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H. Jamal Zubairi
Institute of Business Management (IoBM), Karachi, Pakistan

For any business concern the net profit or bottom line for a particular time period is the end result
of its investing, financing and operating activities. These activities can be visualized as being
influenced by managements decisions and a host of internal and external environmental factors.
This paper investigates how profitability of firms, in the cement manufacturing sector of Pakistan,
is influenced or linked to selected financial and economic indicators. The purpose of the research
is to check whether the linkage of profitability with the selected indicators is in line with the
relevant generally accepted theory. Also, if there appear to be some deviations from the theory,
what the plausible reasons are which can explain these. Furthermore, the conclusions arrived
through data analysis might lead to some useful policy recommendations for Pakistani cement
companies, to better manage their profitability.
JEL classification: C23, G32
Keywords: Profitability, Operating Leverage, Financial Leverage, Liquidity, Gross Domestic
Product (GDP), Return On Assets (ROA), Return on Equity (ROE), Pakistans Cement Industry,
Panel Data

Finance and Economics theories come up with explanations of the likely impact of different
financial and economic factors on the profitability of a business. This paper focuses on studying
the impact of selected variables on profitability of firms in the cement manufacturing sector of
Pakistan. The purpose of the study is to examine the extent to which the linkage of the selected
indicators with profitability conforms to the relevant theory and to provide explanations for any
variations observed. More specifically, the objective is to see whether the cement sector companies
exhibit a commonality in respect of the linkage of the selected variables to profitability. In other
words to what extent can the linkage between a particular variable and profitability be generalized
for the sector as a whole or is there evidence to conclude that the significance of selected variables
differs from company to company.
Data of 12 out of 20 cement companies listed on the Karachi Stock Exchange was analyzed using
an econometric framework over a four year period (financial years 2005 to 2008). Return on
Equity (ROE) and Return on Assets (ROA) are taken as major profitability indicators (dependent
variables) while average share price, current ratio, long term debt to total capitalization, year-onyear revenue growth and GDP are taken as independent variables. The strength of linkage between
the selected dependent and independent variables was tested by applying pooled regression and
diagnostics like R-squared, F-Statistic and DW-Statistic. Results interestingly indicate that only
Electronic copy available at: http://ssrn.com/abstract=1534186

GDP growth (an external factor) has a significant effect on profitability, while none of the other
variables exhibit a statistically significant linkage with profitability during the years 2005-2008.
Following are the details of the findings:
First, out of the chosen independent variables only GDP growth has a significant positive
relationship with profitability. Second, financial leverage as measured by long term debt to total
capitalization has a negative though weak relationship with profitability. The sign of the
relationship supports the Dynamic Tradeoff theory that degree of financial leverage should have a
negative effect on profitability. However, this is contrary to the Static Tradeoff Theory that
postulates a positive relationship between profitability and financial leverage. Third, liquidity as
measured by the current ratio has a weak positive relationship with profitability, which is in
variance with finance theory which stipulates a negative relationship between liquidity and
profitability. Fourth, year-on-year growth in sales revenue has a weak positive impact on the
profitability of the examined firms. This implies inconsistencies in the cost structures of the sample
firms, which means that for a given percentage increase in sales revenue of every firm, the
percentage change in profitability will vary from firm to firm. Fifth, average share price of a firm
has a weak positive relationship with profitability. This shows that share prices of cement firms on
the Karachi Stock Exchange are not a true reflection of their financial performance and there are a
number of other factors impacting on the market price of shares.
The organization of the paper is as follows: Section 2 presents the theoretical basis for the analysis
and main findings of some previous empirical studies in the related area. Section 3 provides a
detailed description of the methodology, operational definitions of the variables, econometric
model and data used in the study. The estimated results are reported in Section 4. Finally, Section
5 concludes the main findings alongwith explanation of the results.
Names of the companies, included in the sample whose Income statement and Balance Sheet
figures were used to extract the data used in this research study, are given at Annexure A.


