EBITDA and Managers’ Investment and Leverage Choices
62 Pages Posted: 30 Dec 2014 Last revised: 20 Nov 2018
Date Written: October 1, 2017
EBITDA is a commonly-used performance measure for (1) valuation, (2) debt contracting, and (3) executive compensation. The widespread use of EBITDA by stakeholders may induce managers to focus their attention on EBITDA. Since EBITDA excludes various expenses, managers who fixate on EBITDA may underweight the excluded expenses when determining their firms’ investments in capital and leverage levels. I find that managers who fixate on EBITDA over-invest in capital and over-lever their firm relative to their industry peers. These results are robust to alternative proxies for managers’ focus on EBITDA and alternative specifications. I also find that firms whose managers focus on EBITDA have weaker operating performance, which is attributed to higher depreciation expense. My primary proxy for managers’ focus on EBITDA is whether they choose to disclose EBITDA in annual earnings announcements. I find that the use of EBITDA in setting executive compensation, the prevalence of EBITDA estimates by analysts, and the use of EBITDA-based covenants in firms’ debt contracts are all positively associated with the propensity to disclose EBITDA in earnings announcements. I find weaker evidence of opportunistic motives explaining EBITDA disclosure. These results are consistent with managers disclosing EBITDA to portray to investors that it is a metric they seek to maximize. Overall, this study suggests that while EBITDA is a widely-used metric, there is a systematic cost to using this measure—it provides managers incentives to over-invest in capital and to acquire excessive debt.
Keywords: EBITDA; overinvestment; over-leverage; firm disclosure
JEL Classification: G14; G3; G32 M40; M41
Suggested Citation: Suggested Citation