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.