Financial leverage and corporate financial health in developing countries: Evidence from India

Abstract

This study investigates the impact of financial leverage on corporate financial stability within the context of India’s evolving economic and institutional landscape. Using a balanced panel dataset of 235 firms listed on the BSE 500 index over the period 2011-2020, the analysis employs the Altman Z-score as a proxy for financial health and stability prediction. Grounded in capital structure theories, including the trade-off theory and pecking order theory, the study explores how leverage, firm size, profitability (EBIT), and retention ratio influence the financial health and stability of firms in developing countries. The regression results reveal a significant negative relationship between financial leverage and the Altman Z-score, underscoring the destabilizing effect of excessive debt. In contrast, firm size and profitability show strong, positive associations with financial health, suggesting that larger, more profitable firms are better equipped to manage financial risks. Interestingly, the retention ratio does not significantly affect the Z-score once other factors are controlled for, challenging assumptions about the protective role of internal financing. These findings reinforce concerns about the systemic risks posed by high corporate debt levels in developing countries like India. The study highlights the importance of firm-level financial discipline and the need for institutional reforms to support sustainable financing practices.