What does a higher return on equity compared to return on assets suggest about a firm's capital management?

A higher return on equity (ROE) compared to return on assets (ROA) indicates that a firm is effectively using its debt to enhance returns to its equity holders. This suggests that the firm is employing leverage, meaning it has borrowed funds to invest in its operations and grow its capital. By using debt, the firm can increase the total amount of capital available for investments, which can lead to a greater return for its equity investors, assuming the returns on those investments exceed the cost of the debt.

When a firm's ROE is significantly higher than its ROA, it generally means that the equity base is smaller relative to the total assets of the firm. Since ROE reflects the profit attributable to equity shareholders, a higher ratio signals that a substantial portion of the firm's assets is financed through debt. This situation is often desirable because it can amplify returns; if the firm successfully manages its debt and generates higher returns on its investments, the equity shareholders benefit from increased profitability without having to invest as much of their own capital.

In contrast, the other options do not accurately capture the implications of a higher ROE relative to ROA. For instance, stating that the firm has poor asset management suggests inefficiency in utilizing assets to generate profit, which is not