The Leverage-Profitability Puzzle Revisited

44 Pages Posted: 24 Apr 2018 Last revised: 6 Sep 2019

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: September 6, 2019

Abstract

The `leverage-profitability puzzle' refers to the inverse unconditional relation between profitability and leverage observed for US industrial companies. 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 debt issues. The conditional relation is positive only if the distribution is financed internally by drawing down cash-balances. This evidence, which contradicts `dynamic inactivity' (tradeoff) theory with costly external finance, 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 (September 6, 2019). Tuck School of Business Working Paper No. 3166707. Available at SSRN: https://ssrn.com/abstract=3166707 or http://dx.doi.org/10.2139/ssrn.3166707

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)

HOME PAGE: http://www.tuck.dartmouth.edu/eckbo

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Michael Kisser

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

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