The linkage of profitability to capital structure is seen differently by the two theories presented by
Myers in 1984. These are the Static Trade-off theory (STT) and Pecking Order Theory (POT). STT
postulates that a companys capital structure is based on a target debt-equity ratio which is arrived
at by evaluating the costs and benefits linked to levels of debt. The factors evaluated include tax
impact, agency costs, financial distress costs etc. On the other hand POT argues that companies
base their capital structure on a hierarchy of decisions. They would first use internal funds
(retained earnings) for their financing needs. If fund requirements for investment projects can not
be fully met from internal sources, a company would go for debt financing from a bank or other
financial institutions, while issuing equity would be considered as a last option for external
financing. This means that companies operating profitably would generally not resort to debt
financing for their new projects, since they have sufficient internal funds available for the purpose.
On the other hand according to STT, profitable companies would prefer raising debt financing to
avail the benefit of tax shield on borrowed funds. Thus, STT supposes a direct relationship
between profitability and leverage, while POT expects an inverse linkage of profitability with
leverage. Moreover, STT argues that larger size companies would show greater preference for debt
financing due to lower chances of going bankrupt. This is supported by the assumption that larger
Electronic copy available at: http://ssrn.com/abstract=1534186

firms are more diversified, which also reduces the bankruptcy probability (see, for details Titman
and Wessels 1988).
Signaling Theory which was first presented by Ross (1977) explains that raising debt can be taken
as a signal to the capital markets that a company is confident that its future net cash flows after
debt servicing, are going to be positive. This is because a company is contractually bound to
service its debt i.e. pay interest and repay principal from its cash flows, otherwise it may be forced
to go into liquidation by its creditors. Thus, higher level of debt reflects the managements as well
as investors positive expectations in respect of future cash flows of the company. With reference
to POT, the issuance of equity by a company, rather than obtaining debt for financing its new
projects, sends a negative signal to the market. This is because managers are expected to have
more and superior information on the company and may therefore be tempted to issue equity when
it is overpriced, thereby hurting the interests of equity investors.
Financial management texts generally postulate an inverse relationship between liquidity and
profitability. Liquidity can be seen in the context of the level of current assets i.e. a high level of
current assets means high liquidity. This translates into a lower level of risk for a firm i.e. it will
have sufficient cash or near cash items, not only to meet its routine needs including payments to
its creditors, but also unexpected cash requirements in the event of an emergency. A similar line of
argument goes for accounts receivables, as these also convert to cash in due course, except for bad
debts which are usually a small percentage of sales. The same reasoning applies to inventory for
products with an established market and satisfactory turnover. However, if inventory constitutes a
relatively high proportion of current assets, this could signal that the demand for the firms
products is declining and in such a situation it would not be prudent to consider inventory to be
liquid. For this reason while liquidity may generally be estimated through the current ratio (current
assets/current liabilities), a stricter measure of liquidity the quick ratio ([current assets minus
inventories]/current liabilities) is more appropriate, when the current assets include a relatively
high percentage of inventories.

Modigliani and Miller (1958) in the first version of their paper tried to identify the effect of capital
structure on earnings and market value. They argued that in an economy without corporate and
personal taxes, capital structure does not matter. In other words, under a restrictive set of
assumptions, an un-leveraged firm has the same market value as a leveraged firm. They later added
corporate taxes to their model and then demonstrated that earnings and market value of the firm
can only be maximized by using 100% debt in their financing mix. Their findings were based on
the assumptions that business risk can be fairly gauged by the standard deviation of operating
income (EBIT); also that all present and prospective investors have homogeneous expectations
about corporate earnings and the riskiness of those earnings. They also assumed that capital
markets in which companies stocks and bonds are traded are perfect. Their most important
assumption was that the debt of firms and individuals was riskless, so the interest rate on debt was
a risk-free rate. Their model with corporate taxes demonstrated that benefits from debt arise
because of tax deductibility of interest payments.
Gahlon and Gentry (1982) came up with a model for estimating beta which is the measure of
riskiness of an asset as compared to the risk of a market portfolio. The variables used in the model
incorporated both operating and financial leverage as measured by DOL (degree of operating
leverage) and DFL (degree of financial leverage). The model focused on the impact of operating
and financing decisions on an assets systematic risk and valuation. The models findings
confirmed that DOL and DFL are representative of asset risk. Also beta was shown to be a
Electronic copy available at: http://ssrn.com/abstract=1534186

