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The IUP Journal of Accounting Research and Audit Practices:
Impact of Financial Leverage on the Payoffs to Stockholders and Market Value
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This paper examines the effect of financial leverage on the shareholders’ return and market value of 50 Indian companies listed on NSE and BSE—10 each (five high leverage and five low leverage) from auto, cement, FMCG, oil and gas and pharmaceutical industries of India. Shareholders’ return has been calculated through earnings per share and return on equity ratio, while market value is measured through dividend payout and price-earning ratio. Linear regressions are used to quantify the effect of financial leverage on shareholders’ return and market value.

 
 
 

Financial leverage refers to the extent to which a firm relies on debt. The more debt financing a firm uses in its capital structure, the more financial leverage it employs. Financial leverage is used to magnify the shareholders’ earnings, and it is based on the assumption that the fixed charges/cost funds can be obtained at a cost lower than the firm’s rate of return on its assets (Buse et al., 2006). When the difference between the earnings from assets financed by fixed cost funds and the costs of these funds is distributed to the equity stockholders, they will get additional earnings without increasing their own investment.

Financial leverage is an important aspect of financial management. For maximization of the value of the firm and shareholders’ return, the management tries to arrive at a proper mixture of debt and equity, which is not an easy task to do (Schauten and Spronk, 2006). Earnings per share of the company can be increased with financial leverage because the aftertax cost of the debt is less than the return on investing the borrowed money. On the other side, it is also true that the risk of leverage also increases as the debt ratio or the debt/equity ratio increases, and change in the company’s situation can also affect the leverage in negative direction. So every company has to cover the interest cost of debt if the return on equity decreases. This can mean a more noticeable decrease in Earnings Per Share (EPS) than if there were less leverage.

 
 
 

Accounting Research and Audit Practices, Economic Performance, Millennium Development Goals, Corporate Sustainability, Economic Transactions, Social Management, Environmental Accounting, Corporate Houses, Environmental Management System, Community Development, Waste Management, German Firms, United Nations Environment Program.