Determining Force behind Value Premium The Case of Financial Leverage and Operating Leverage

摘要

The determining force behind the value premium is the matter of debate amongthe researchers. Some are of the opinion that the financial distress risk determines value premiumwhereas other theorize that value premium is basically the compensation for operating leverage(investment activity risk). This research provides empirical evidence on this theoretical contradictionby investigating the relationships of financial leverage (FL) and operating leverage (OL) withstock returns, the book to market ratio (B/M), and systematic risk on non-financial sector firms tradingat the Pakistan stock exchange (PSE). This research empirically finds significant and direct influenceof operating leverage on stock returns, the book to market ratio, and systematic risk respectively.Overall findings provide support for the theoretical models which have a linked book to market effectwith operating leverage. Thus, we conclude that investment activity risk seems to be the major factorthat determines value premium.