function of DOL / DFL, the coefficient of variation of companys gross earnings, and correlation
of cash returns to equity holders with the total monetary return on all capital assets or the total
investment. Another study by Mandelker and Rhee (1984) provides evidence about the linkage
between DOL, DFL and beta. They proved empirically that between 38 to 48 percent changes in a
cross-section of data are explained by DOL and DFL.
Mseddi and Abid (2004) explored the connection between company value and risk. They used
panel data to estimate DOL and DFL of 403 non-financial USA firms over the period 1995 to
1999. They reported that both financial and operating risk have a significant positive impact on
company value. They further provide evidence that excess return is a positive and increasing
function of DOL, DFL and systematic risk for all firms in the sample that exhibit a positive
correlation between sales changes and market portfolio returns. Eljelly and Abuzar (2004)
empirically examined the linkage of profitability with liquidity, as indicated by the current ratio
and cash cycle. They studied a sample of Saudi Arabian companies taken from the major economic
sectors, excluding power generation and banking, covering the years 1996 to 2000.The correlation
and regression analysis demonstrated a significant inverse relationship between company
profitability and liquidity, while a direct and strong relationship was seen to exist between
company size and profitability. This relationship, however, was more pronounced within industrial
sectors but not across all companies. Liquidly and size have more influence on profitability of
capital intensive industrial sectors as compared to their impact on service sector organizations.
Amongst the indicators of liquidity, the strongest influence on profitability was of current ratio
(CR), irrespective of industrial sector. However, when sectors were analyzed separately, liquidity
indicated by the cash gap was found to have a more significant impact on profitability. However,
this impact was of lesser significance for service sector or labour intensive companies but more
significant in the case of manufacturing and capital intensive companies. The study also found that
significance of the impact of liquidity on profitability varies from industry to industry. Although
firms may find it necessary to hold a certain minimum level of liquidity, the study shows that on
the one hand firms may lose profit opportunities by having very low liquidity, while on the other
they could be incurring unnecessary costs by carrying excessively high liquidity. In line with these
findings, Kesseven Padachi (2006) also found that low profitability was linked to the tying up of
large amounts of investment in inventories and receivables.
Larry et al. (1995) found an inverse relationship between a companys leverage and its growth rate.
This relationship was more pronounced in case of companies whose true growth potential was not
given due recognition by the capital markets or their perceived value was considered lower than
that needed to override the effect of debt overhang. They also confirmed that leverage did not
adversely affect the growth of companies which were reputed to be highly profitable. For studying
the leverage and growth linkage, data used covered a long time period of 20 years. Employing
regressions of investments on distinct parts of company cash flows, they found that reduction in
operating flows did not adversely affect investment to such an extent as was the case when a
comparable cash outflow was needed for debt servicing. The extent of leverage used depends on
managements own assessment of future growth. Thus, managers anticipating profitable growth
opportunities might feel that raising external funds and subsequent associated cash outflows could
be an impediment to growth. Consequently, an inverse relationship between leverage and
profitability could arise because of high growth companies managements deliberate preference
for a low leverage capital structure. Samuel H. Baker (1973) measured financial leverage inversely
by computing the ratio of equity to assets i.e. the lower this ratio the higher would be the leverage.
In line with finance theory, they found the relationship between profitability to be negative as well
as significant.

Sudipto Dasgupta and Kunal Sengupta (2002) in their study titled Financial Constraints,
Investment and Capital Structure: Implications from a Multi-Period Model examined the
relationship between profitability and leverage. They found that within a dynamic framework
profitability could be directly related to leverage, which is at variance from most studies using oneperiod models that show an inverse linkage between leverage and profitability. This result is
however in line with the conclusions of a study by MacKay and Phillips (2001), which found that
within an industry, financial leverage and profitability are directly related. Also Zubairi and Rashid
(2008) found a positive relationship between liquidity and profitability of automobile sector firms
in Pakistan. This was attributed to the sellers market scenario prevailing during the period under
review. In this period automobile firms were routinely getting advance payments from their
buyers, for up to five months before delivery, thereby enjoying substantially high liquidity.
Fama and French (2000) conclude that: The pecking order model predicts that more profitable
firms have less book and market leverage. The leverage regressions support the pecking order
model. Myers (1984) argued that, high profitability firms having access to substantial internal
funds prefer to avoid using the costlier external sources of financing i.e. debt and external equity,
to the maximum extent possible. If the variability of profits from existing projects is estimated to
be high, it would be prudent for companies to borrow presently instead of waiting for profits to
actually materialize. This borrowing would also help in keeping high cash balances, to overcome
possible liquidity constraints that might occur in the future. The level of borrowings can of course
be enhanced by firms, if the profitability of existing projects is high. Thus, we can conclude that, at
variance with the generally accepted theory, under specific conditions, a direct relationship
between leverage and profitability can also exist.
Timothy G. Sullivan (1974) while probing the relationship between company power and use of
leverage found that more powerful firms used relatively less debt in their capital structure. Thus
the common assertion that the higher profitability of these powerful firms could be because of
employing higher financial leverage, is refuted by Timothy G. Sullivans findings.
F. Samiloglu and K. Demirgunes (2008) studied and analyzed the effect of working capital
management on firm profitability. The sample for their study comprised manufacturing firms listed
on the Istanbul Stock Exchange. The data covered the years 1998-2007 and the variables included
for determining firm profitability comprised the various components of the cash conversion cycle.
The study found through multiple regression analysis that during the period under review, average
collection period of accounts receivable, inventory turnover in days and leverage had an inverse
and significant relationship with profitability, while growth in sales impacted positively and
significantly on profitability. However, the variables; cash conversion cycle, firm size and fixed
financial assets did not significantly affect profitability.


