Capital Structure, Firm Size, and Firm Value: Instrumental Variable Evidence from Indian Listed Firms

This study examines the determinants of firm value among listed Indian firms, with a specific focus on the effects of firm size, inflation, and leverage on market valuation proxied by Tobin's Q. Endogeneity, particularly reverse causality between firm size and firm value, remains a persistent methodological concern in corporate finance research. To address this, instrumental variable two-stage least squares (IV-2SLS) estimation was employed, using the second and third lags of firm size as instruments across a panel of 100 listed Indian firms. Three key findings emerged from the analysis. Firm size exhibited a statistically significant negative effect on Tobin's Q (β = negative, p < 0.05), supporting diseconomies of scale and agency cost theories. Inflation did not significantly influence firm value, a result consistent with the principle of nominal neutrality. Leverage showed a marginally positive effect on firm value, offering partial support to the trade-off theory's prediction of tax shield benefits from debt financing. The model explained 95.7% of the variation in firm value, and instrument validity was confirmed by a first-stage F-statistic of 9,476.45, far exceeding the conventional threshold of 10.These findings carry meaningful implications for corporate managers, investors, and regulators operating within emerging market environments. Managers should exercise caution with aggressive expansion strategies, as unchecked firm growth may erode shareholder value rather than enhance it.