, potentially leading to a loss of own- the DEBEQT ratio’s impact on ROE, revealing a positive
ership to creditors (Hansmann & Kraakman, 2000). and statistically insignificant, consistent with the findings
Furthermore, the DEBEQT ratio exhibited a positive by Efendi et al. (2019) and Marito and Sjarif (2020). This
and significant effect on the ROA of Japanese firms con- suggests that an increase in DEBEQT has the potential
sistent with previous research by Amanda (2019), to enhance ROE if the firm chooses to leverage it further.
Hertina and Saudi (2019), and Hertina (2021). This Moreover, the study found that COVID-19 pandemic
implies that an increase in the DEBEQT is associated had a negative and statistically insignificant effect on
with higher ROA. The study also identified a negative ROE, consistent with previous research by Amnim et al.
12
Table 8. The Effect of Financial Leverage on Financial Performance (ROE).
Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Mode 8
ACR –1.444*** – – – – – – –
(0.121) 1.453*** 1.443*** 1.441*** 1.403*** 1.324*** 1.332*** 1.586***
(0.121) (0.121) (0.121) (0.124) (0.119) (0.119) (0.121)
CCR –1.834*** – –1.81*** – – – – –
(0.221) 1.871*** (0.221) 1.879*** 1.797*** 1.189*** 1.015*** 1.081***
(0.222) (0.221) (0.221) (0.221) (0.223) (0.228)
ICR 6.472*** 6.589*** 6.435*** 6.514*** 6.462*** 6.586*** 6.38*** 6.398***
(0.209) (0.209) (0.209) (0.209) (0.209) (0.204) (0.205) (0.213)
DSCR –1.698*** – – – – 0.108 –0.206* –
(0.081) 1.713*** 1.693*** 1.705*** 1.508*** (0.136) (0.122) 0.693***
(0.081) (0.081) (0.081) (0.15) (0.182)
DEBEQT 0.002 –0.012 0.001 0.013 0.067 0.559*** 0.526*** 0.279***
(0.101) (0.101) (0.101) (0.101) (0.109) (0.105) (0.104) (0.107)
AGE –0.007* –0.003 –0.006 –0.008* –0.007* –0.005 –0.005 –0.004
(0.004) (0.004) (0.004) (0.004) (0.004) (0.004) (0.004) (0.004)
SIZE 0.816*** 0.802*** 0.813*** 0.818*** 0.813*** 0.618*** 0.624*** 0.574***
(0.091) (0.092) (0.091) (0.091) (0.091) (0.09) (0.09) (0.089)
COVID–19 –0.207 –0.393
(0.227) (0.331)
EPUJ –0.01** –
(0.005) 0.034***
(0.004)
GEPU 0.004*** 0.02***
(0.001) (0.002)
ACR 3 DSCR –0.11 –0.132
(0.074) (0.09)
CCR 3 DSCR – –
0.866*** 1.053***
(0.052) (0.318)
ICR 3 DSCR –0.81*** –0.191
(0.05) (0.3)
Constant –4.319*** – – – – – – –2.29***
(0.734) 4.468*** 3.251*** 4.811*** 4.407*** 4.512*** 4.455*** (0.788)
(0.736) (0.883) (0.748) (0.738) (0.719) (0.719)
R-square 0.400 0.401 0.402 0.402 0.401 0.431 0.430 0.453
F-tests (p-value) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
***p\.01. **p\.05. *p\.1.