This section presents the measurements of the variables and discussion of different measures of the
variables, null hypothesis and methodology used to test the hypothesis and provides information
about the sources of data and sample size.




Return on Equity & Return on Assets (as dependent variables)

Average Share Price
Liquidity (Current Ratio)
Financial Leverage (Long Term Debt to Total Capitalization)
Year to year growth in revenue
Gross Domestic Product (GDP)

Following is a brief introduction of the variables used in the study:

Return on Equity and Return on Assets

These are computed by dividing the net income by total stockholders equity and total assets
respectively. For the purpose of this paper net income before tax has been used to avoid possible
distortion in results due to any special tax treatment position of any firm. The ratios have been
taken in percentage terms.
Average Share Price
For the purpose of this study, the market price of the firms share has been taken from Karachi
Stock Exchanges website and the average price prevailing in a particular year has been taken for
comparison with and analysis of its relationship with profitability indicators of the corresponding
The most common liquidity measures of a firm are its current and quick ratios. The current ratio is
used as an indicator of a companys ability to meet it short term debt obligations through its
current assets. It is measured by: current assets / current liabilities. If inventory comprises a high
percentage of current assets a stricter liquidity measure called quick ratio is considered to be a
more appropriate indicator of liquidity, which is calculated by: (current assets inventories) /
current liabilities. There are no universally good or bad current and quick ratios, since these have
to be seen in the context of the nature of business or the industry to which a firm belongs.
However, in general, the higher these ratios, the safer is a firm from the point of view of short term
creditors. Since these ratios are calculated on a particular balance sheet date, they can also be seen
as measures of a firms ability to pay off its short term creditors out of the cash proceeds from its
current assets, in the extreme case of the firm being liquidated due to its inability to continue
operations as a going concern. In this paper the liquidity measure used is the current ratio,
calculated in the standard way i.e. Current Assets (Cash + Marketable Securities + Accounts
Receivable + Inventories) / Current Liabilities.
Financial Leverage (Long Term Debt to Total Capitalization)
Companies can finance their assets through a combination of debt and equity. Leverage ratios
show the extent of a firms reliance on borrowed funds. Leverage ratios tell us how a firm is
financing its operations and provide some insight into its financial strength. The higher the
proportion of debt in the capital structure of a company, the higher is its default risk because debt
carries a fixed cost which has to be paid irrespective of its operating performance. Thus, a high
proportion of debt makes a firm more vulnerable to default with a slight decline in operating
performance. In practice, there are many variations of this ratio. It is therefore important to be clear
on what figures are being taken from a company's financial statements for computing this ratio. In

