Levered Returns and Capital Structure Imbalances
62 Pages
Posted: 24 Jan 2017
Last revised: 15 Jun 2017
Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics; Centre for Economic Policy Research (CEPR)
University of Lausanne
Bocconi University, IGIER and CAREFIN
Date Written: March 4, 2017
Abstract
We revisit the relation between equity returns and financial leverage through the lens of a trade-off model with costly capital structure rebalancing. The model provides a “lookalike” Modigliani-Miller equation that predicts that expected equity returns depend on whether a firm’s leverage is above or below its target leverage. The data support the model predictions. Controlling for leverage, overlevered (underlevered) firms earn higher (lower) returns. Controlling for target leverage the textbook positive relationship between leverage and returns is restored, while target leverage is negatively related to returns.
Keywords: Leverage, Cross Section of Returns, Target Leverage, Dynamic Capital Structure, Financial Frictions
JEL Classification: G12, G32
Suggested Citation:
Suggested Citation
Ippolito, Filippo and Steri, Roberto and Tebaldi, Claudio, Levered Returns and Capital Structure Imbalances (March 4, 2017). Available at SSRN: https://ssrn.com/abstract=2903515 or http://dx.doi.org/10.2139/ssrn.2903515
