Operating Leverage, Profitability and Capital Structure

CICF 2013 Shanghai, China; EFA 2013, Cambridge UK; 24th CFEA (Kenan-Flagler Business School)

41 Pages Posted: 31 Jan 2013 Last revised: 22 Oct 2017

See all articles by Zhiyao Chen

Zhiyao Chen

The Chinese University of Hong Kong (CUHK) - Department of Finance

Jarrad Harford

University of Washington

Avraham Kamara

University of Washington - Michael G. Foster School of Business

Date Written: 26 Sep, 2017

Abstract

Operating leverage increases profitability and reduces optimal financial leverage. Thus, operating leverage generates a negative relation between profitability and financial leverage that is thought to be inconsistent with the trade-off theory, but is commonly observed in the data. We demonstrate the effect of operating leverage on firms’ profitability and financial leverage, as well as on the empirical relation between profitability and financial leverage, by using China’s entry into the World Trade Organization in 2001 and its effect on the capital-labor ratio of US firms.

Keywords: operating leverage, capital structure, financial leverage, trade-off theory,profitability, default risk

JEL Classification: G32

Suggested Citation

Chen, Zhiyao and Harford, Jarrad and Kamara, Avraham, Operating Leverage, Profitability and Capital Structure (26 Sep, 2017). CICF 2013 Shanghai, China; EFA 2013, Cambridge UK; 24th CFEA (Kenan-Flagler Business School). Available at SSRN: https://ssrn.com/abstract=2209070 or http://dx.doi.org/10.2139/ssrn.2209070

Zhiyao Chen (Contact Author)

The Chinese University of Hong Kong (CUHK) - Department of Finance ( email )

Shatin, N.T.
Hong Kong

Jarrad Harford

University of Washington ( email )

Box 353226
Seattle, WA 98195-3226
United States
206-543-4796 (Phone)
206-543-7472 (Fax)

HOME PAGE: http://faculty.washington.edu/jarrad/

Avraham Kamara

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States
206-543-0652 (Phone)
206-221-6856 (Fax)

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