A note on operating leverage and expected rates of return

Guthrie, Graeme

doi:10.1016/j.frl.2010.10.004

Cited by 31 publications

(25 citation statements)

References 22 publications

(22 reference statements)

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“…Contrary to what is required by this framework, public firms have a relatively easy time disposing of assets when hit by persistent shocks to their profitability. This substantially reduces their risk and the financial returns they elicit, along the lines suggested by Guthrie (2011).…”

mentioning

confidence: 98%

Investment and the Cross‐Section of Equity Returns

Clementi¹,

Palazzo

2018

The Journal of Finance

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The data show that, upon being hit by adverse profitability shocks, large public firms have ample latitude to divest their least productive assets, reducing the risk faced by shareholders and the returns that they are likely to demand. In the one‐factor production‐based asset pricing model, when the frictions to capital adjustment are shaped to respect the evidence on investment, the model‐generated cross‐sectional dispersion of returns is only a small fraction of that documented in the data. Our conclusions hold even when operating or labor leverage is modeled in ways shown to be promising in the extant literature.

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mentioning

confidence: 98%

Investment and the Cross‐Section of Equity Returns

Clementi¹,

Palazzo

2018

The Journal of Finance

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“…For example, assuming highly irreversible but cheap-to-exercise growth options, Carlson, Fisher, and Giammarino (2004), Zhang (2005), and Cooper (2006) predict a mostly positive relation, potentially explaining value and investment anomalies in stock returns. Assuming more reversible growth options, Sagi and Seasholes (2007), Guthrie (2011), and Hackbarth and Johnson (2015) predict a negative relation, potentially explaining momentum and profitability anomalies. Combining low investment reversibility with expensive-to-exercise growth options, Hackbarth and Johnson (2015) show that the relation can also be U-shaped, potentially explaining both groups of anomalies above.…”

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confidence: 99%

Real Options Models of the Firm, Capacity Overhang, and the Cross Section of Stock Returns

Aretz¹,

Pope

2018

The Journal of Finance

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We use a stochastic frontier model to obtain a stock‐level estimate of the difference between a firm's installed production capacity and its optimal capacity. We show that this “capacity overhang” estimate relates significantly negatively to the cross section of stock returns, even when controlling for popular pricing factors. The negative relation persists among small and large stocks, stocks with more or less reversible investments, and in good and bad economic states. Capacity overhang helps explain momentum and profitability anomalies, but not value and investment anomalies. Our evidence supports real options models of the firm featuring valuable divestment options.

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“…(), in our model the firm can abandon operations if demand falls sufficiently (say, when x falls to x a ). We include the option to abandon for two reasons: (i) it ensures that limited liability is not violated, that is, firm value is never negative, irrespective of how low x falls; and (ii) it has been shown that the abandonment option has a non‐trivial impact on the company's DOL (Wong, ; Guthrie, ).…”

Section: The Modelmentioning

confidence: 99%

“…In computing the DOL, we use the traditional measure, following Guthrie (), section 2.1, in particular his Equation . Let R = net revenues (given by R = xQ γ ), and π = profits (given by π = xQ γ – fQ ); then DOL = ( dπ / dR )( R / π ).…”

Section: The Modelmentioning

confidence: 99%

The relationship between operating leverage and financial leverage

Sarkar

2018

Accounting & Finance

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We model the relationship between operating and financial leverage. When operating leverage is exogenously specified, financial leverage is a monotonically decreasing function of operating leverage. When financial leverage is exogenously specified, operating leverage is initially increasing and subsequently decreasing in financial leverage. Finally, when both operating and financial leverage are chosen by the firm, they can be positively related, negatively related or unrelated, depending on which underlying parameter is driving the changes. Thus, operating leverage and financial leverage do not always behave as substitutes, as argued in the traditional literature. The relationship is complex, possibly non-monotonic and dependent on the circumstances; empirical tests need to take this reality into account.

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A note on operating leverage and expected rates of return

Cited by 31 publications

References 22 publications

Investment and the Cross‐Section of Equity Returns

Investment and the Cross‐Section of Equity Returns

Real Options Models of the Firm, Capacity Overhang, and the Cross Section of Stock Returns

The relationship between operating leverage and financial leverage

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