this paper financial leverage has been taken as the proportion of long term debt in the total long
term financing sources, measured by long term debt / (long term debt + equity).
Year-to-Year Growth in Revenue
Year to year growth in revenues has been calculated in percentage terms by comparing the net sale
figure of a firm for a particular year with the net sales of the previous year, measured as follows:
[(Net sales year 2 net sales year 1) / net sales year 2] X 100%.
Gross Domestic Product - GDP
GDP is the monetary measure of all finished goods produced and services provide in a country,
within a time period, usually a financial year. It includes all of private and public consumption,
government outlays, investments and exports less imports that occur within a particular country.
GDP growth rate is one of the most common indicators of a countrys economic performance.
Gross National Product GNP
Another indicator of a countrys economic performance is GNP. It is the total value of the finished
goods and services produced/provided within a country in a year, plus the income of its nationals,
whether working in the country or abroad, less the income of foreign nationals working in that
country. Using GNP as a measure of the economic condition of a country implies that a higher
GNP as compared to a previous year is reflective of an improvement in the standard of living of a
countrys nationals.
For this paper the year-wise GDP growth measured at current and constant prices in percentage has
been used as the indicator for performance of the economic performance of Pakistan. The figures
have been taken from Economic Survey published by Government of Pakistan. GNP was not
considered a relevant variable for the purpose of this paper since cement is a product which uses
local raw materials, mainly limestone and clay.
Methodology and Hypotheses
The main object of the study is to know whether the key financial and economic indicators affect
profitability (ROA & ROE) of the firms in the cement sector of Pakistan.
In order to achieve this objective, we tested the following five hypotheses for profitability*:

Profitability* of the firm is not significantly affected by the average share price of the firms
Profitability* of the firm is not significantly affected by the liquidity as measured by its
current ratio
Profitability* of the firm is not significantly affected by financial leverage as calculated by
the Long-Term Debt to Total Capitalization ratio
Profitability* of the firm is not significantly affected by the YoY Growth in revenues
Profitability* of the firm is not significantly affected by the growth in GDP

* Includes both profitability measures, i.e., Return on Assets & Return on Equity

We ran panel regressions to test the above hypotheses. Panel data analysis facilitates analysis of
cross-sectional and time series data. The pooled regression, also called the constant coefficients
model, is one where both intercepts and slopes are assumed constant. The cross section company
data and time series data are pooled together in a single column assuming that there is no
significant cross section or inter temporal effects. Specifically, the econometric model is defined as

PF = 0 + 1ASP + 2CR + 4LTDTC + 5YoYRG + 6GDP +


(Equation I)

Profitability represented by ROA & ROE

Average Share
Current Ratio
= Long Term Debt to Total Capitalization
= Year-on-year Growth in Revenues
Gross Domestic Product
the error term with zero mean and constant variance

The possible expected effects of the said variables on firms profitability are shown in Table 1.

Average Share
YoY Growth in
GDP Growth


Table-1: Expected Relationships

Expected relationship
Measure (proxy)
with Profitability
Av. Price during
financial year
Current Assets / Current
LTD / (LTD + Total
Equity) [%]


In percentage


In percentage


Sample and Sources of Data

The study is limited to performance of the cement sector of Pakistan during 2005 - 2008. Due to
data constraints 12 out of 20 companies listed on the Karachi Stock Exchange were included in the
study. Financial data of these firms over years 2005 to 2008 was used. This translates into 48 firmyear observations for panel regression, which can reasonably form results. The data has been
obtained from the financial statements of the respective cement companies. Data on GDP growth
has been taken from Economic Survey published by the Government of Pakistan.


This section presents the results of the regression analysis. The interpretation and detailed
discussion of the empirical findings are also reported in the section. Finally, a possible explanation,
on the basis of the financial theory, is given to explicate the empirical findings.

A. Regression Analysis Results

Using the pooled regression technique, we ran the regression of profitability on average share price
of the firm, liquidity (current ratio), leverage (long-term debt to total capitalization), growth in
revenues and GDP growth(GDP) with an aim to investigate whether these five variables have
significant explanatory power or not. The measures of profitability are taken as Return on Assets
and Return on Equity. The Average Share Price is taken in PKR. The remaining four variables
namely, liquidity, leverage, YoY growth in revenues and GDP growth are in percentage form. The
estimated results are reported in Tables 2 & 3.
Table-2: Pooled Regression Results (ROE)
Dependent Variable: ROE
Method: Least Squares
Sample: 1 48
Included observations: 48


