Levered Returns and Capital Structure Imbalances

78 Pages Posted: 24 Jan 2017 Last revised: 10 Jan 2022

See all articles by Filippo Ippolito

Filippo Ippolito

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics; Centre for Economic Policy Research (CEPR)

Roberto Steri

University of Luxembourg

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance; Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Alessandro Villa

Federal Reserve Bank of Chicago

Date Written: January 9, 2022

Abstract

We revisit the relation between equity returns and financial leverage through the lens of a dynamic trade-off model with costly capital structure rebalancing. The model predicts that expected equity returns depend on whether a firm's leverage is above or below its target leverage. We provide empirical evidence in support of the model predictions. Controlling for leverage, overlevered (underlevered) firms earn higher (lower) returns. A quantitative version of our model reproduces key facts about capital structure rebalancing and equity returns for U.S. corporations. Overall, our results indicate that financial flexibility crucially affects the link between leverage and equity returns.

Keywords: Leverage, Cross Section of Returns, Target Leverage, Dynamic Capital Structure, Financial Frictions

JEL Classification: G12, G32

Suggested Citation

Ippolito, Filippo and Ippolito, Filippo and Steri, Roberto and Tebaldi, Claudio and Villa, Alessandro, Levered Returns and Capital Structure Imbalances (January 9, 2022). Available at SSRN: https://ssrn.com/abstract=2903515 or http://dx.doi.org/10.2139/ssrn.2903515

Filippo Ippolito (Contact Author)

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(+34) 93 542 2578 (Phone)
(+34) 93 542 1746 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Roberto Steri

University of Luxembourg ( email )

Kirchberg, 6, rue Richard Coudenhove-Kalergi
Luxembourg
Luxembourg

HOME PAGE: http://https://sites.google.com/site/robertosteripersonalpage/

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance ( email )

Via Roentgen 1
Milan, 20136
Italy

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Alessandro Villa

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

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