Abstract
This article examines the association between corporate leverage and profitability. Using firm-level data on manufacturing sector in India for 1995–2004, the findings indicate that corporate profitability and cash flows declines as leverage rises. More importantly, the marginal effect of an increase in leverage on earnings is larger for firms that participate in international debt markets than other firms. The results are robust after controlling for the economic environment and various firm-specific controls.
Acknowledgements
The views expressed and the approach pursued in the article reflects the personal opinion of the author.
Notes
1 The original sin refers to the inability of emerging markets to borrow abroad in their own local currencies that compels them to issue in foreign currencies to capture foreign savings and exposes them to currency risk.
2Market participants are firms that participated in international debt markets in the past and have foreign debt outstanding at the beginning of the current period.
3Using the logarithm of firm size has the advantage that it gives a much smaller weight to large firms.
4The small and medium-sized firms (SME), as classified by the Indian Ministry of Industry, are those with gross fixed assets less than Rs. 100 million (about US$ 2.3 million).
5 Employing the logarithm instead of levels reduces the effect of extreme changes in the nominal exchange rate.
6 In the case of traded sector, for instance, a currency devaluation would have two effects: the competitive effect (raise the expected value of future export receipts) and the balance sheet effect (increase the local currency value of foreign liabilities and reduce the firms' borrowing capacity).
7 The classification of SIC (Standard Industrial Classification) two-digit sectors into ‘tradables’ and ‘nontradables’ is based on Forbes (Citation2002).