Effects of debt ratios on firm value
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Panel Threshold Effect of Debt Ratio on Firm Value in Taiwanese Listed Companies FengLi Lina a Associate Professor, Department of Accounting, Chaoyang University of Technology, Taichung, Taiwan. Ph.D Candidate, College of Business, Feng Chia University, Taichung, Taiwan, ROC. Abstract The goal in this paper is to analyze whether leverage affects firm value for a panel of 272 Taiwanese listed companies during the nineyear period 1997 to 2005. Advanced panel threshold regression model is performed to test if there exists an “optimal” debt ratio , which may result in threshold effects and asymmetrical relationships between debt ratio and firm value. Tobin’s q is adopted as proxy variables for firm value. The result in this study shows that there exists two thresholds effect between debt ratio and firm value. The estimated threshold value ( γˆ1 , γˆ 2 ) are found to be 48.92% and 49.55%. Among three coefficients ( αˆ 1 , αˆ 2 , αˆ 3 ), the estimate of coefficient αˆ1 , αˆ 3 are negative but not significant which means when the debt ratio is smaller than 48.92% or greater than 49.55% , the relationship between debt ratio and firm value is unclear. In the second regime, where the debt ratio is between 48.92% and 49.55%, the estimate of coefficient αˆ 2 is 0.009, which implies Tobin’s q will be increased by 0.009% via 1% increase of debt ratio. Tobin’s q will also be increased. Thus, this suggests that financial managers should utilize the relevant financial leverage wisely in order to maximize the firm’s value. Keywords: Tobin’s q, Panel threshold effect, Debt ratio 1. Introduction The theory of business finance in a modern sense starts with the Modigliani and Miller (1958) capital structure irrelevance proposition, showing that the firm value and weighted average cost of capital is unaffected by the financial structure of the firm. However, Modigliani and Miller’s (1958) perfect market assumptions: such as no transaction costs, no taxes, symmetric information and identical borrowing rates, and risk free debt, are contradictory to the operations in the real world. The literature on capital structure emphasis has been placed on releasing the assumptions made by Modigliani and Miller, in particular by taking into account corporate taxes (Modigliani and Miller, 1963), personal taxes (Miller, 1977), information asymmetries (Ross, 1977; Myers and Majluf, 1984; Myers, 1984), agency costs (Jensen and Meckling, 1976; Myers,1977; Kim and Sorensen,1986), and bankrup...
Panel Threshold Effect of Debt Ratio on Firm Value in Taiwanese
Listed Companies
FengLi Lin
a
a
Associate Professor, Department of Accounting, Chaoyang University of Technology, Taichung, Taiwan.
Ph.D Candidate, College of Business, Feng Chia University, Taichung, Taiwan, ROC.
Abstract
The goal in this paper is to analyze whether leverage affects firm value for a panel of 272 Taiwanese
listed companies during the nineyear period 1997 to 2005. Advanced panel threshold regression model is
performed to test if there exists an “optimal” debt ratio , which may result in threshold effects and
asymmetrical relationships between debt ratio and firm value. Tobin’s q is adopted as proxy variables for
firm value.
The result in this study shows that there exists two thresholds effect between debt ratio and firm
value. The estimated threshold value (
1
ˆ
γ
,
2
ˆ
γ
) are found to be 48.92% and 49.55%. Among three
coefficients (
1
ˆ
α
,
2
ˆ
α
,
3
ˆ
α
), the estimate of coefficient
1
ˆ
α
,
3
ˆ
α
are negative but not significant which means
when the debt ratio is smaller than 48.92% or greater than 49.55% , the relationship between debt ratio
and firm value is unclear. In the second regime, where the debt ratio is between 48.92% and 49.55%, the
estimate of coefficient
2
ˆ
α
is 0.009, which implies Tobin’s q will be increased by 0.009% via 1%
increase of debt ratio. Tobin’s q will also be increased. Thus, this suggests that financial managers should
utilize the relevant financial leverage wisely in order to maximize the firm’s value.
Keywords: Tobin’s q, Panel threshold effect, Debt ratio
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Effects of debt ratios on firm value

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