New Concepts about DOL-DFL Nexus: The Relationships with Market Sensitivities, Firm-Specific Risk and Other Issues

Marco A. Paganini

International Journal of Economics and Finance, 2022, vol. 14, issue 1, 16

Abstract: This paper investigates several issues related to the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL) in the light of advanced concepts on the matter proposed by recent studies. In particular, the paper treats mainly the relationships between DOL and market sensitivities and the impact of the uncertainty on DOL and DFL volatility together with minor issues. We used the DOL function already developed to analyse what market conditions facilitate or hinder, with or without economies of scale, Revenue development or a profit-maximising policy. DOL records the reaction coming from the factor and product markets together with the management decision process. DOL highlights whether the current economic strategy is, or not, successful and why, so that management can perceive clues to evaluate both the policy and its implementation. The uncertainty related to six fundamental economic variables determining EBIT and Net Profit growth volatility eventually contaminates DOL and DFL. Not all such variables impact DOL and DFL volatility, but when it happens, the firm’s risk is representable through the asymptotes of the DOL and DFL curves generated by each specific variable. Such a risk rate is independent of the chosen uncertainty range and is firm unique in any financial period. In normal economic conditions, DOL undervalues firm-specific risk while DFL carries out a containment function. The higher risk rate comes from the unit price change, that coupled with a sturdy quantity/mix growth, could induce negative economic and financial results.

Date: 2022
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