Std. Error









Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion

Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat


The diagnostics R-squared and F-statistic (significant at 8%) are low as is usually remains the case
cross-section analysis, while DW statistics shows no auto-correlation problem. Moreover, all the
coefficients have the expected signs. Moreover low mean and high standard deviation of ROE
show that there is no consistency in profitability across companies in the cement sector.
The results are very interesting, as none of the firm specific factors is significantly linked to ROE.
The only factor, out of the variables considered, which has a significant effect on ROE is GDP
growth, as shown by t-statistic (significant at 3.3%). Since the demand for cement is closely
related to the real sector of the economy, the significant impact of GDP growth is not surprising.
Also, since cement pricing in Pakistan is usually controlled by a cartel of manufacturers, an
increase in demand resulting from growth in the real sector is usually accompanied by a rise in
cement prices and consequent increase in profitability (ROE). Similarly, the ROE would tend to go
down in the event of a slump in the economy.
Average share price is showing a weak positive linkage with ROE. This is understandable, as the
period under study witnessed some turbulent times in the equity markets. Moreover, this is
evidence, which shows that the share prices on KSE are driven more by speculation rather than
company or sector fundamentals like ROE.
Liquidity (current ratio) is found to have an insignificant positive relationship with ROE. This is in
slight variation with finance theory, although previous studies show that in certain peculiar
industry situations, a strong positive association of liquidity with profitability may also be
observed. In the case of the cement industry, there are slim chances of firms carrying excessive

cash balances, since unlike most other industries they do not need cash to buy raw materials on a
regular basis. This is because a long-term investment by way of lease rights on deposits of lime
stone and clay, the main raw materials, has already been done while setting up the plant. As for
finished goods inventory, relatively high levels may result either from over estimation of demand
or the desire to maintain a high plant capacity utilization, in order to keep the per unit cost of
product on the lower side. Thus, a weak to moderate positive relationship between current ratio
and ROE would not be unreasonable to expect.
Leverage (long-term debt to total capitalization) is exhibiting a weak negative relationship with
ROE. While the sign of the relationship is consistent with most studies which find a strong
negative relationship between leverage and profitability, the weak linkage in our study needs to be
explained. In contrast to most other sectors, the cement sector firms are not competing for
purchasing raw materials since the main raw materials (lime stone and clay) have already been
procured through leasehold rights. The price paid for leasehold rights and depletion rate determine
the cost charged for these raw materials on the incomer statement. Due to differences in the price
of leasehold rights, and depletion rates, the per unit production cost is likely to be inconsistent
across the companies. A similar inconsistency in the depreciation charge per unit can be expected
because of the differences in plant procurement cost and the difference in the ages of the new and
old cement plants. Raw materials and depreciation costs, being a significant proportion of cost of
sales, the gross profit and operating profit per unit of production are bound to exhibit
inconsistencies across firms. Thus leverage alone cannot reasonably be expected to show a strong
relationship with ROE.
Year to year growth in revenues exhibits a weak positive linkage to ROE. Again a plausible reason
for this result is because of inconsistencies in gross profit and operating profit margins across
firms. In other words, a similar percentage increase in sales revenues in all the firms will result in
varying degrees of change in profitability (ROE) across the firms.


Table-3: Pooled Regression Results (ROA)

Dependent Variable: ROA
Method: Least Squares
Date: 03/28/09 Time: 16:12
Sample: 1 48
Included observations: 48


Std. Error








Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat


Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion


We have taken the same firm specific external factor as determinants of ROA; another measure of
profitability. The diagnostics like R-squared, F-statistic (significant at 1%) and DW-statistic
(which lies close to the indecision zone) have no serious statistical problem and results are fine.
Again, low mean and relatively high standard deviation of ROA show that there is no consistency
in profitability across firms in the cement industry.
The results are broadly the same for ROA as were for ROE. Again, GDP growth is the only factor
that has a significant effect on cement sector ROA (significant at 6%). The probable explanation
for these results is the same as that for ROE. However, the results reaffirm that the firm level
factors are not consistently strongly linked to profitability across companies and the cement sector
as a whole primarily relies on robust real sector performance for its growth and profitability.
Moreover, all the coefficients have the expected signs thus reflecting well on estimation results.
To check whether the values of estimated parameters of model remain consistent through the
examined time period, we ran the Chows test on an overlapping sample by sequentially adding ten
points of data and computing the F-statistic and log likelihood to test the null hypothesis, that is,
parameters of the estimation model are stable over time. The estimated results are reported in
Tables 4 & 5.
Table-4: Estimates of Chows Test (Under ROE)
Chow Breakpoint Test: 10
Log likelihood ratio

