Leverage, Excess Leverage and Future Returns

Posted: 28 May 2008 Last revised: 17 Jan 2013

See all articles by Judson Caskey

Judson Caskey

University of California, Los Angeles (UCLA) - Accounting Area

John S. Hughes

University of California at Los Angeles

Jing Liu

The Cheung Kong Graduate School of Business

Date Written: March 7, 2011

Abstract

We examine the cross-sectional relation between leverage and future returns while considering the dynamic nature of capital structure and potentially delayed market reactions. Prior studies find a negative relation between leverage and future returns that contradicts standard finance theory. We decompose leverage into optimal and excess components and find that excess leverage tends to drive this negative relation. We also find that excess leverage predicts firm fundamentals, and that the negative relation between excess leverage and future returns may be explained by investors’ failure to react promptly to information contained in excess leverage about future financial distress and asset growth.

Keywords: leverage, excess leverage, stock returns, capital structure, market efficiency

JEL Classification: G12, G14, G32

Suggested Citation

Caskey, Judson and Hughes, John S. and Liu, Jing, Leverage, Excess Leverage and Future Returns (March 7, 2011). Review of Accounting Studes, Vol. 17, No. 2, 2012, Available at SSRN: https://ssrn.com/abstract=1138082 or http://dx.doi.org/10.2139/ssrn.1138082

Judson Caskey

University of California, Los Angeles (UCLA) - Accounting Area ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States

HOME PAGE: http://sites.google.com/site/judsoncaskey/

John S. Hughes

University of California at Los Angeles ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States
310-794-9553 (Phone)
310-267-2193 (Fax)

Jing Liu (Contact Author)

The Cheung Kong Graduate School of Business ( email )

1 East Changan Avenue, Oriental Plaza
E3/3F
Beijing
China

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