Association between Degree of Leverages and Firm Value

Abstract

This study aims to empirically investigate the association between degree of leverages, operating and financial, and firm value in the context of India, one of big ten emerging markets (Garten, 1997). This study examines this association for 231 manufacturing firms listed in National Stock Exchange (NSE) in India over a period from 2001-2002 to 2010-2011. The independent variables, degrees of operating and financial leverage, and a market price-based dependent variable, called price-earnings ratio as a proxy of firm value, are taken to examine this relationship by using standard ordinary least square regression Asian Journal of Finance & Accounting ISSN 1946-052X 2016 ajfa.macrothink.org 213 models at the levels of individual firm and portfolio of firms. The findings of this study show a statistically significant negative relationship between firm value and degree of operating leverage and a statistically insignificant relationship between firm value and degree of financial leverage both at the levels of individual firm and portfolio of firms. Using the data from a country like India, one of fastest growing emerging markets in the world, this study provides an important insight on the effect of leverages on the firm value, the association between independent accounting variables and stock price-based dependent variable, to the practitioners, the scholars and the finance managers.

Impact of relative and absolute financial risks on share prices: a Zimbabwe Stock Exchange perspective

“…While our findings contradict whatGupta, Kumar, and Verma (2016) found out in India, they support whatOgbulu and Emeni (2012) found out on the Nigerian stock market. Value relevance of absolute risk for low-risk firms is, to a certain extent, in line with the signalling theory byRoss (1977).…”

“…A myriad of empirical studies has been done to determine the impact of a firm's financing options on a firm's value. Gupta, Kumar, and Verma (2016) studied the link between firm value (dependent variable) and operating and financial leverage in Indian manufacturing firms. The study used price/earnings ratio to measure firm value and OLS regression was used to model the relationship.…”

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“…Study by Winarto (2015) suggests that profitability has positive and significant effect toward firm value. Study by Gupta et al (2016) suggest that finance leverage did not related with firm value while study by Gill and Obradovich (2012) suggest that leverage has positive effect toward firm value. Based on the differences in previous study's results, author would like to study the effect of profitability and leverage toward dividend policies and firm value.…”

“…Leverage or the ability of the firm to pay its debt would not only affect the dividend policy, but also affect firm value, Winarto (2015). If the proportion of firm's debt was high then the risk bear by the firm (related with firm's ability) would also high and it would affect public perception regarding firm value, Gupta et al, (2016) and Gill and Obradovich (2012). This showed that, H 4 : Leverage has significant effect toward firm value.…”