Relationship between financial risks and firm value: A moderating role of capital adequacy

Abstract

The study of firm value and financial risks became more important after the global financial crisis of 2007–2008, as the required risk was mismanaged, resulting in a deterioration in firm value. It is important to study the relationship between financial risks and firm value. This study aims to examine the moderating effect of capital adequacy on the relationship between financial risks and the firm value of listed banks in Pakistan. This study is based on half-yearly secondary data of 560 sample observations from 2009 to 2021. Multiple regression and panel data estimation techniques were employed for the analysis. The study used firm value as a dependent variable, proxied by Tobin’s Q, along with five independent variables and one moderating variable. The results of this study indicate that a higher capital adequacy ratio (CAR) increases firm value and has a moderating effect on financial risks and firm value. Nonperforming loans, net interest margin, and cost income ratio are found to have a significant negative relationship with firm value. The study concludes that the stock prices of listed banks in Pakistan are declining persistently, which causes the stock’s worth to shift from being inflated to being undervalued.