Operating Leverage, Profitability, and Stock Returns under Different Aggregate Funding Conditions

68 Pages Posted: 30 Jun 2021 Last revised: 3 Sep 2021

See all articles by Luis García-Feijóo

Luis García-Feijóo

Florida Atlantic University - Department of Finance

Tyler Jensen

Iowa State University - Ivy College of Business - Department of Finance

Paul Koch

Iowa State University; University of Auckland Business School; The University of Sydney

Date Written: September 3, 2021

Abstract

Operating leverage (OL) and profitability are interrelated determinants of stock returns. We show that the outperformance of firms with high OL is driven by periods of unconstrained aggregate funding conditions. Firms with high OL are more risky in general, but when the Fed eases funding constraints, investors bid up their stock prices to reflect lower risk and greater performance expected for these stocks. This time-varying OL effect also explains the differential performance of alternative profitability measures that treat OL differently. Our results extend research linking monetary policy, OL, and profitability by documenting important time-varying interrelations among these characteristics and returns.

Keywords: Operating leverage, aggregate funding conditions, profitability, monetary policy, sticky input prices, time-varying risk premium

JEL Classification: E22, E44, E52, G11, G12, G14

Suggested Citation

Garcia-Feijoo, Luis and Jensen, Tyler and Koch, Paul, Operating Leverage, Profitability, and Stock Returns under Different Aggregate Funding Conditions (September 3, 2021). Available at SSRN: https://ssrn.com/abstract=3870016 or http://dx.doi.org/10.2139/ssrn.3870016

Luis Garcia-Feijoo

Florida Atlantic University - Department of Finance ( email )

777 Glades Rd
Boca Raton, FL 33431
United States
954-236-1239 (Phone)

Tyler Jensen (Contact Author)

Iowa State University - Ivy College of Business - Department of Finance ( email )

Ivy College of Business
3230 Gerdin Business Building
Ames, IA 50011-2063
United States

Paul Koch

Iowa State University ( email )

Ames, IA 50011-2063
United States
5152942491 (Phone)
5152943355 (Fax)

HOME PAGE: http://https://www.business.iastate.edu/directory/pkoch/

University of Auckland Business School ( email )

Private Bag 92019
Auckland Mail Centre
Auckland, 1142
New Zealand

The University of Sydney ( email )

University of Sydney
Sydney, NSW 2006
Australia

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