Does Debt Explain the Investment Premium?
71 Pages Posted: 9 Dec 2018
Date Written: November 19, 2018
The investment premium -- the finding that firms with low asset growth deliver high average returns -- is an integral part of recent factor models. I document empirically that the investment premium (1) reflects leverage, (2) does not exist among zero-leverage firms, and (3) increases with firms' refinancing intensities. This new evidence challenges prominent explanations of the investment premium including the q-theory of investment and behavioral finance. To explain the evidence, I develop a model in which firms make both optimal investment and financing decisions. The model shows that the investment premium reflects both leverage and refinancing intensities consistent with my empirical findings.
Keywords: Equity returns, investments, leverage, debt maturity, debt overhang
JEL Classification: G12, G13, G31, G32, G33
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