SAGE Open
(2021) and Jin et al.(2022). EPUJ displayed a negative Lastly, GEPU was found to have a negative and sta-
and statistically significant effect on ROE, commensurate tistically significant effect on Tobin’s Q, in line with the
with the previous studies’ findings (Garcı́a-Gómez et al., findings of Suh and Yang (2021). This indicates that
2022; Iqbal et al., 2020). On the other hand, GEPU had a improvements in GEPU could lead to a higher Tobin’s
positive and statistically significant effect on ROE, sug- Q for firms. The moderating effect of DSCR on the rela-
gesting that if GEPU is improved, it will lead to better tionship between ACR, CCR, and ICR showed a nega-
ROE for the firms. The study’s findings that GEPU has tive and statistically significant effect on Tobin’s Q,
a positive and statistically significant impact on ROE suggesting that DSCR can influence how these liquidity
support the results of Matousek et al. (2020) and Athari and financing metrics relate to Tobin’s Q.
(2021). The moderating effect of DSCR on the relation-
ship between ACR, CCR, and ICR shows a negative and Dealing With Endogeneity
statistically significant effect on ROE. One of the primary concerns in our analysis pertains to
Table 9 presents the effect of financial leverage, the addressing the issue of endogeneity among the explana-
COVID-19 pandemic, EPUJ, and GEPU on Tobin’s Q. tory variables. Failing to adequately address this with
Firstly, the study found that ACR has a positive and sta- endogeneity problem can lead to biased estimations
tistically significant effect on Tobin’s Q. An increase in within our regression model (J. Li et al., 2021; Zaefarian
the firm’s ACR by 1%, results in a higher Tobin’s Q of et al., 2017). Our aim in tackling the endogeneity prob-
0.006%, indicating that a higher cash reserve contributes lem was to render the independent variables exogenous
to greater firm value. by introducing lags to those variables previously consid-
Secondly, CCR exhibited a negative and statistically ered endogenous (Ullah et al., 2021). In the existing liter-
significant effect on Tobin’s Q. When the firm increases ature, both internal and external instruments have been
its CCR by 1%, Tobin’s Q experiences a decline of employed to mitigate the problem of endogeneity. In our
0.011%. This implies that holding excess cash for busi- study, we applied the robust two-step GMM to address
ness activities may not be conducive to enhancing firm this concern. The GMM facilitates the identification of
value, in contrast to the positive impact on ROE. endogenous variables and employs instrumental vari-
Thirdly,ICR demonstrated a positive and statistically ables to transform them into exogenous variables
significant effect on Tobin’s Q. Thispositive relationship through the introduction of lags.Furthermore, the
is attributed to the availability of funds after servicing GMM methodology is effective in dealing with issues
debt interest, which can be used to acquire additional such endogeneity, heteroskedasticity, and autocorrection
assets, thereby expanding the firm’s earnings base problems (Le & Tran, 2021; Nguyen et al., 2021).
(Miller, 1988; Myers, 2001). A 1% increase in ICR by Our GMM results, presented in Tables 10 to 12, are
the firm contributes to a 0.011% rise in Tobin’s Q. robust and corroborate our main findings outlined in
Moreover, DSCR had a positive and statistically sig- Tables 7 to 9. The study used AR (2) and Sargan tests to
nificant effect on Tobin’s Q, indicating that firms with check the validity of the GMM model. The null hypoth-
stronger debt service capabilities tend to have higher esis for AR (2) test suggests the absence of autocorrela-
Tobin’s Q values, reflecting their higher market value tion and the statistically insignificant results for the
relative to book value. This aligns with the notion that Sargan tests underscores the validity of our GMM find-
well-managed debt can be value-enhancing for a com- ings. Consequently, we can confidently assert that our
pany. On the other hand, DEBEQT exhibited a negative GMM model results are valid.
and statistically significant effect on Tobin’s Q, consis- The results show that our results for the GMM model
tent with the findings of Setiyawati et al. (2018) and are valid.Examining Table 10, our analysis reveals that the
Ibrahim and Isiaka (2020). This suggests that an increase dynamic panel, representing the lag of ROA, exhibits a
in the DEBEQT ratio is associated with a decrease in positive and statistically significant impact on ROA. The
Tobin’s Q, implying that excessive equity financing may outcomes in Table 11 indicate that the dynamic panel, rep-
not always lead to higher firm value. resenting the lag of ROE, similarly exerts a positive and
Regarding the external factors, the study found that statistically significant influence on ROE. Lastly, the
the COVID-19 pandemic had a negative and statistically results presented in Table 12 highlight that the dynamic
insignificant impact on Tobin’s Q, aligning with prior panel, representing the lag of Tobin’s Q, also displays a
research (Bose et al., 2021; Phang et al., 2023). Similarly, positive and statistically significant impact on Tobin’s Q.
EPUJ displayeda negative and statistically significant
effect on Tobin’s Q, consistent with findings by Iqbal
et al. (2020) and Suh and Yang (2021). This implies that
Conclusions
elevated economic policy uncertainty in Japan negatively The primary objectives of this study was to investigate
influences Tobin’s Q. the effect of financial leverage on the financial
14
Table 9. The Effect of Financial Leverage on Financial Performance (Tobin’s Q).
Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8
ACR 0.006*** 0.006*** 0.006*** 0.006*** 0.006*** 0.006*** 0.006*** 0.005***

