Levered Returns and Capital Structure Imbalances

Filippo Ippolito, Roberto Steri and Claudio Tebaldi
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Filippo Ippolito: Universitat Pompeu Fabra, Barcelona Graduate School of Economics, and Centre for Economic Policy Research (CEPR)
Roberto Steri: University of Lausanne and Swiss Finance Institute
Claudio Tebaldi: Bocconi University

No 18-36, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We revisit the relation between equity returns and financial leverage through the lens of a trade-off model with costly capital structure rebalancing. The model provides a “lookalike” Modigliani-Miller equation that predicts that expected equity returns depend on whether a firm’s leverage is above or below its target leverage. The data support the model predictions. Controlling for leverage, overlevered (underlevered) firms earn higher (lower) returns. Controlling for target leverage the textbook positive relationship between leverage and returns is restored, while target leverage is negatively related to returns.

Keywords: Leverage; Cross Section of Returns; Target Leverage; Dynamic Capital Structure; Financial Frictions (search for similar items in EconPapers)
JEL-codes: G12 G32 (search for similar items in EconPapers)
Pages: 64 pages
Date: 2018-05
New Economics Papers: this item is included in nep-cfn
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1836

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