Measuring Operating Leverage
Review of Asset Pricing Studies
131 Pages Posted: 1 May 2018 Last revised: 2 Aug 2021
Date Written: July 29, 2021
We examine a simple measure of operating leverage: the ratio of fixed costs (measured by depreciation and amortization plus selling, general, and administrative expenses) to the market (or book) value of assets. We find that this measure of operating leverage positively predicts returns. This operating leverage measure is not explained by common factors and performs better than the traditional measures of operating leverage. Furthermore, an exploratory two-factor model with the operating leverage factor works at least as well as, but does not subsume, the Fama and French five-factor model.
Keywords: operating leverage, fixed costs, stock returns, factor models
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