The Net Benefits to Leverage

Abstract

I estimate the market's valuation of the net benefits to leverage using panel data from 1994 to 2004, identified from market values and betas of a company's debt and equity. The median firm captures net benefits of up to 5.5% of firm value. Small and profitable firms have high optimal leverage ratios, as predicted by theory, but in contrast to existing empirical evidence. Companies are on average slightly underlevered relative to the optimal leverage ratio at refinancing. This result is mainly due to zero leverage firms. I also look at implications for financial policy. Copyright (c) 2010 the American Finance Association.

When does leverage hurt productivity growth? A firm-level analysis

“…Unlike existing studies that use traditional cross-sectional or panel regressions using observed leverage ratios 6 , the threshold model allows us to determine optimal leverage despite firms' temporary deviations from the optimum. Again, we reach conclusions similar to those of Korteweg (2010).…”

“…This suggests a positive relationship between profitability and optimal leverage. Bearing in mind that this result is not a formal test of the trade-off theory, the conclusion is nevertheless qualitatively similar to the theoretical prediction of the trade-off theory and the empirical results of Korteweg (2010).…”

“…All the results point to the existence of an optimal leverage ratio where the net benefits of debt in terms of productivity gains are exhausted. Our paper reaches some qualitatively similar conclusions to Korteweg (2010). Using a different methodology and a market-based assessment of the net benefits to leverage, the author finds that as leverage increases, net benefits to leverage first increase and then decrease, and finally turn negative for distressed firms.…”

“…Our results suggest that the proportion of firms with excessive leverage is higher among relatively less profitable firms in most sample countries. Korteweg (2010) finds that the degree of overleverage is higher for low-profit firms in a US sample, so this may not be a phenomenon that is limited to transition countries alone.…”

On the value and determinants of the interest tax shields

“…This variability arises as these …rms choose considerably di¤erent levels of optimal debt due to their dissimilar fundamental characteristics. In order to shed further light on this …nding, we study the importance of the di¤erent primitive features of 1 In related papers, van Binsbergen, Graham, and Yang (2010) and Korteweg (2010) report that the net bene…ts of debt account for 3.5% and 5.5% of …rm value, respectively.…”