Leverage, excess leverage, and future returns

Leverage, excess leverage, and future returns 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Leverage, excess leverage, and future returns

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Publisher
Springer Journals
Copyright
Copyright © 2011 by Springer Science+Business Media, LLC
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-011-9176-1
Publisher site
See Article on Publisher Site

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.

Journal

Review of Accounting StudiesSpringer Journals

Published: Nov 30, 2011

References

  • Have the tax benefits of debt been overestimated?
    Blouin, J; Core, J; Guay, W
  • Optimal financial policy and firm valuation
    Brennan, M; Schwartz, E
  • Investor and (Value Line) analyst underreaction to information about future earnings: The corrective role of non-earnings-surprise information
    Brous, P; Shane, P
  • In search of distress risk
    Campbell, J; Hilscher, J; Szilagyi, J

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