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
CCR –0.011*** – – – – – – –0.01***
(0.001) 0.011*** 0.011*** 0.011*** 0.011*** 0.009*** 0.008*** (0.001)
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
ICR 0.011*** 0.011*** 0.011*** 0.011*** 0.011*** 0.011*** 0.011*** 0.012***
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
DSCR 0.022*** 0.022*** 0.022*** 0.022*** 0.022*** 0.009*** 0.007*** 0.008***
(0.004) (0.004) (0.004) (0.004) (0.004) (0.001) (0.001) (0.001)
DEBEQT –0.006*** – – – – – – –
(0.001) 0.006*** 0.006*** 0.006*** 0.006*** 0.004*** 0.004*** 0.005***
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
AGE –0.012*** – – – – – – –
(0.002) 0.013*** 0.013*** 0.013*** 0.012*** 0.013*** 0.013*** 0.011***
(0.002) (0.002) (0.002) (0.002) (0.002) (0.002) (0.002)
SIZE 0.008*** 0.008*** 0.008*** 0.008*** 0.008*** 0.008*** 0.008*** 0.074***
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (005)
COVID-19 –0.003 –0.002
(0.003) (0.003)
EPUJ – –
0.023*** 0.028***
(0.004) (0.004)
GEPU –0.028** –0.036*
(0.012) (0.019)
ACR 3 DSCR –0.037 –0.034
(0.408) (0.498)
CCR 3 DSCR – –
0.030*** 0.012***
(0.003) (0.002)
ICR 3 DSCR – –
0.027*** 0.007***
(0.003) (0.002)
Constant –0.018*** – 0.007*** – – – – –0.01*
(0.004) 0.017*** (0.006) 0.014*** 0.018*** 0.018*** 0.018*** (0.005)
(0.004) (0.004) (0.004) (0.004) (0.004)
R-square 0.212 0.213 0.238 0.216 0.212 0.228 0.226 0.266
F-tests (p-value) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
***p\.01. **p\.05. *p\.1.

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Table 10. Dynamic Panel-Data Estimation, Two-Step Robust System GMM (ROA Results).
Lag of ROA 0.011*** 0.021*** 0.013*** 0.010*** 0.004** 0.003 –0.003 –0.020***
(0.002) (0.002) (0.002) (0.002) (0.002) (0.002) (0.021) (0.003)
ACR 1.375*** 0.081 1.367*** 1.273*** 1.756*** 1.700*** 1.848*** 0.446***
Arhinful and Radmehr
(0.117) (0.110) (0.112) (0.112) (0.109) (0.110) (0.113) (0.126)

CCR 4.500*** 4.620*** 4.480*** 4.453*** 4.525*** 4.504*** 4.579*** 4.126***
(0.097) (0.100) (0.096) (0.097) (0.097) (0.098) (0.098) (0.115)
ICR 2.651*** 2.214*** 2.719*** 2.592*** 2.879*** 2.769*** 2.705*** 2.729***
(0.088) (0.089) (0.087) (0.090) (0.088) (0.088) (0.088) (0.109)
DSCR 0.197*** 0.218*** 0.214*** 0.194*** 1.289*** 1.062*** 0.962*** 1.077***
(0.044) (0.039) (0.043) (0.042) (0.074) (0.066) (0.054) (0.143)
DEBEQT 2.237*** 1.249*** 2.228*** 2.110*** 2.472*** 2.181*** 2.125*** 3.278***
(0.078) (0.074) (0.071) (0.079) (0.074) (0.070) (0.068) (0.118)
AGE –0.107*** –0.087*** –0.114*** –0.081*** –0.122*** –0.124*** –0.132*** –0.005***
(0.007) (0.007) (0.007) (0.007) (0.007) (0.007) (0.007) (0.001)
SIZE –1.885*** 0.362 (0.91) –1.643*** –1.193*** –1.348*** –1.617*** –1.376*** –2.691***
(0.280) (0.278) (0.279) (0.307) (0.299) (0.304) (0.234)
COVID-19 –0.796*** –0.753***
(0.038) (0.478)
EPUJ 0.004*** 0.007***
(0.001) (0.001)
GEPU –0.037*** –0.012***
(0.002) (0.004)
ACR 3 DSCR –0.908*** –0.350***
(0.056) (0.054)
CCR 3 DSCR –0.701*** –0.382***
(0.050) (0.185)
ICR 3 DSCR –0.835*** –0.967***
(0.045) (0.160)
AR 1 0.000 0.000 0.001 0.001 0.000 0.005 0.003 0.000
AR 2 0.538 0.540 0.540 0.552 0.557 0.559 0.601 0.650
Sargan 0.275 0.277 0.279 0.280 0.283 0.284 0.289 0.341
***p\.01. **p\.05. *p\.1.