0.306383 Probability
2.390535 Probability


Chow Breakpoint Test: 20

Log likelihood ratio

0.455884 Probability
3.515156 Probability


Chow Breakpoint Test: 30

Log likelihood ratio

1.882665 Probability
13.09951 Probability



Table-5: Estimates of Chows Test (Under ROA)

Chow Breakpoint Test: 10
Log likelihood ratio

1.961596 Probability
11.02111 Probability


Chow Breakpoint Test: 20

Log likelihood ratio

0.859429 Probability
5.142404 Probability


Chow Breakpoint Test: 30

Log likelihood ratio

1.147415 Probability
6.749277 Probability


Based on the calculated statistics both F-statistic and log likelihood ratio, the study is unable to
reject the null hypothesis that estimated parameters are consistent over time except for
insignificant log likelihood ratio at 30 break point in the case of ROE only. It implies that there is
no structural break in the model. Another way to check the reliability of the model is to determine
whether the estimated residuals are white noise. To proceed with this, we applied the augmented
Dickey-Fuller (ADF) test to the estimated residual from the model (presented in equation-I). The
results are presented in Tables 6 & 7.
Table-6: Augmented Dickey-Fuller Test Results (Under ROE)
ADF Test Statistic


1% Critical Value*
5% Critical Value
10% Critical Value


*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(RESIDROE)
Method: Least Squares
Date: 03/28/09 Time: 16:42
Sample(adjusted): 3 48
Included observations: 46 after adjusting endpoints


Std. Error








Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood


Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion



Table-7: Augmented Dickey-Fuller Test Results (Under ROA)

ADF Test Statistic


1% Critical Value*
5% Critical Value
10% Critical Value


*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(RESIDROA)
Method: Least Squares
Date: 03/28/09 Time: 16:46
Sample(adjusted): 3 48
Included observations: 46 after adjusting endpoints


Std. Error








Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat


Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion


The ADF test results provide strong evidence to reject the null hypothesis that the estimated
residual has a unit root. This implies that the residuals are stationary. It means that the mean and
variance of the residuals do not vary much with time.


In this study, data of a sample of 12 firms in the cement sector was analyzed through a pooled
regression model to ascertain whether the selected independent variables could serve as true
determinants of profitability. The data used in this study covered four financial years i.e. 2005 to
2008 or 48 firm-year observations for panel regression. The data analysis provides strong evidence
to come to the following conclusions:

GDP growth has a significant positive impact on profitability.

Average market price of share has a weak positive linkage with firm profitability
Liquidity has a weak positive association with profitability.
Financial leverage has a negative but insignificant influence on profitability in terms of
ROE but a more significant (at 10%) linkage with ROA.
5) Year on year growth in revenue has a positive but statistically insignificant linkage with
profitability when measured as ROE. However year on year growth has a significant
positive linkage with profitability in terms of ROA.

The direction of relationship of chosen independent variables with profitability corroborates

conventional theory and is also generally supported by previous studies. However, the linkage of
profitability (both ROA and ROE) is significant only in the case of GDP growth. This means that
the selected firm specific factors are not important determinants of profitability (both ROA and
ROE) of cement sector firms in Pakistan. Thus, the results of the study cannot form the basis for

formulating any industry-wide policy guidelines for optimizing firm profitability. In other words it
may be concluded that firm specific factors impact on the profitability of individual firms in
different ways. Two plausible reasons for this are:
(i) Differences in firm-wide per unit production cost of raw materials, as leasehold rights for
limestone and clay deposits, the main raw materials, may have been obtained by different
firms at widely varying rates.
(ii) Disparity in firm-wide plant depreciation cost per unit of production, due to wide
fluctuations in book value of plant and machinery of individual firms resulting from
differences in age and procurement price of the cement plants of the companies included in
the sample.
However, for a firm confirmation of the above plausible reasons, further research would be
required. Also, since all possible independent variables have not been covered in this study, future
studies can probe into whether there are some other firm level factors which have a commonality
with respect to their impact on profitability of cement sector firms in Pakistan. Most importantly,
the impact of firm level factors may also be inconsistent due to wide discrepancies and errors in
the reported profitability figures. The discrepancies may result from the financial statements being
influenced by certain differences in accounting policies amongst firms and possible doctoring of
accounts in some cases.


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Annexure A
Names of Pakistans Cement Sector Firms Included in the Research