Can Operating Leverage Be the Cause of the Value Premium?

Luis García‐Feijóo and Randy D. Jorgensen
Authors registered in the RePEc Author Service: Luis Garcia-Feijoo

Financial Management, 2010, vol. 39, issue 3, 1127-1154

Abstract: Recent theoretical models (Carlson, Fisher, and Giammarino, 2004) predict an association between the book‐to‐market equity ratio (BE/ME) and operating leverage in the cross‐section. Consistent with these models, we find a positive association between BE/ME and the degree of operating leverage (DOL), between DOL and stock returns, and between DOL and systematic risk. Overall, our findings provide support for a risk‐based explanation for the value premium that is consistent with existing theoretical models. The evolution of systematic risk associated with firm‐level investment activity, rather than financial distress, seems to be the main determinant of the value premium.

Date: 2010
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