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The leverage-profitability puzzle resurrected

Eckbo, B. Espen; Kisser, Michael
Journal article, Peer reviewed
Accepted version
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Available from 2022-11-05 (Locked)
URI
https://hdl.handle.net/11250/2985747
Date
2020
Metadata
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  • Scientific articles [1667]
Original version
Review of Finance, 2021, Volume 25, Issue 4, Pages 1089–1128,   10.1093/rof/rfaa032
Abstract
With zero capital structure rebalancing costs, dynamic trade-off theory predicts that firms stay at their leverage targets with more profitable firms staying at higher leverage. This prediction is rejected by the robustly negative correlation between leverage and profitability. When rebalancing costs are added to this theory, it predicts a positive leverage–profitability correlation only in periods where companies pay these costs and actively rebalance their capital structures. However, we show that the correlation is negative when firms issue debt and distribute the proceeds to shareholders—precisely the case where the theory predicts it should be positive. Our results thus resurrect the leverage–profitability puzzle.
Publisher
Oxford Uni. Press
Journal
Review of Finance
Copyright
Oxford University Press

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