Effect of Financial Leverage on Firm's Market Value Creation in Bangladesh: A Comparison between MNCs and Domestic Firms

Effect of Financial Leverage on Firm's Market Value Creation in Bangladesh: A Comparison between MNCs and Domestic Firms

Syed Md. Khaled Rahman (Shahjalal University of Science & Technology, Sylhet, Bangladesh)
Copyright: © 2017 |Pages: 18
DOI: 10.4018/IJCFA.2017070103

Abstract

This article contends that a firm's performance is affected by various factors and capital structure is one of the factors among them. The basic objective of the research is to analyze and compare the impact of financial leverage on firms' Market to Book Value (MV/BV) and Tobin's Q ratio of DSE-listed MNCs & domestic firms of Bangladesh over a 20-year period (1996-2015). Explained variables are Market to Book Value (MV/BV) and Tobin's Q ratio. Explanatory variables of the interest are indicators of six financial leverage ratios. MV/BV is negatively related with leverage ratios of both types of companies. Domestic companies' MV/BV decreases by 0.016 times for 1% increase of debt ratio while MNCs' MV/BV decreases by 0.048 times for 1% increase of debt-equity ratio and vice-versa. With debt-equity ratio, domestic companies' Tobin's Q is positively related while that of MNCs is negatively related.
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Literature Review

Modigliani and Miller (1958) were the first ones to landmark the topic of capital structure and they argued that capital structure was irrelevant in determining the firm’s value. Lubatkin and Chatterjee (1994) have proved that there exists a relationship between capital structure and firm value. Rajan and Zingales (1995) as well as Fama and French also (1998) found that there was negative relationship between debt and financial achievement. Champion (1999) found positive association between leverage and firm performance. Booth et al., (2001) in their study found that in the developing countries, the profitability of a firm has a consistently negative relationship with financial leverage. Siddiqui and Rahman (2002) in their study attempted to present a comparison of capital structures between MNCs and local blue chip companies enlisted with the DSE. The results indicated that the capital structures of the firms depend on the industry within which they operate. Islam and Islam (2003) had studied on the linkage between capital structure and profitability of North Bengal Paper Mills Limited. The unfavorable debt-equity ratio had adversely affected the profitability of the mill measured in terms of ROCE and ROI. Uddin, Hossain and Abdullah (2004) had undertaken a research on capital structure of DSE listed companies. The aim of their study was to analyze the effect of DAR (Debt to Asset Ratio) on risk and return of shareholders’ stock. They found that DAR had insignificant positive correlation with the average stock returns. Zeitun and Tian (2007) as well as Abor (2007) indicated that firm performance is negatively related to capital structure.

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