52 Pages Posted: 22 Mar 2011 Last revised: 21 Nov 2014
Date Written: November 20, 2014
Using a measure of operating leverage that directly reflects the importance of fixed operating costs in firms’ cost structures, we show that high fixed cost firms have lower leverage ratios and also much larger cash holdings than low fixed cost firms. This conservative behavior is not solely a result of a trade-off between operating leverage and financial leverage, since even high fixed cost firms without any debt in their capital structure have significantly larger cash holdings than similar low fixed cost firms. We show that the conservative financial policies allow high fixed cost firms to limit the amount by which they have to cut investment if sales are low. Our evidence also suggests that the financial conservatism of high fixed cost firms is value-maximizing. We conclude that operating leverage is an important determinant of financial policies and helps explain why many firms have very low net leverage ratios.
Keywords: Operating leverage, fixed costs, capital structure, cash holdings, financial conservatism
JEL Classification: G30, G32
Suggested Citation: Suggested Citation
Kahl, Matthias and Lunn, Jason and Nilsson, Mattias, Operating Leverage and Corporate Financial Policies (November 20, 2014). AFA 2012 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1787184 or http://dx.doi.org/10.2139/ssrn.1787184
By John Graham