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Equivalent-Risk Class Hypothesis: An Empirical Study

Published online by Cambridge University Press:  19 October 2009

N. Krishna Rao
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Extract

Studies [1, 3, 4, 5] pertaining to the relationship between a firm's cost of capital and the debt component of its capital structure have been implicitly assuming the equivalent-risk class hypothesis to be true. According to the hypothesis, firms belonging to the same industry group do not exhibit significant differences in regard to business risk and can, therefore, be treated as belonging to an equivalent risk class. The validity of this hypothesis, as borne out by the research of Wippern [8] and, later, of Gonedes [2], has become questionable. The purpose of the present paper is to replicate the test carried out by Gonedes with a set of sampled data from Indian industries. A brief review of the two existing studies is given below.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 7 , Issue 3 , June 1972 , pp. 1763 - 1771
Copyright
Copyright © School of Business Administration, University of Washington 1972

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References

[1]Barges, Alexander. The Effect of Capital Structure on the Cost of Capital, Prentice-Hall, Inc., 1963.Google Scholar
[2]Gonedes, Nicholas J., “A Test of the Equivalent Risk-Class Hypothesis.” Journal of Financial and Quantitative Analysis, June 1969.CrossRefGoogle Scholar
[3]Miller, Merton and Modigliani, Franco. “Some Estimates of the Cost of Capital to the Electric Utility Industry, 1954–1957,” American Economic Review, June 1966.Google Scholar
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[5]Sarma, L.V.L.N. and Rao, K. S. Hanumanta. “Leverage and the Value of the Firm.” The Journal of Finance, Vol. XXIV, No. 4, September 1969.Google Scholar
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[7]The Stock Exchange Official Directory, Volumes 2, 3, and 4, Bombay: The Stock Exchange.Google Scholar
[8]Wippern, Ronald F. “A Note on the Equivalent Risk-Class Assumption.” reprinted in J. Fred Weston and D.H. Woods, Theory of Business Finance: Advanced Readings, Wadsworth Publishing Co., 1967.Google Scholar