Changes In Financial Leverage Research Articles

The Impact of R&D Innovation Success on the Relationship between R&D Investment and Financial Leverage

This paper explores the interrelationship between R&D investment, financial leverage, and a firm’s R&D innovation success. Using a sample of UK and EU firms, we predict that changes in one-year-ahead R&D investment are negatively associated with changes in financial leverage in the current period. Crucially, we also predict that this negative association is positively moderated by the extent to which firms are successful in generating commercially viable and technically feasible innovations from their R&D work. We use insights from International Accounting Standard (IAS) 38: Intangible Assets to measure R&D innovation success. Our empirical findings offer strong support for each of our theoretical predictions. Consequently, we contribute to the extant literature by demonstrating that R&D innovation success influences how firms finance their subsequent investments in R&D. Our work also shows that accounting disclosures have the potential to play an important role in open innovation networks.

تاثیر تغییرات اهرم مالی و هزینه بدهی بر تطابق درآمد و هزینه

Accounting rules mandate that the cost of debt should be recorded as an expense, while the cost of equity does not appear in the income statement. Therefore, the amount of financing expense, and thus net income, in the income statements depends on how firms finance their business. In this study, the effect of changes in financial leverage and interest expense have been studied on revenue-expense matching in the companies listed on the Tehran Stock Exchange. The sample includes 199 companies listed in the Tehran Stock Exchange from 1383 to 1397. The results show that revenue-expense matching is higher for companies with a large reduction in financial leverage. In addition, incremental changes in the financial leverage have a negative effect on the simultaneous relation between revenues and non-operating expenses matching. Also, the results show that only reduction changes in interest expense led to an improvement in simultaneous revenues and non-operating expenses matching. In general, results indicate that differential accounting treatment of the costs of debt and equity can affect earnings attributes through a change in capital structure

Does institutional ownership affect the value relevance of accounting information?

PurposeDrawing upon agency theory, this study aims to assess the value relevance (VR) of accounting information released by non-financial firms listed on the Kuwait stock exchange for the period of 2015-2018. Also, the influence of institutional ownership level and other explanatory variables, namely, book value per share, earnings per share, growth in assets and changes in financial leverage on share prices is examined.Design/methodology/approachTo test the hypotheses, the Ohlson (1995) model is extended. This study uses panel data analysis and applies appropriate statistical techniques to measure empirical relationships.FindingsThe results show that the VR of accounting information released by the Kuwaiti non-financial listed firms varies over the period of 2015-2018. Book value and earnings have significant and positive effects on share prices. In recent years, the VR of book value information has been growing, while that of earnings information has been declining. Institutional ownership level has a significant and positive influence on the VR of accounting information released by the Kuwaiti non-financial listed firms. The findings confirm a positive power, signalling growth in assets regarding the share prices. However, no significant relationship between changes in financial leverage and share prices is found.Practical implicationsThe findings of the study provide evidence of the linkage between VR and institutional ownership level, which promotes the understanding of the influence of institutional investors on a firm’s market value. Empirical evidence from Kuwait will have international implications and can serve as a guide for accounting researchers studying other emerging markets. Capital market regulators can provide guidelines in the form of information characteristics and elements of financial statements that need improvement. Finally, the findings assist non-financial listed firms to enhance the quality of accounting information by identifying the strengths and weaknesses in their financial reports.Originality/valueThis study extends the previous literature by investigating a relatively new set of data in more depth than that has been examined by prior research, which focusses on the relationship between accounting information and the firm’s market value.

