CORPORATE TRADE-OFF HYPOTHESIS: AN INVESTIGATION OF RELATIONSHIP BETWEEN BUSINESS AND FINANCIAL RISK

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Abstract

This survey is focused on the investigation of the concept of the corporate trade-off hypothesis (CTH), which suggests that firms adjust business risk and financial leverage to obtain the desirable amount of total systematic risk. The empirical tests were carried on a sample of 319 firms from the food and beverage manufacturing sector that covered the period 2008-2016. Prior empirical research has examined the relationship between business and financial leverage using market data. The aim of this research was to explore this relationship using accounting data. The use of accounting data made it possible to include unlisted companies in our survey. The results show that there is an inverse relationship between the variables of operating beta and mean debt ratio, which measure business risk and financial leverage respectively. Consequently, the empirical findings support the hypothesis that the corporate trade-off hypothesis is operative, for the cluster of food and beverage manufacturing companies.

Keywords: Systematic Risk, Business Risk, Financial Leverage, Trade-off Hypothesis, Operating Leverage, Financial Risk

Received: 30.11.2017

Accepted: 15.02.2018

JEL Classification: G32, M41, M10

How to cite this paper: Eleftheriadis, I. M. (2018). Corporate trade-off hypothesis: An investigation of relationship between business and financial risk. Corporate Ownership & Control, 15(2-1), 258-263. https://doi.org/10.22495/cocv15i2c1p11