Leverage and the Cost of Capital for U.S. Banks
66 Pages Posted: 5 Sep 2014 Last revised: 4 Mar 2018
Date Written: February 1, 2018
We examine the relationship between leverage and the weighted-average cost of capital (WACC) for U.S. banks. Ignoring tax effects, leverage appears to have virtually no impact on the WACCs of too-big-to-fail banks. We find significant differences in this relationship across different mutually-exclusive asset-size classes of banks, suggesting a one-size-fits-all approach to research in this area may be inappropriate. In particular, the WACCs of small- and medium-sized banks are likely to rise with increased capital requirements. We attribute these results to differences in the strength and scope of government guarantees and in the composition of banks’ assets and liabilities.
Keywords: systematic risk, equity beta, bank leverage, cost of capital, Modigliani-Miller
JEL Classification: C33, G21, G28, G32
Suggested Citation: Suggested Citation