On the Relationship between Systematic Risk and the Degrees of Operating and Financial Leverage

On the causality analysis of the correlation between financial leverage and systematic risk: evidence from Indonesian Stock Exchange

“…The high (or low) level of beta can affect and cause the high (or low) level of financial leverage, and on the contrary, the high (or low) level of financial leverage can affect and cause the high (or low) level of beta. However, in contrast to the prior studies from Gahlon and Gentry (1982) and Lee and Hooy (2012), the two conditional variables (operating leverage and size) do not significantly affect the causality relation between beta and financial leverage when using inter-temporal data. This study contributes to the new insight that financial leverage and beta are the two variables with bidirectional causality, showing that risks from both fundamental (financial/micro-economy) and market (macro-economy) are tightly linked to each other inter-temporally (in the long run).…”

“…This means that the two conditional variables (operating leverage and size) can be actually removed because they are not structurally influential in the model. This finding is not consistent with the conceptual clarification of Gahlon and Gentry (1982), stating that financial leverage and operating leverage are the determinants of the systematic risk.…”

“…The shares reflecting the high financial leverage will be considered as highly risky, aggregatively affect the market price, and then influence the stock's systematic risk. Another plausible explanation comes from Gahlon and Gentry (1982) who suggest that systematic risk should be estimated through models of real-asset risk measures. They consider DOL (degree of operating leverage) and DFL (degree of financial leverage) as the determinants of systematic risk originating from real-asset risk measures as a critique for current approach in estimating beta (systematic risk).…”

“…Although some researchers find that intrinsic business risk (i.e., the demand volatility of a firm's output due to macroeconomic conditions) is the main component of market beta (e.g., Griffin & Dugan, 2003;Mensah, 1992;Chung, 1989), most literatures acknowledge the impact of financial-and-operating leverage on market beta (e.g., Mandelker & Rhee, 1984; Gahlon & Gentry, 1982;Hill & Stone, 1980;John & Reisman, 1994;Schlueter & Sievers, 2013, etc.). To summarize, systematic risks (beta) are influenced by operating leverage, size, dividends, unexpected earning co-variability, business lines, and specifically financial leverage; and this comes to the opposite insight that financial leverage is one of the determinants of systematic risk (beta).…”

Does Intellectual Capital Affect the Volatility of Returns? An Empirical Investigation on Italian Listed Companies

“…Thus, operating leverage correlates to greater volatility in earnings and thus stock returns. This positive relation between has operating leverage and volatility has been documented in the prior literature (Lev, 1974;Myers, 1977;Turnbull, 1977;Gahlon and Gentry, 1982;Mandelker and Ghon Rhee, 1984). Table 2 reports descriptive statistics on the variables used in the study for each of the three years used to construct the sample.…”