The relationship between corporate governance and the dynamicity of capital structure in firms enlisted in Tehran Stock Exchange

Big corporate companies with lots of stockholders have a direct effect on countries' economy. Thus, studying such firms is an inevitable requirement to study on the national economy of countries and to remove the problems and to improve the performance and strategies utilized. Due to the effect of decisions related to capital structure and changes in it on the achievement of the firm's goals, several studies have been carried out regarding the effect of corporate governance mechanisms on decisions related to capital structure. But there has not been any experimental studies done regarding the effect of corporate governance on the modification speed of capital structure towards optimal capital structure. Thus, the present research has been carried out to supply evidences regarding the role of corporate governance variables and their quality in the speed of modification of capital structure towards optimal capital structure. Methodology: The dependent variable in this research is the dynamicity of capital structure and the independent variable is corporate governance that is comprised of three elements as: institutional stockholders, board members' independence, and the existence of internal audit. To test the research hypotheses we have used the historical data of the years between 2009 and 2013 related to 139 firms enlisted in Tehran Stock Exchange and by using Chang et al. (2014) model. To study about the normality of research data we have done tests related to skewness and pulling and normality and in order to observe lack of self-correlation of the data we have used Durbin-Watson tests. Also in order to test the linear correlation amount between the two variables we have used Pearson's correlation coefficient. Finally the data were adjusted by multiple regression method to approve or reject the research hypotheses within the models proposed. Results: The research results showed that corporate governance quality affects the dynamicity of capital structure Conclusion: and based on findings we can accept that speed coefficient of the changes in financial leverage has been meaningful in both groups of strong and weak corporate governance firms and this variable has affected the dynamicity of capital structure.

Impact of corporate governance index quality on correction speed of capital structure in firms enlisted in Tehran Stock Exchange

Big corporate companies with lots of stockholders have a direct effect on countries' economy. Thus, studying such firms is an inevitable requirement to study on the national economy of countries and to remove the problems and to improve the performance and strategies utilized. Due to the effect of decisions related to capital structure and changes in it on the achievement of the firm's goals, several studies have been carried out regarding the effect of corporate governance mechanisms on decisions related to capital structure. But there has not been any experimental studies done regarding the effect of corporate governance index on the modification speed of capital structure towards optimal capital structure. Methodology: Thus, the present research has been carried out to supply evidences regarding the role of corporate governance variables and their quality in the speed of modification of capital structure towards optimal capital structure. The dependent variable in this research is the dynamicity of capital structure and the independent variable is corporate governance that is comprised of three elements as: institutional shareholders, board members' independence, and the existence of internal audit and They have been used to measure corporate governance index. To test the research hypotheses we have used the historical data of the years between 2009 and 2013 related to 139 firms enlisted in Tehran Stock Exchange and by using Chang et al. (2014) model. To study about the normality of research data we have done tests related to skewness and pulling and normality and in order to observe lack of self-correlation of the data we have used Durbin-Watson tests. Also in order to test the linear correlation amount between the two variables we have used Pearson's correlation coefficient. Finally the data were adjusted by multiple regression method to approve or reject the research hypotheses within the models proposed. Results: The research results showed that corporate governance quality affects the dynamicity of capital structure Conclusion: and based on findings we can accept that speed coefficient of the changes in financial leverage has been meaningful in both groups of strong and weak corporate governance firms and this variable has affected the dynamicity of capital structure.

Empirical evidence on the relationship of capital structure and the value of the firm among Mexican public firms

This paper estimates the impact of capital structure changes on the market value of a sample of 69 non-financial firms listed in the Mexican Stock Exchange, during the period 2004 to 2014. Using Pooled Ordinary Least Squares (OLS), Fixed Effects (FE) and Random Effects (RE) regressions, we confirm the extensively documented positive influence of leverage on firm value; i.e. there is a clearly positive and statistically significant relationship between changes in financial leverage (debt ratios and debt to invested capital) and changes in Tobin’s Q (our proxy variable for firm value). When the sample is distributed in sub samples of firms with low and high leverage, small and big size, low and high profitability, or low and high risk, the financial leverage coefficients vary in magnitude and, in the case of debt ratios, remain highly significant. Our main contribution consists in the analysis of the estimated parameters, contributing to a better understanding of the impact of financial leverage changes on the value of different types of firms. These findings have important implications for corporate financial strategies, as well as for portfolio managers’ investment choices.

