Exploring the Leverage and Profitability Relation in the Norwegian Market

Abstract

The Leverage-Profitability Puzzle has long been one of the most well-known empirical inconsistency in the literature on capital structure. There are few empirical studies that focus solely on the Norwegian market in relation to capital structure. This leaves a gap in knowledge of Norwegian firms' capital structure, and this thesis aims to provide empirical evidence on the relationship between leverage and profitability in the Norwegian market. Dynamic trade-off theory predicts that more profitable firms choose higher levels of leverage when they actively rebalance their capital structure. When firms undertake capital structure rebalancing finaced by debt issues and distribute the proceeds to shareholders, the theory predicts a positive correlation between leverage and profitability. However, we find empirical evidence in the Norwegian market where the correlation between leverage and profitability is negative.