Financial risk and firm value: is there any trade-off in the Indian context?

Abstract

Purpose – The objective of the paper is to investigate the relationship between financial risk and the value of the company. In this context, the study is to revisit the trade-off theory of capital structure in the Indian context. Design/methodology/approach – After applying outlier, the study considered 389 nonfinancial companies from BSE500 from 2001 to 2018 collected from the Capitaline database. The statistical package E-views 10 has been utilized for analysis. To understand the nature of the data the descriptive analysis, correlation analysis, normality, unit root, multi-collinearity and Heteroskedasticity were conducted. The Panel Estimated Generalised Least Square with cross-section weight was found suitable for analysis due to the existence of cross-correlated residuals. Further, the study has classified the levels of financial risk to determine the relationship of different levels of financial risk with corporate value. Findings – It was found that the financial risk and corporate value had a significant negative relation during the period of study. On class interval-wise financial risk analysis, it was found that the debt-equity (DE) of around 1:1 may be considered optimal. Below that threshold limit, the DE affects value positively above which the ratio affects the value negatively. Originality/value – The paper makes an attempt to determine the optimal financial risk at the corporate level in the Indian context.

Keywords

• Value of the firm
• Financial risk
• Debt-equity ratio
• Trade-off theory
• Panel EGLS model