Role of Operating Leverage and Financial Leverage in Value Premium
Author: Hafiz Muhammad Zia Ul Haq

The determining force behind the value premium is the matter of debate among the researchers, some are of the opinion that the financial distress risk determines value premium, whereas there are recent emerging line of researches (Berk, Green and Naik (1999), Carlson et al (2004), Zhang (2005) and Cooper (2006)) which suggest that value premium is the compensation for operating leverage (investment activity risk). This thesis provides empirical evidence for these models by examining the relationship of degree of operating leverage (DOL) and degree of financial leverage (DFL) with book to market ratio, systematic risk and stock returns on non-financial firms of Karachi stock exchange. The financial leverage is examined due to its interactive nature with operating leverage and positive correlation with financial distress risk. The study empirically finds positive relationship of operating leverage with book to market ratio, systematic risk and stock returns. Overall results provide support for the recent models which have linked operating leverage with book to market ratio and concludes that investment activity risk seems to be the major determining factor of value premium. Key words: degree of operating leverage, degree of financial leverage, systematic risk, book to market ratio, market capitalization, stock returns and value premium. Supervisor:- Dr Arshad Hassan

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Keywords : Financial Leverage, Leverage Role, Operating Leverage, Value Premium
Supervisor: Arshad Hassan

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