Substitution Financial and Operating Leverage and Its Distress and Performance Effects

Fathi, Saeed; Hosseini Haji Hasan, Said Ebrahim; Moazeni, Khashayar

doi:10.30699/ijf.2025.393865.1405

Substitution Financial and Operating Leverage and Its Distress and Performance Effects

Document Type : Original Article

Authors

Saeed Fathi ¹

Said Ebrahim Hosseini Haji Hasan ²

Khashayar Moazeni ³

¹ Associate Prof., Department of Management, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran.

² MSc., Department Of Management, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran.

³ MSc., Department of Finance and Banking, Faculty of Management and Accounting, Allameh Tabataba'i University, Tehran, Iran.

10.30699/ijf.2025.393865.1405

Abstract

The main goal of managing for-profit companies is to maximize shareholders' wealth, and to achieve it, management needs to make decisions regarding the sources and uses of capital. Different theories have been tried to explain the relationship between capital structure and performance, and have estimated a different relationship for financial leverage and company performance in different conditions. Financial leverage and operational leverage are two factors that influence the performance and macro policies of the company in terms of the profitability process. This research examines the effect of operational leverage and financial leverage on the company's profitability and financial distress, and finally examines the effect of replacing these two Leverages to maximize the profitability process and reduce the risk of financial distress. The sample includes 263 companies listed in the Tehran Stock Exchange and the Iran OTC Company from 2011 to 2021, which have passed the four screening factors of this study. The fixed effect panel regression method was used to test the first and second hypotheses. The results indicate a positive relationship between operational leverage and the profitability of companies, while the relationship between financial leverage and the profitability of companies is negative. On the other hand, both Leverages increase the risk of financial helplessness. To improve profitability, operational leverage can be replaced by financial leverage. Increasing operational leverage and reducing financial leverage can be used as a tool to grow the company's profitability; however, to reduce the helplessness of the companies and improve the profitability process, operational leverage can be replaced with financial leverage. Flexibility in financing companies is more than flexibility in the operational sector; that is why replacing operational leverage with financial leverage is more appropriate to improve profitability and reduce the risk of financial helplessness.

Keywords

Operating leverage

Financial Leverage

Profitability

Financial Distress

Financial Performance

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