The Leverage-Profitability Puzzle Revisited with Costly Rebalancing

43 Pages Posted: 24 Apr 2018 Last revised: 9 Jul 2020

See all articles by B. Espen Eckbo

B. Espen Eckbo

Tuck School of Business at Dartmouth; European Corporate Governance Institute (ECGI)

Michael Kisser

BI Norwegian Business School

Date Written: July 8, 2020


The `leverage-profitability puzzle' refers to the persistent inverse relation between profitability and leverage observed for US industrial companies, which contradicts capital structure tradeoff theory with exogenous investment. Recent research suggests that the relation may be conditionally positive - in periods when firms actively rebalance leverage by distributing cash to shareholders - and negative in other periods. However, we show that the relation is conditionally negative when the shareholder distribution is financed with new debt issues. The conditional relation is positive only when the distribution is financed internally by drawing down cash-balances. This evidence effectively resurrects the original leverage-profitability puzzle.

Keywords: Capital structure, tradeoff theory, dynamic inaction, recapitalizations, leverage-profitbility correlation, pecking order

JEL Classification: G32

Suggested Citation

Eckbo, B. Espen and Kisser, Michael, The Leverage-Profitability Puzzle Revisited with Costly Rebalancing (July 8, 2020). Tuck School of Business Working Paper No. 3166707, Available at SSRN: or

B. Espen Eckbo (Contact Author)

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States
603-646-3953 (Phone)
603-646-3805 (Fax)


European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Michael Kisser

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442

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