The effect of firms' financial and operating leverage on profitability: An empirical study in Borsa İstanbul

Using a sample of 200 firms listed on Istanbul Stock Exchange during the period 2008-2017, this study examines the effect of operating leverage on profitability, and the role of sales growth in determining this effect. Moreover, the study analyzes the effect of operating and bankruptcy risks on the relationship between financial leverage and profitability. T-Test, Mann- Whitney U test, Ordinary Least Squares (OLS) and fixed effects regressions and Structural Equations Modeling are used to test the research's hypotheses. The results indicated that operating leverage has a negative impact on profitability, and that this negative impact is weaker/stronger for firms with high/low sales growth. The results also showed that financial leverage has negative effect on profitability. Moreover, the negative impact of financial leverage on firm profitability is exacerbated by business risk and bankruptcy risk. The negative impact of debt ratio on profitability is higher for firms with high business and bankruptcy risks compared to firms with low business and bankruptcy risks. As a result, firms with low sales level should decrease operating leverage to improve their profitability. On the other hand, the profitability of firms with high business risk and bankruptcy risk can be enhanced by reducing debt ratio.