Author(s): Shehla Akhtar, Sadia Saeed, Shazia Hassan & Syed Muhammad Aamir Shah
The study empirically analyzes the influence of financial leverage on the stock market response in the non-financial sector of Pakistan. The financial leverage has been studied at a market and a firm level but the control effect of industry has not been discussed before. Apart from earlier studies, the paper brings in to focus the dimensions of stock market response including stock market reaction and the stock market returns (Cready & Gurun, 2010). Multiple financial ratios including debt to equity and debt to total capitalization are used for quantifying the financial leverage. Similarly, market to book ratio and earning yield ratios are selected for computing the stock market reaction and stock market returns. The panel regression with fixed/random effect is applied to the data comprised of 13 years from 2007 to 2019. The findings of the study support that companies should consider the contribution of financial leverage on stock market response while estimating stock valuation. Moreover, shareholders should consider the levered stocks for investment to get abnormal returns in different industries. The study provides empirical evidence for the implementation of market timing and trade-off theory in Pakistan.