The Enhancing Effect of Financial Market Development on the Relationship Between Leverage and Firm Performance

This study attempts to develop a model, based on current corporate finance theories, which explains the enhancing effect that financial development variables have on the direct or indirect relationship between leverage and the performance of East European firms listed on local stock exchanges. The paper tests the influence of capital structure changes and of some important financial development variables on the performance of large companies from Eastern Europe. The study uses a number of major independent variables like changes in leverage and changes in the level of financial development of the banking system or capitalization of stock exchanges. Thus, a static panel analysis is used to test the relationship between these variables and the performance of Eastern European companies coming of the three most dominant sectors of industry (engineering, fuel & power and chemical & pharmaceutical) over a period of ten years Empirical results, obtained using a fixed effect regression, sustain the traditional theory that leverage is an important determinant of firm's performance, and validate the initial hypothesis that the level of financial development of each country strongly enhances this relation.