Leverage, excess leverage, and future returns

Judson Caskey (), John Hughes () and Jing Liu ()
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Judson Caskey: UCLA Anderson School of Management
John Hughes: UCLA Anderson School of Management
Jing Liu: Cheung Kong Graduate School of Business

Review of Accounting Studies, 2012, vol. 17, issue 2, No 8, 443-471

Abstract: Abstract We examine the cross-sectional relation between leverage and future returns while considering the dynamic nature of capital structure and potentially delayed market reactions. Prior studies find a negative relation between leverage and future returns that contradicts standard finance theory. We decompose leverage into optimal and excess components and find that excess leverage tends to drive this negative relation. We also find that excess leverage predicts firm fundamentals and that the negative relation between excess leverage and future returns may be explained by investors’ failure to react promptly to information contained in excess leverage about future financial distress and asset growth.

Keywords: Leverage; Excess leverage; Kink; Market inefficiency; Stock market anomaly (search for similar items in EconPapers)
JEL-codes: G12 G14 G29 (search for similar items in EconPapers)
Date: 2012
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DOI: 10.1007/s11142-011-9176-1

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