On Discerning the Implications of Operating and Financial Leverage Ratios on the systematic risk of enterprises: Evidence from SENSEX firms in India

With the proliferation of advancements surrounding the investment analysis, an area that has received only token attention from the practitioners and academicians pertains to the factors (beyond the market) implicating the systematic risk of securities. It is surprising that, even while there is an overwhelming consumption of the notion surrounding the critical role rendered by the security beta in bearing the corporate valuation process to fruition, there is almost an implied incongruity towards establishing the implications of fundamental business variables bearing an influence on the beta value of securities. The seminal studies conducted by Hamada (1972); Mandelker & Rhee(1984); Huffman (1989); Duett, et al., (1996); Ryan (1997); Faff, et al., (2002); Bernardo, et al., (2007); Alaghi (2011); and Ozdagli (2012) have attempted to discern the implication of fundamental business variables represented by operating and financial leverage on the systematic risk of enterprises that bear as significant additions to the literature in this area. However, the paucity of such studies particularly in respect of the emerging markets like India,serves as a significant contributor towards deciphering the interrelationship between systematic risks and fundamental business variables of enterprises thereby enriching the existing expanse of literature. In this paper, we seek to re-examine the hypothesis surrounding the implications of the fundamental business variables: Operating Leverage (OL) and Financial Leverage (FL) on the enterprise-wide systematic risk represented by security beta. On identifying OL and FL independently, we found a statistically significant relationship that FL bears on security beta.However, when we considered the Combined Leverage (CL), we observed a statistically significant relationship with security beta. Our sample consists of all the firms forming part of India’s benchmark capital market (SENSEX).