The impact of leverage on the cost of capital and market value

Enrico Battisti, Luigi Bollani, Nicola Miglietta and Antonio Salvi

Management Research Review, 2020, vol. 43, issue 9, 1081-1096

Abstract: Purpose - This paper aims to investigate the impact of leverage on the cost of capital and market value in the Indonesia Stock Exchange (IDX), where there areSharīʿahand non-Sharīʿahcompliant firms. Design/methodology/approach - This study uses a mixed methods sequential exploratory design and is based on an empirical analysis undertaken with a sample of firms listed on the IDX. In particular, a qualitative analysis was conducted to identify theSharīʿah-compliant firms and the qualitative study was designed to compare some financial elements inSharīʿahand non-Sharīʿahcompliant listed companies. The correlations among the main elements observed are considered and a principal component analysis describes the framework. Findings - First, the results of the analysis show that for theSharīʿah-compliant companies, identified as those that apply Islamic principles, the lower level of leverage that it is typical of these type of firms implies a higher cost of capital [cost of equity and weighted average cost of capital (WACC)] than non-Sharīʿahones. Secondly, for theSharīʿah-compliant companies, the lower level of leverage entails a higher market value measured by the multiples method (price/earning and enterprise value/operating profit) than for non-Sharīʿahones. Originality/value - This paper sheds new light on how leverage can affect the cost of capital and market value in the case ofSharīʿahand non-Sharīʿahcompliant listed companies in the IDX. In particular, this research highlights the fact thatSharīʿah-compliant firms, despite having a higher WACC, create more market value compared to non-Sharīʿahcompliant ones.

Keywords: Cost of capital; Leverage; Market value; Indonesia stock exchange; Market multiples; Sharīʿah-compliant company (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:mrrpps:mrr-01-2019-0007

DOI: 10.1108/MRR-01-2019-0007

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