Business Strategy and Excess Leverage
Posted: 31 Jul 2019
Date Written: July 28, 2019
Purpose: The purpose of this study is to investigate whether excess leverage is associated with business strategy for non-financial and non-utilities US firms over the period from 1999 to 2017. We also examine the link between the cross-sectional difference in excess leverage and long-term debt issuance and earnings volatility.
Empirical methodology: We use a comprehensive measure of business strategy based on Miles and Snow’s (1978, 2003) theoretical framework, following Bentley et al. (2013). Based on Miles and Snow’s (1978, 2003) theoretical framework, we account for two endpoints (prospectors and defenders) of the business strategy continuum. To test our empirical predictions, we use fixed-effect regression models.
Findings: We find that firms following an innovation-oriented business strategy (prospectors) are associated with lower excess leverage. Especially, compared with defenders, prospectors are likely to have lower excess debt. Our further analyses show that these firms issue less long-term debt and exhibit greater earnings volatility, which leads to increased operating risk. The negative association between a firm’s business strategy and excess leverage is consistent with the trade-off theory of capital structure.
Contribution: This study relates to the literature that focuses on the strategic aspect of a firm’s risk-taking behavior. Prior studies show that a firm’s business strategy has an impact on its financial reporting and tax planning practices among others. We add to this line of research by showing the effect of business strategy on excess leverage.
Keywords: Business strategy, Excess leverage, Debt issuance, Earnings volatility, Operating risk
JEL Classification: L1, G32
Suggested Citation: Suggested Citation