Question

Assume that you are interested in examining the effect of earnings volatility (uncertainty) on firms’ target capital structure using a panel data of firms listed on Palestine Exchange between 2012 and 2019. In light of your study of capital structure decisions, you think that earnings volatility is a determinant factor of capital structure. Moreover, you reason that earnings volatility effect on leverage targets is greater than the impact of firm size, market-to-book ratio, assets tangibility, R&D intensity, ..., and it is the most critical among all time-varying determinants of leverage targets. Further, you think that high level of uncertainty decreases debt tax shields, increases potential financial distress costs, and exacerbates debtholder–shareholder conflicts, thereby leading to a lower optimal target of capital structure.

1. What should be your testable hypotheses?

Answer 1

Yes, earning volatility has an important effect on the Leverage because the long-term existence of the company and the short term debt repayment of the company in terms of liquidity risk can lead to financial distress caused and long-term debt can lead to solve and see if the company does not have the proper earning stability and the company's earning a fluctuating in regards with the economic condition so the company will be likely to collapse in adverse economic scenario and such companies should always try to maintain earning stability along with a debt repayment structure so that there should be enough earning in order to repay the debt as there will be a lot of financial distress caused and there will be increase in share holder conflict and there will be lower optimal target of the capital structure.

My testable hypothesis would be including Times earnings ratio (TIE). It will be helpful to to estimate the overall impact of the earning and the ability of the company to repay the debt in the short-term so there will be no default risk and no liquidity risk.

My testable hypothesis will also be including the liquidity ratios such as current ratio & the quick ratio so that there will be enough cash in order to repay the debt in longer period of time.

My testable hypothesis will also include historical mean of the stability of earnings of the company in different quarters so that there will be a prediction regarding the repayment ability of the company so that there will be proactiveness in management of the debt capital and hence my testable hypothesis will be including all such measures in order to check the firm's ability in order to repay the debt and periodic repayment structure in order to reduce the risk