Leverage Effect between ROA and ROE During the Covid-Crisis Based on a Hungarian Company Database

Abstract

This paper is devoted to examining two extremely popular financing principles in the practice of Hungarian companies during the Covid-crisis. The leverage effect explains how the Return on Equity can be improved compared to the Return on Assets, the risk matching principle states that the risky assets should be financed mostly from equity and the secure assets should be financed mostly from debt. The Covid-crisis is an excellent opportunity to study the relevance of these principles. The validity of these principles is examined in a sample containing about 30.000 company financial reports. The most important findings are the following: The profitability does not determine the leverage, but the high leverage determines the low profitability. The profitability is the consequence of former decisions about the debt-equity relationship, the debt/equity ratio would be the consequence of the profitability. The risk matching principles cannot be justified by the used sample.

Keywords

• leverage effect, risk matching principle, ROA, ROE