Abstract:
The financial leverage-operating leverage trade-off hypothesis states that as financial leverage
increases, management of firms will seek to reduce the exposure to operating leverage in an
attempt to balance the overall risk profile of a firm. It is the objective of this study to test this
hypothesis and ascertain whether operating leverage can indeed be added to the list of factors
that determine the capital structure of South African firms. Forty-six firms listed on the
Johannesburg Stock Exchange between 1994 and 2015 are analysed and the impact of operating
leverage is determined. The results are split into two periods, that is, the period before the
global financial crisis (1994–2007) and after the global financial crisis (2008–2015). The impact
of operating leverage during these two periods is then compared to determine whether a
change in the impact of operating leverage on the capital structure can be observed especially
following the crisis. The results show that the conservative nature of South African firms
leading up to 2008 persisted even after the global financial crisis. At an industry level, the
results reveal that operating leverage does not have a noticeable impact on capital structure
with the exception of firms in the industrials sector of the South African economy.