15
16
Table 11. Dynamic Panel-Data Estimation, Two-Step Robust System GMM (ROE Results).
Lag of ROE 0.128*** 0.126*** 0.114*** 0.115*** 0.134*** 0.121*** 0.116*** 0.116***
(0.006) (0.006) (0.005) (0.005) (0.006) (0.006) (0.006) (0.006)
ACR –4.690*** –4.730*** –3.780*** –4.095*** –4.031*** –3.349*** –2.922*** –4.012***
(0.384) (0.361) (0.347) (0.356) (0.337) (0.349) (0.376) (0.272)
CCR 1.329*** 1.624*** 1.204*** 1.394*** 0.901*** 1.222*** 1.533*** 2.163***
(0.209) (0.217) (0.210) (0.205) (0.202) (0.221) 0.236) (0.216)
ICR 8.782*** 8.409*** 8.628*** 8.712*** 8.90*** 9.045*** 8.897*** 7.20***
(0.209) (0.217) (0.207) (0.200) (0.195) (0.206) (0.212) (0.204)
DSCR –1.032*** –1.128*** –1.134*** –1.062*** –1.792*** –0.822*** –0.383*** –0.374***
(0.091) (0.103) (0.087) (0.095) (0.194) (0.180) (0.123) (0.189)
DEBEQT 1.992*** 1.312*** 2.456*** 1.826*** 2.018*** 2.325*** 2.387*** 0.900***
(0.190) (0.022) (0.187) (0.189) (0.189) (0.182) (0.193) (0.165)
AGE –0.018 –0.005 0.025 0.044*** –0.012 –0.039*** –0.056*** –0.044***
(0.015) (0.016) (0.014) (0.015) (0.015) (0.015) (0.016) (0.014)
SIZE –2.023*** –0.681 –4.499*** –1.895*** –3.300*** –2.857*** –2.709*** –2.918***
(0.056) (0.586) (0.558) (0.546) (0.550) (0.538) (0.563) (0.587)
COVID-19 –1.205*** –1.116***
(0.078) (0.097)
EPUJ –0.017*** –0.016***
(0.001) (0.002)
GEPU –0.010*** –002**
(0.001) (0.001)
ACR 3 DSCR 1.370*** 2.754***
(0.147) (0.167)
CCR 3 DSCR –0.242*** –2.356
(0.116) (0.302)
ICR 3 DSCR –0.712*** –4.008***
(0.105) (0.277)
AR 1 0.000 0.000 0.001 0.001 0.000 0.005 0.003 0.000
AR 2 0.512 0.554 0.556 0.589 0.590 0.623 0.665 0.678
Sargan 0.207 0.310 0.311 0.354 0.344 0.364 0.376 0.381
***p\.01. **p\.05. *p\.1.

SAGE Open
Table 12. Dynamic Panel-Data Estimation, Two-Step Robust System GMM (Tobin’s Results).
Lag of Tobin’s Q 0.308*** 0.314*** 0.251*** 0.296*** 0.303*** 0.309*** 0.308*** 0.253***
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
ACR –0.029*** –0.096*** 0.025*** –0.043*** 0.024*** 0.035 0.036 0.017
Arhinful and Radmehr
(0.005) (0.041) (0.004) (0.004) (0.004) (0.044) (0.043) (0.040)

CCR 0.031*** 0.035*** 0.030*** 0.047*** 0.040*** 0.024*** 0.023*** 0.084***
(0.005) (0.005) (0.004) (0.005) (0.005) (0.005) (0.005) (0.029)
ICR 0.146*** 0.1460*** 0.069*** 0.123*** 0.161*** 0.015*** 0.015*** 0.072***
(0.004) (0.004) (0.003) (0.004) (0.004) (0.004) (0.004) (0.028)
DSCR 0.059*** 0.055*** 0.042*** 0.058*** 0.118*** 0.045*** 0.051*** 0.032***
(0.002) (0.002) (0.002) (0.002) (0.004) (0.004) (0.003) (0.004)
DEBEQT 0.026*** 0.028*** 0.114*** 0.035*** 0.061*** 0.041*** 0.041*** 0.117***
(0.004) (0.004) (0.003) (0.003) (0.004) (0.004) (0.004) (0.004)
AGE –0.029*** –0.021*** 0.080*** 0.030*** –0.036*** –0.030*** –0.030*** –0.108***
(0.002) (0.002) (0.002) (0.002) (0.002) (0.002) (0.002) (0.003)
SIZE –0.014 –0.010*** –0.046*** –0.040*** –0.015*** –0.016*** –0.016*** –0.375***
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)
COVID–19 –0.038*** –0.043***
(0.002) (0.002)
EPUJ –0.031*** –0.031***
(0.003) (0.003)
GEPU –0.007*** 0.009***
(0.001) (0.001)
ACR 3 DSCR –0.048*** –0.098***
(0.002) (0.02)
CCR 3 DSCR 0.069*** 0.057***
(0.024) (0.007)
ICR 3 DSCR 0.035 0.057
(0.020) (0.035)
AR 1 0.000 0.000 0.001 0.001 0.000 0.005 0.003 0.000
AR 2 0.372 0.378 0.379 0.409 0.409 0.430 0.450 0.541
Sargan 0.451 0.402 0.408 0.467 0.502 0.543 0.553 0.591
***p\.01. **p\.05. *p\.1.

