Leverage and value relevance of financial statements

The paper examines the correlation between leverage and value relevance of financial statements. More specifically we investigate the impact of leverage on the value relevance of financial statements of USA listed firms. We choose for our sample USA listed firms as the US stock exchange market (NYSE - NASDAQ)  is the largest in the world including the leading companies in terms of growth, revenues and financial strength. Also the corporate credit market (Corporate bonds) is very advanced and firms can choose their leverage level according to their needs. The choice of our basic factor, leverage, comes from the fact that leverage is one of the most important variables of a firm. Leverage provides material information about: the financial position of the company, its ability to produce net profits for its shareholders, the need for additional capitals, investments etc. Our purpose is to examine the way that leverage has affected the importance of financial statements and specific accounting variables to investors. We create portfolios with different leverage levels and compare them in terms of value relevance of their financial statements. We also compare the importance of the two most significant accounting variables, earnings and book value (equity) across different levels of leverage. We examine which variables gain or lose in importance between different leverage levels. Our analysis is based on Ohlson's model using price models. The results of the empirical tests indicate that as leverage increases, the value relevance of financial statements decreases. According to this, investors tend to look for additional information about the financial position of companies beyond financial statements. Also according to our findings, earnings increase in terms of value relevance against Book Value. This finding indicates that at higher leverage levels the investors pay attention to the ability of the company to produce earnings (that help it to repay loan installments) and they are less interested in the financial position as expressed by equity.