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Topics: Risk, Finance, Operating leverage Pages: 11 (3688 words) Published: December 17, 2012
African Journal of Business Management Vol.6 (3), pp. 1095-1099,25 January, 2012 Available online at DOI: 10.5897/AJBM11.2266 ISSN 1993-8233 ©2012 Academic Journals

Full Length Research Paper

Operating leverage and systematic risk
Kheder Alaghi
Armenian State Agrarian University, Armenia. E-mail: Accepted 25 October, 2011

The aim of this paper is to study the effect of operating leverage in the systematic risk of listed companies in Tehran Stock Exchange. In this study, operating leverage (OL) as independent variable and systematic risk (β) as the dependent variable are considered. SIG ≤ 0.05 means H0 hypothesis is rejected; otherwise there is no adequate reason for rejecting H0. For testing the hypothesis of this study, linear regression technique has been used. According to the results obtained, H0 is confirmed because SIG = 0.20 > 0.05. Thus, operating leverage has no effect on the systematic risk of listed companies in Tehran Stock Exchange. Key words: Operating leverage, capital structure, systematic risk, financial leverage, earnings before interest and taxes (EBIT). INTRODUCTION Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). The notion implies that a choice has an influence on the existing outcome (or existed). Potential losses themselves may also be called "risks". Almost any human endeavour carries some risk, but some are much more risky than others. Return on equity, free cash flow (FCF) and price-to-earnings ratios are a few of the common methods used for gauging a company's well-being and risk level. One measure that does not get enough attention is operating leverage, which captures the relationship between a company's fixed and variable costs. In good times, operating leverage can supercharge profit growth; in bad times, it can crush profits. Even a rough idea of a firm's operating leverage can tell you a lot about a company's prospects. In this article, we will give you a detailed guide to understanding operating leverage (Aquino, 2003). Essentially, operating leverage boils down to an analysis of fixed costs and variable costs. Operating leverage is highest in companies that have a high proportion of fixed operating costs in relation to variable operating costs. This kind of company uses more fixed assets in the operation of the company. Conversely, operating leverage is lowest in companies that have a low proportion of fixed operating costs in relation to variable operating costs. Total risk can be divided into two parts: business risk, and financial risk. Operating leverage is an index of business risk. Business risk refers to the stability of a company's assets if it uses no debt or preferred stock financing. Business risk stems from the unpredictable nature of doing business, that is, the unpredictability of consumers’ demand for products and services. Works that relate accounting numbers to market measures of systematic equity risk was largely undertaken (Ryan, 1997). A major contribution of the Mandelker and Rhee (1984) model over Hamada and Rubinstein type models, is that it utilizes leverage values based on accounting flow numbers (degree of operating and financial leverage) rather than market stock numbers (level of operating and financial leverage). More recent proposals on changes in accounting disclosure of risk mean that a theoretically sound model of the relationship between accounting measures and market measures of risk is timely (Scholes, 1996). Identification of this relationship is helpful on a number of fronts. Firstly, the instability of market betas over time means that ex-post measures of market risk are not good predictors of future risk. Identification of an appropriate relationship between accounting variables and market risk could lead to improved predictive models of future market risk. Secondly, financial models of risk...
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