The Public Market Equivalent and Private Equity Performance

The authors show that the public market equivalent approach is equivalent to assessing the performance of private equity (PE) investments using Rubinstein’s dynamic version of the CAPM. They developed two insights: (1) one need not compute betas of PE investments, and any changes in PE cash flow betas due to changes in financial leverage, operating leverage, or the nature of the business are automatically taken into account; (2) the public market index used in evaluations should be the one that best approximates the wealth portfolio of the investor considering the PE investment opportunity.We provide the theoretical foundation for the use of the public market equivalent (PME) measure, which is often used to evaluate private equity (PE) performance. We show that the PME is equivalent to valuing cash flows using Rubinstein’s dynamic capital asset pricing model. Establishing this link enables us to show that the Kaplan and Schoar PME measure is surprisingly robust. The PME gives an estimate of the risk-adjusted performance of PE funds without having to calculate any betas, even if the betas of the cash flows vary over the life of the investments, for example, owing to changes in financial leverage, operating leverage, or the nature of the businesses. Further, a PE fund cannot artificially increase its PME by increasing its leverage. The discount rate used to calculate the PME should approximate the return on the investor’s overall wealth portfolio, and it may vary across investors, even for the same fund. Unlike the standard CAPM, the PME does not evaluate performance relative to the market returns of other investments with similar risks. Instead, the PME evaluates investment performance as an integrated part of the investor’s overall portfolio. Because the PME is derived from a formal asset-pricing model, it does not suffer from the problems of the internal rate of return (IRR), which is an alternative performance measure that is often used to evaluate PE performance. Unlike the IRR, the PME always exists, and it is always unique. Because the PME is equivalent to a present value (PV) calculation, it cannot be manipulated, for example, by PE funds’ deliberately choosing the timing and magnitudes of their investments, unlike the IRR. Compared with the standard CAPM, the PME also has several advantages: it is easier to calculate, it does not require any betas—which are typically estimated from the market risks of comparable traded companies—and it doesn’t require any assumptions about the expected market risk premium. Overall, the PME appears to be an attractive, robust, and easily applicable method for evaluating PE funds’ past performance or the performance of other alternative assets for which regularly quoted market prices and returns are unavailable.

The Effects of Financial Leverage Changes on Stock Returns: A Study of Exchange Rate Volatility

This essay aims to discuss the changes of capital structure toward stock returns and return on assets, with a further introduction of interference factors of exchange rate risks. The correlational changes of both factors would be analyzed in terms of different fluctuation levels. The empirical results show significant discoveries: both the factors have positive correlations. Reasons can be deduced from the willingness of trading firms, the company operational requirements, and the psychology of return expectation. Thus, this study suggests the investors to include exchange rate fluctuation index, while the government shall timely open up to corporate transactions and the corporate should carry out overall exchange rate and interest rate hedging.

Change in parent’s cost of equity capital around equity carve-out

Equity carve-out transactions typically result in greater disclosure and more analysts following. Does this change in information environment affect the parent firm’s cost of capital? Having a sample of 142 equity carve-out transactions completed between 1982 and 1997, I examine this question by estimating their cost of equity with a residual income model. The results show that the average cost of equity of parent firms declines by about 64 basis points after carve-outs, after controlling for changes in financial leverage and risk-free rate. This decline in the cost of equity is greater for multi-divisional firms. Equity carve-outs that create pure-plays result in a larger decline in the cost of equity. Furthermore, the greater the increase in analyst following, the larger is the decline in the cost of equity around carve-outs. Overall these results imply that reduction in information asymmetry surrounding equity carve-outs is a key reason for the decline in cost of external financing. The major contribution of this paper is to show that it is the decline in the cost of equity, rather than an expected improvement in future earnings, that generates value for parent firms in equity carve-out transactions.

