Correlation between Financial Leverage and Firm Value in Companies Listed in the Tehran Stock Exchange: A Case Study

Abstract

The financial lever is a norm in measuring the scale of using debt in the firm's capital structure. One of the most important issues in financial discussions is obtaining a blend of capital structure which has the most attractions for the investors. The structure of capital is a required link between debt and the equity that provides financial needs for preparing the company's properties.

The capital structure as the most important parameter in evaluating companies has been stated. In addition, the aim of determining the capital structure is to identify an ideal combination of financial sources in each company, in order to increase the shareholders’ wealth. Choosing an ideal capital's structure leads to a decrease in the company’s expenses and an increase in its value in the market. This research belongs to the descriptive (quasi-experimental) researches and its plan is classified as post-event ones. The hypotheses in this research have been tested through the statistical methods of correlation analysis. Based on the results of this research, there is a negative significant correlation between the financial leverage and other variables as earnings per share, price earnings ratio, return on equity, return on asset and operation profit in 153 accepted companies in Tehran Stocking Market in a five year period between the years (2005) to (2010) have been confirmed. According to the correlations between these variables, it will be suggested for the shareholders to involve the mentioned variables in their financial decisions in order to make an ideal structure; and the managers do possible investments, through decreasing the proportion of debts, for increasing the value of their company. They also need to make shareholders closer to choose influential and possible resources for their wealth to be increased by the use of strategic planning.

Keywords: Financial Leverage, Firm value, Earnings per share, Return on equity, Return on asset