Refinancing, Profitability, and Capital Structure
52 Pages Posted: 4 Nov 2012 Last revised: 26 Oct 2015
Date Written: March 2, 2014
We revisit the well-established puzzle that leverage is negatively correlated with measures of profitability. In contrast, we find that at times when firms are at or close to their optimal level of leverage, the cross-sectional correlation between profitability and leverage is positive. At other times, it is negative. These results are consistent with dynamic trade-off models in which infrequent capital structure rebalancing is optimal. The time series of market leverage and profitability in the quarters prior to rebalancing events match the patterns predicted by these models. Our results are not driven by investment layouts, market timing, payout, or mechanical mean reversion of leverage.
Keywords: Dynamic Tradeoff Theory
JEL Classification: G30, G32
Suggested Citation: Suggested Citation