Hamada's equation, the Sarbanes‐Oxley Act of 2002 and the UK Companies Act of 2006

PurposeThe purpose of this paper is to show that Hamada's equation, which is used operationally to evaluate changes in capital structure as a result of changes in financial leverage, is subject to a number of non‐trivial deficiencies. Each of these deficiencies is of sufficient importance to nullify the fundamental purpose of this equation, render its function impossible, and epistemologically contradict its functioning. Moreover, to the extent that it is dependent on the empirically invalid capital asset pricing model (CAPM), Hamada's equation defies basic requirements of sound research methodology. Since it cannot do what it purports to do and is an operational fiction, it cannot assist directors with capital structure valuations in terms of Section 172 of the UK Companies Act of 2006. Further, if used operationally, is likely to contravene Section 807 §1348 of the Sarbanes‐Oxley Act of 2002.Design/methodology/approachA secondary survey of Hamada's equation, recent UK and US legislation and the literature of corporate financial management is undertaken in order to examine whether the fundamental purpose, function and functioning of this equation could validly and reliably achieve what it purports to achieve.FindingsThe derivation of Hamada's equation assumes perfect competition, yet to achieve its fundamental purpose and its function it is dependent on financial markets being inefficient and imperfectly competitive. Thus, its functioning requires a state that its mathematical derivation negates. Epistemologically, this equation is unsound, and since it is also dependent on an empirically invalid approach to the calculation of the cost of capital, the CAPM, Hamada's equation is an invalid valuation equation.Originality/valueThis paper shows that Hamada's equation defies basic requirements of sound research methodology, cannot assist directors with their duties in terms of Section 172 of the UK Companies Act of 2006 with regard to capital structure and financial leverage management, and is in conflict with Section 807 § 1348 of the Sarbanes‐Oxley Act of 2002.

The impact of macroeconomic uncertainty on firms' changes in financial leverage

AbstractWe investigate the relationship between a firm's measures of corporate governance, macroeconomic uncertainty and changes in leverage. Recent research highlights the role of governance in financing decisions. Previous research also indicates that macroeconomic uncertainty affects a firm's ability to borrow. In this paper we investigate how both these channels of influence affects firms' financing decisions. Our findings show that macroeconomic uncertainty has an important role to play, both by itself and in interaction with a measure of corporate governance. Copyright © 2009 John Wiley & Sons, Ltd.

Some Explanations to What's Wrong with the Economic Value Added?

The paper supplies additional explanations to my earlier published article What's Wrong with the Economic Value Added. It stresses that the construction of Accounting based Capital Charge doesn't mean the departure from market values of cost of equity and cost of debt. On the contrary Accounting based Capital Charge restores the truth and adds the amounts of opportunity costs on equity invested and debt invested according to the weights of equity and debt in the total amount of Invested Capital. Accounting based EVA still maintains the linkage with the market capital structure by means of Cost of Levered Equity, which should be used to calculate Accounting based Capital Charge. The Cost of Levered Equity embraces the effects of capital structure, as well as Cost of Debt does, which is also reacts to the changes in financial leverage.

The Value-Relevance of Changes in Financial Leverage Beyond Growth in Assets and GAAP Earnings

The economic performance of a firm is not directly observable. Prior research has shown that accounting earnings and cash flows measure the otherwise unobservable economic performance. However, these measures of performance are noisy and other variables can help us learn about economic performance. We argue that changes in financial leverage provide information about performance beyond what is available from earnings and cash flows. This concept is different from the traditional view in which financial leverage is a measure of risk. We show that changes in financial leverage are value-relevant beyond accounting earnings. As part of this analysis, we also provide evidence on the value-relevance of growth in assets. For both changes in financial leverage and growth in assets, we document that the information in these variables is incremental to the information in earnings, operating cash flows, and accruals. Although our focus is on contemporaneous returns, we also find that the market does not impound available information in changes in financial leverage in a timely fashion.

Discussion of “The Value-Relevance of Changes in Financial Leverage Beyond Growth in Assets and GAAP Earnings”

Dimitrov and Jain examine whether changes in leverage are associated with firm performance after controlling for growth in assets and accounting earnings. They find that firms with increases (decreases) in leverage have negative (positive) current and future stock returns and negative (positive) accounting performance in future periods. By providing new evidence on the relation between debt financing and firm performance, the study extends prior research on the economic implications of firms' financing choices. I examine potential measurement problems associated with the authors' empirical construct for changes in leverage. These problems stem from the use of accounting book values of assets and liabilities in the measurement of leverage and the endogeneity of firms' decisions to change leverage levels. I comment on the unusual characteristics of firms with extreme changes in leverage and their possible effect on the authors' results and inferences. I also discuss issues involved in interpreting the authors' results, particularly the plausibility of alternative explanations suggested by prior research. Lastly, I identify several questions raised by this study that can be examined in future research.

