Not All Profits are Created Equal: New Evidence on the Profits-Leverage Puzzle
73 Pages Posted: 23 Oct 2017
Date Written: October 2, 2017
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: Suggested Citation