Capital structure and value of reported earnings: evidence from an emerging market

ABSTRACT

This article documents a nonlinear impact of capital structure on the value of reported earnings in India during the period between 2009 and 2015. Our results show that earnings reported by firms with moderate level of debt are more valuable than earnings reported by firms with low or high level of debt. Our results are robust across various proxies of capital structure and across various sub-samples. This article argues that moderate level of debt is associated with low-agency problems, while low and high level of debt is synonymous to high-agency problems. Differences in agency problems result in reported earnings that have very different levels of relevance.

KEYWORDS:

• Capital structure
• agency problems
• value
• earnings
• emerging markets

JEL CLASSIFICATION:

• G32

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ We used robust regression for all estimations. Robust regression produces White corrected robust variance estimates (to control heteroscedasticity).

² As an additional test, this article also computes the standard errors by clustering the observations within each firm. Petersen (2009) considers such clustering as a mechanism to account for serial correlation and heteroscedasticity. Our unreported results show that significance of variables remains qualitatively the same.