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Impact of Interest Coverage Ratio on the Financial Performance of Listed Companies in Nigeria

Abstract

Interest coverage ratio is an important financial indicator used to assess a company's ability to meet its interest obligations from operating earnings. It measures the extent to which a company's earnings are sufficient to cover the interest expenses arising from its debt obligations. A higher interest coverage ratio generally indicates stronger debt-servicing capacity and lower financial risk, while a low ratio may indicate difficulties in meeting interest obligations and increased exposure to financial distress. Financial performance reflects the extent to which a company effectively utilizes its resources to generate profits, maintain financial stability, and create value for its shareholders. In Nigeria, listed companies operate in an economic environment characterized by high interest rates, inflation, exchange rate volatility, rising operating costs, changing monetary policies, and economic uncertainty. These conditions can increase borrowing costs and place additional pressure on companies with significant debt obligations. Effective management of interest-bearing debt has therefore become increasingly important for maintaining sustainable financial performance. Regulatory institutions such as the Financial Reporting Council of Nigeria (FRCN), the Securities and Exchange Commission (SEC), and the Nigerian Exchange Group (NGX) promote transparent financial reporting and sound corporate governance practices that enable investors and other stakeholders to assess corporate financial health and risk. Despite these regulatory efforts, variations in debt structures, borrowing costs, operating earnings, and interest obligations may expose listed companies to different levels of financial risk and consequently influence their financial performance. Although previous studies have examined leverage, debt management, and financial performance, empirical evidence regarding the impact of interest coverage ratio on the financial performance of listed companies in Nigeria remains limited and inconclusive. Against this background, this study investigates the impact of interest coverage ratio on the financial performance of listed companies in Nigeria. The study is anchored on Trade-Off Theory, Pecking Order Theory, and Agency Theory. Trade-Off Theory suggests that companies balance the benefits of debt financing, including tax advantages, against the costs associated with financial distress and debt-servicing obligations. A strong interest coverage ratio indicates a company's greater capacity to manage the costs associated with its debt financing. Pecking Order Theory explains that companies generally prefer internally generated funds before resorting to external debt financing, and excessive reliance on debt may increase interest obligations and financial risk. Agency Theory suggests that debt can serve as a monitoring mechanism by constraining managerial discretion, but excessive debt obligations may create financial pressures that adversely affect corporate performance. Collectively, these theoretical perspectives provide a comprehensive framework for explaining the relationship between interest coverage ratio and financial performance of listed companies in Nigeria. The study adopts a quantitative research design using a structured questionnaire administered to chief financial officers, finance managers, accountants, financial controllers, treasury managers, internal auditors, external auditors, investment analysts, and other professionals involved in financial and debt management within selected listed companies in Nigeria. A stratified random sampling technique will be employed to ensure adequate representation of companies operating in the financial services, manufacturing, consumer goods, industrial goods, oil and gas, telecommunications, agriculture, healthcare, and other sectors listed on the Nigerian Exchange Group (NGX). Interest coverage ratio will be measured using the relationship between earnings before interest and tax and interest expense, operating earnings relative to interest obligations, debt-servicing capacity, adequacy of interest payment coverage, and management of interest-bearing liabilities, while financial performance will be measured using Return on Assets (ROA), Return on Equity (ROE), net profit margin, operating profit margin, earnings per share, and profit growth. Primary data collected from respondents will be analyzed using descriptive statistics to summarize respondents' demographic characteristics and perceptions regarding interest coverage ratio and financial performance. Structural Equation Modeling (SEM) will be employed to examine the impact of interest coverage ratio on financial performance. The measurement model will be evaluated using Cronbach's Alpha, Composite Reliability (CR), Average Variance Extracted (AVE), and Confirmatory Factor Analysis (CFA) to establish the reliability and validity of the research instrument. Additional diagnostic tests, including multicollinearity assessment, common method bias analysis, and model fit indices such as the Comparative Fit Index (CFI), Tucker-Lewis Index (TLI), Root Mean Square Error of Approximation (RMSEA), and Standardized Root Mean Square Residual (SRMR), will be conducted to ensure the adequacy, consistency, reliability, and robustness of the structural model. The study anticipates that interest coverage ratio will have a significant positive impact on the financial performance of listed companies in Nigeria. Companies with stronger interest coverage ratios are expected to possess greater capacity to meet interest obligations from operating earnings, thereby reducing the likelihood of financial distress and improving financial stability. A strong interest coverage position may also increase the confidence of creditors and investors, reduce perceived financial risk, improve access to financing, and enable companies to direct a greater proportion of their operating resources toward productive investments rather than excessive debt-servicing costs. Conversely, a low interest coverage ratio may indicate weak operating earnings relative to interest expenses and increase the risk of default, financial distress, refinancing difficulties, and declining profitability. Persistent increases in interest expenses without corresponding improvements in operating earnings may further constrain cash flows and adversely affect shareholder returns. Consequently, effective management of interest-bearing debt and maintenance of adequate interest coverage are expected to contribute significantly to improved financial performance and financial stability among listed companies in Nigeria. This study is expected to make significant theoretical and empirical contributions to the literature on corporate finance, accounting, financial risk management, and corporate performance by providing comprehensive evidence on the relationship between interest coverage ratio and financial performance of listed companies in Nigeria. Unlike previous studies that broadly examined leverage, capital structure, or debt management, this research specifically evaluates interest coverage ratio as a determinant of financial performance using primary data and Structural Equation Modeling (SEM). The findings will provide valuable insights for listed companies, financial managers, accountants, treasury managers, auditors, investors, lenders, the Financial Reporting Council of Nigeria (FRCN), the Securities and Exchange Commission (SEC), the Nigerian Exchange Group (NGX), professional accounting bodies, policymakers, regulators, and academic researchers regarding the importance of debt-servicing capacity. The study will also provide evidence-based recommendations for improving debt management, controlling financing costs, strengthening interest payment planning, optimizing capital structure, improving operating earnings, and maintaining adequate interest coverage to promote sustainable financial performance among listed companies in Nigeria.

Keywords: Interest coverage ratio, financial performance, listed companies, debt management, financial risk, interest expense, profitability, financial stability, Structural Equation Modeling (SEM), Nigeria.