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Not All Profits are Created Equal: New Evidence on the Profits-Leverage Puzzle

73 Pages Posted: 23 Oct 2017  

Davidson Heath

University of Utah David Eccles School of Business

Giorgo Sertsios

Universidad de los Andes, Chile

Date Written: October 2, 2017

Abstract

A robust and controversial finding in the capital structure literature is the inverse relation between profitability and leverage. We revisit this relation in light of a novel quasi-natural experiment that increases market power for a subset of firms and has product-market spillovers on their suppliers. We find that treated firms and their suppliers similarly increase their profitability, but only suppliers reduce their leverage in response. The different nature of profitability shocks explains the results: The profitability increase was permanent and riskless for treated firms, but transitory and risky for suppliers. Unobserved components of profitability variation seem to explain earlier findings.

Keywords: profits-leverage puzzle, trademarks, product markets, capital structure, customer-supplier relations, market power

JEL Classification: G32, L10

Suggested Citation

Heath, Davidson and Sertsios, Giorgo, Not All Profits are Created Equal: New Evidence on the Profits-Leverage Puzzle (October 2, 2017). Available at SSRN: https://ssrn.com/abstract=3056440

Davidson Heath (Contact Author)

University of Utah David Eccles School of Business ( email )

Salt Lake City, UT 84112
United States

Giorgo Sertsios

Universidad de los Andes, Chile ( email )

Mons. Álvaro del Portillo
Las Condes
Santiago, 12.455
Chile

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