Purpose
The purpose of this paper is to examine the nature of the relationship between business risk and financial leverage. While past theoretical and empirical studies on this topic use similar variables, overall, their findings are inconclusive. In this paper, the author contends this is partially due to inappropriate proxies for business risk that are commonly used in these research papers. To correct for this misspecification, this paper proposes an alternative proxy for business risk that is isolated from the effects of financial leverage.
Design/methodology/approach
Past research on the relationship between business risk and financial leverage uses some variations in a firm’s operating cash flow as a proxy for business risk. This proxy cannot solely reflect business risk and may very well be affected by the level of financial leverage, especially for financially distressed firms. This paper proposes an alternative proxy for business risk that is isolated from the effects of financial leverage. This proxy is the cost of capital of an all-equity firm. The theoretical model developed in this paper is based on deriving the optimum level of debt as a function of business risk in the context of the Modigliani and Miller Proposition II model.
Findings
The findings show a positive linkage between business risk and financial leverage. This relationship is robust to the various forms the cost of financial distress function may take.
Originality/value
The mixed findings in past research papers regarding the relationship between business risk and financial leverage are mainly due to “inappropriate” measures of business risk that do not only reflect one firm attribute and are contaminated with other factors mainly financial leverage. As such, since the variable of interest is misspecified, the outcome of these studies cannot be credible. This paper attempts to correct for such misspecification by proposing a proxy that only reflects business risk. In addition, the proposed model is based on the widely acceptable Modigliani and Miller static theory of capital structure.
Purpose -The purpose of this paper is to examine the extent to which information technology (IT) and human capital accumulation have contributed to the recent rapid economic growth of the United Arab Emirates (UAE). Design/methodology/approach -Well-established prior theories suggest that both factors are key growth ingredients. Results from cointegration tests confirm these prior theories and support a strong long-run (equilibrium) relationship linking real economic growth in the UAE with both IT (alternatively defined) and human capital. However, additional tests based on the Gonzalo and Granger technique reveal that human capital plays a particularly significant role in the growth process.Findings -These results lend support to the notion that good education is a prerequisite before new technologies can produce economic benefits. In contrast with robust long-run effects, results from error-correction models indicate that neither IT nor human capital has any significant short-run effect on real growth. Originality/value -The paper is of value by demonstrating that efforts to invigorate the education system and the technological infrastructure in the UAE must persist over a long period of time, before they can produce their expected economic benefits.
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