Profitability and financial leverage: Evidence from a quasi-natural experiment

52 Pages Posted: 23 Oct 2017 Last revised: 14 Dec 2021

See all articles by Davidson Heath

Davidson Heath

University of Utah - David Eccles School of Business

Giorgo Sertsios

Universidad de los Andes, Chile

Date Written: August 26, 2021

Abstract

The relationship between profitability and leverage has been controversial in the capital structure literature. We revisit this relation in light of a novel quasi-natural experiment that increases market power for a subset of firms. We find that treated firms increase their profitability throughout the treatment period. However, they only transiently reduce financial leverage, gradually reverting to their pre-shock level. Firms respond differently according to size, with large firms gradually adjusting their leverage towards a new target and small firms reducing it. The patterns are broadly consistent with dynamic trade-off models with both fixed and variable adjustment costs.

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, Profitability and financial leverage: Evidence from a quasi-natural experiment (August 26, 2021). Available at SSRN: https://ssrn.com/abstract=3056440 or http://dx.doi.org/10.2139/ssrn.3056440

Davidson Heath (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Giorgo Sertsios

Universidad de los Andes, Chile ( email )

Mons. Álvaro del Portillo
Las Condes
Santiago, 12.455
Chile

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