Financial leverage and labor productivity in microfinance co-operatives in Tanzania

Abstract

Microfinance co-operatives (MFCs) are increasingly accessing loans from other financial institutions to finance their lending activities. However, knowledge about the association between loans from other institutions and MFCs’ performance is limited. Therefore this paper contributes to the body of knowledge by extending the application of agency theory to investigate the effect of financial leverage on MFCs’ labor productivity. The paper applies fixed effect regression models on panel data of 442 observations established from a sample of 115 MFCs operating in five regions in Tanzania. The results show that financial leverage has a negative effect on labor productivity. The findings revealed that an increase in financial leverage results in lower labor productivity, which could be due to underinvestment because of the debt overhang problem, higher financing costs (which reduce future investments), high labor costs resulting from the high monitoring of lending, and loan collection activities. Such findings suggest that MFCs have to contain their costs and ensure that they generate more revenues from loans accessed from other financial institutions.