Testing the information quality of the degree of operating leverage disclosed in financial reports

Abstract

Taiwan is the only country requiring public firms to disclose the degree of leverage (DOL). Mandatory disclosure of DOL could help amateur investors to get a clear picture of a firm's financial position. This paper tests the relationship between the DOL and the operating risk of companies in Taiwan. The consistency quality of DOL disclosed in financial reports is also examined. DOLs transformed by Model 1 (regulated by the Securities and Futures Commission, Taiwan) and Model 2 (Mandelker and Rhee, 1984) have a more significant relationship with risk. This finding is an important contribution of this paper. We also find that DOL information presented in financial statements is not consistent by time-series comparisons. This paper concludes that the degree of operating leverage presented in financial statements from Taiwanese public companies might lack reliability and relevance.consistency; financial leverage; operating leverage; information quality; financial reporting; financial disclosure; Taiwan; degree of leverage.