Leverage Structure Dynamics and Firm Value: Evidence From Bangladesh

Leverage Structure Dynamics and Firm Value: Evidence From Bangladesh

Mohammad Nazim Uddin, Mohammed Shamim Uddin Khan, Mosharrof Hosen, Md. Shahnur Azad Chowdhury
Copyright: © 2022 |Pages: 18
DOI: 10.4018/IJABIM.305115
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Abstract

The paper aims to examine the impact of leverage structure dynamics on firm value in Bangladesh. To this end, the panel techniques (GMM and PCSE) were used to control for serial correlation, heteroskedasticity, and cross-sectional difficulties in the panel data set. The paper found that leverage structure influences firm value. The result also supports the trade-off theory, which asserts that tax savings on interest expenses result in a lower total cost of capital and ultimately upturn firm value. Lastly, the paper highlights the significance of endogenous variables such as liquidity, profitability, tangibility, and tax rate on firm value in Bangladesh.
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1. Introduction

Globalisation and privatisation have grown concomitantly in the corporate business arena, with firms struggling to find a competent corporate leadership for their long-term success in today's global economic climate (Xie, Lin & Li, 2022; Zhao et al., 2022). To thrive in this competitive and global economy, a firm must design an optimal leverage structure that generates a positive change in firm value. The leverage structure affects the cost of financing, thereby impacting the stock's market price (Landi et al., 2022). The comprehensive relationship between leverage structure and firm value has been recognized, but the relationship may vary in signs and traits depending on the development of financial system and corporate governance practices in a country (Uddin et al., 2019). The financial manager of a firm is responsible for designing a suitable leverage structure that yields the optimal benefits of tax structure for its firm (Habib, 2019). Generally, leverage structure is to be designed based on business risk and profitability of firms, such that a balance is striked between the possibility of bankruptcy and gaining the tax benefits (Alber & Youssef, 2020). The management, on the other hand, must assess the relative benefits of financial instruments and capital market behavior in order to choose the best leverage structure for value creation.

The ultimate purpose of the financial manager is to maximize the firm value, which management attempts to achieve via the implementation of certain administrative and financial policies. The use of effective finance and investment policies contributes to the firm value. Such policies are frequently chosen based on the views of shareholders, directors and management. Managers often select a leveraging structure that enables achievement of their firms aim (Uddin, 2021). This leverage structure provides a framework of the weighted average costs of the fund and firm value. If the leverage structure is not correctly formulated, the firm may collapse sooner or later. Many capital structure theories describe the various comprehensive links between leverage and corporate value. Modigliani and Miller Theorem (1958, 1963) proposed that a firm value is unaffected by leverage structure, while the trade off-theory proposed otherwise (Sibindi, 2016). The cost of deviation is determined to be insignificant according to the pecking order theory, since there is no optimal capital structure. Several ideas have led to various hypotheses being developed about the relationship between leverage structure and firm value. In Bangladesh, no comprehensive empirical research on the link between leverage structure and firm value exists, and hence the significance of this study.

We have chosen Bangladeshi manufacturing sectors for our investigation for several reasons: First, previous research has focused on the developed economies, and their outcomes may not be applicable to emerging economies, such as Bangladesh.Second, due to prolonged military rule, Bangladesh has dealt with various forms of monetary exploitations in its money and capital markets over the past decade(Rahman & Rana, 2018;Uddin, 2019). This has significantly impacted the Bangladeshi manufacturing firms’ financial decisions.Third, the manufacturing industry is regarded as the mainstay of production in Bangladesh, albeit its current fragility owing to a lack of solid corporate qualities. Poor accounting standards and audits, lack of accountability, lack of transparency, management inefficiency, and political turbulence are the main factors influencing firm's long-term value maximization (Uddin, 2021; Stilitz& Weiss, 1981; Pontines, 2008).

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