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The Impact of Financial Leverage on Shareholders’ Systematic Risk

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  • David Yechiam Aharon

    () (Department of Business Administration, Ono Academic College, Kiriat Ono 5500003, Israel)

  • Yossi Yagil

    () (Jacobs School of Management, Department of Business Administration, University of Haifa, Haifa 3498838, Israel
    Department of Business Administration, Western Galilee College, Akko 2412101, Israel)

Abstract

This paper tests the degree to which a sustainable relationship exists between financial leverage and the systematic risk of shareholders under the following capital market imperfections: corporate and personal taxes as well as risky debt and bankruptcy costs. This beta-leverage relationship has not yet been examined empirically in prior studies nor compared with the theoretical parameter values implied by well-known formulations in the literature. Using data from publicly traded American industrial firms, we found that risky debt models, rather than their corresponding risk free debt models, are more sustainable and appropriate for describing the link between equity beta and financial leverage. Our findings imply that estimating betas or unlevering betas based on risk free debt models might lead to unsustainable and inaccurate estimates of key corporate parameters such as the cost of capital, and may consequently lead to inappropriate capital budgeting decisions. In this respect, the results of this study might have consequences to the recently growing area of sustainable finance in the sense that investment decisions made by different bodies and institutions in the country are more consistent with market imperfections that exist in the economy. In other words, our findings can be in line with a sustainable financial marketplace that contributes to the economic efficiency in the long run and can be related to social well-being.

Suggested Citation

  • David Yechiam Aharon & Yossi Yagil, 2019. "The Impact of Financial Leverage on Shareholders’ Systematic Risk," Sustainability, MDPI, Open Access Journal, vol. 11(23), pages 1-23, November.
  • Handle: RePEc:gam:jsusta:v:11:y:2019:i:23:p:6548-:d:289032
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    References listed on IDEAS

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    More about this item

    Keywords

    equity risk; financial leverage; unlevered beta; market imperfections; sustainable finance;

    JEL classification:

    • Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics
    • Q0 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General
    • Q2 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation
    • Q3 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation
    • Q5 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics
    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products

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