17
18 SAGE Open
performance of firms listed in the Tokyo stock market. corporation’s assets to generate enough earnings to be
Our sample consisted of 257 companies from the auto- added to its earnings, allowing them to service all its debt
motive, construction, electronic, metal, and telecommu- obligations.
nications sectors during the period spanning from 2000 The study also suggests to the managers that they
to 2021. To assess the effect of financial leverage on should reduce the percentage of debt financing used in
financial performance, we employed both the random their capital structure, which would reduce the amount
effect model and the GMM to estimate the effect of of interest and principal that they are supposed to pay
leverage on various financial performance indicators. on the use of debt financing. Reducing the percentage of
The study used three dependent variables: ROA, ROE, debt financing would lead to better earnings in the future
and Tobin’s Q. The study used five independent vari- by enabling the corporation to pay for all its debt and
ables: CCR, ACR, ICR, DSCR, and the DEBEQT ratio. reducing the risk of financial distress and bankruptcy.
In addition, we included five control variables: the size
of the firms, age, the COVID-19 pandemic, EPUJ, and Declaration of Conflicting Interests
GEPU. The author(s) declared no potential conflicts of interest with
Our findings revealed that CCR and ICR exerted a respect to the research, authorship, and/or publication of this
positive and statistically significant effect on ROA, article.
whereas ACR exhibited a negative and statistically insig-
nificant effect on ROA. In terms of ROE, we observed Funding
that ACR, CCR, and DSCR had a negative and statisti- The author(s) received no financial support for the research,
cally significant influence, while ICR had a positive and authorship, and/or publication of this article.
statistically significant impact. Regarding Tobin’s Q,
ACR, ICR, and DSCR demonstrated a positive and sta- Ethics Statement
tistically significant effect, while CCR and DEBEQT Not applicable.
had a negative and statistically significant impact.
Furthermore, our analysis indicated that the COVID-
19 pandemic had a detrimental effect on ROA, ROE, ORCID iD
and Tobin’s Q. EPUJ was found to negatively impact Richard Arhinful https://orcid.org/0000-0002-6327-4231
these financial performance metrics as well. Conversely,
GEPU had a positive effect on ROA, ROE, and Tobin’s References
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Arhinful Radmehr 2023 The Impact of Financial Leverage On The Financial Performance of The Firms Listed On The Tokyo

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Original Research

Richard Arhinful1 and Mehrshad Radmehr1

Introduction important management tool that can be used to increase

Construction and materials 121 47.08

Table 2. Variable and Measurements.

Variables Abbreviations Measurements

Model 4 denotes interest coverage ratio, ‘‘DSCR’’ denotes debt

FP = b0 + b1ACR + b2CCR + b3ICR Estimation Method

Table 3. Descriptive Statistics.

Variable Obs Mean Std. dev. Min Max

ROA (%) 5,654 2.311 4.238 242.62 65.87

Table 4. Matrix of Correlations.

(1) ROA 1.000

shareholder equity was 5.204%. The average TOB was

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Mode 8

ACR –0.129 –0.141 –0.13 –0.125 –0.065 –0.04 –0.048 –0.185*

***p\.01. **p\.05. *p\.1.

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Mode 8

***p\.01. **p\.05. *p\.1.

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8

ACR 0.006*** 0.006*** 0.006*** 0.006*** 0.006*** 0.006*** 0.006*** 0.005***

***p\.01. **p\.05. *p\.1.

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8

(0.117) (0.110) (0.112) (0.112) (0.109) (0.110) (0.113) (0.126)

***p\.01. **p\.05. *p\.1.

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8

***p\.01. **p\.05. *p\.1.

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8

(0.005) (0.041) (0.004) (0.004) (0.004) (0.044) (0.043) (0.040)

***p\.01. **p\.05. *p\.1.

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ACR 0.006* 0.006* 0.006* 0.006* 0.006* 0.006* 0.006* 0.005*

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