The Nexus Between Share Prices and Financial Risk in South Africa : A Comparative Analysis of High and Low Risk Firms

Abstract

Indebtedness threatens a firm's survival if it performs poorly and fails to service its debts. While other empiricists have focused on the effect of long-term debt on firm value, we extend the frontiers by defining financial risk (debt) as total liabilities. We analyse information content of financial risk on the Johannesburg Stock Exchange for the 2010-2017 period using dynamic panel models. Financial risk is estimated using the debt/equity ratio and total debt. The sample is divided into high-risk and low-risk firms based on average debt/equity ratio. Using two-step System GMM, we found out that debt/equity ratio is value relevant in both high- and low-risk firms. Total debt is value relevant for lowrisk firms but not value relevant for high-risk firms. Equity investors are advised to include debt/equity ratio in valuations. Company managers should keep total liabilities below market capitalisation and standards setters should safeguard the integrity of reported liabilities.