Effect of Changes in Financial Leverage on the Relation , Between Earnings and Stock Returns: Evidence from Korean Firms

This study examines whether a firm's default risk as measured by its financial leverage affects the relationship between accounting earnings and stock returns, viz., the earnings response coefficient (ERC). From analytical results, we hypothesize that the ERC is a negative function of the firm's default risk. We test this hypothesis by comparing the ERC’s between pre-change and post-change period, using a sample of Korean firms that experienced changes in their financial leverages through either the issue of new debt or the retirement of outstanding debt. The empirical results indicate that the ERC's have decreased for the issue of new debt, but increased for the retirement of outstanding debt from pre-change to post-change period. Furthermore, these shifts in the ERC's are statistically significant, even after controlling for the differences in the systematic risk and growth between pre-change and post-change period. Overall, our findings suggest that the default risk is an important factor affecting the ERC for the Korean firms.

The Value Relevance of Changes in Financial Leverage

Economic performance (economic profits, economic income, or underlying operating performance) of a firm is not observable. Market participants use accounting earnings and other proxies to measure the otherwise unobservable economic performance. Ball and Brown (1968) show that accounting earnings capture the economic performance to some extent. In particular, they find that accounting earnings are correlated with stock returns (value relevant). We hypothesize and show that changes in financial leverage are also value relevant. We document a significantly negative association between changes in financial leverage and contemporaneous risk-adjusted stock returns. The information in changes in financial leverage is incremental to the information in earnings-based measures. Furthermore, we find that changes in financial leverage are also negatively associated with future risk-adjusted returns. This evidence suggests that the information in changes in financial leverage is not impounded in stock prices in a timely fashion.

The Information Content of Changes in Financial Leverage

We show a significantly negative association between changes in financial leverage and contemporaneous risk-adjusted stock returns. The results are consistent with the hypothesis that changes in financial leverage are affected by and, therefore, signal changes in underlying operating performance. Furthermore, we find that changes in financial leverage are also negatively associated with future risk-adjusted returns. We show that changes in financial leverage are correlated with future changes in return on equity, which may partially explain the anomalous pattern in future returns.

The Impact of the Introdution of the Euro on Foreign Exchange Rate Risk Exposures

This paper examines whether the introduction of the Euro in 1999 was associated with lower stock return volatility, market risk exposures and foreign exchange rate risk exposures for 12,821 nonfinancial firms in Europe, the United States, and Japan. We show that though the Euro led to a significant decrease in the volatility of trade-weighted exchange rates of European countries, stock return variances of nonfinancial firms increased after its introduction. However, the Euro was also accompanied by significant reductions in market risk exposures for nonfinancial firms in and outside of Europe. We show that the reduction in market risk was not as a result of changes in financial leverage, and that it is concentrated in firms with a high fraction of foreign sales in Europe, a high fraction of total foreign sales and larger market capitalizations. In addition to its impact on market betas, the Euro has a positive effect on the incremental foreign exchange rate exposures, particularly for multinationals.

Financial Leverage Changes Associated with Corporate Mergers

Financial Leverage Changes Associated with Corporate Mergers

Financial leverage changes associated with corporate mergers

We empirically examine whether firms increase financial leverage following mergers. Firms could increase financial leverage either because of an increase in debt capacity or because of unused debt capacity from pre-merger years. We find that financial leverage of combined firms increases significantly following mergers. A cross-sectional analysis shows that the change in financial leverage around mergers is significantly positively correlated with the announcement period market-adjusted returns. Further tests indicate that the increase in financial leverage is an outcome of an increase in debt capacity, although there is weak evidence that some of the increase in financial leverage is a result of past unused debt capacity.