Operating Leverage, Profitability and Capital Structure
CICF 2013 Shanghai, China; EFA 2013, Cambridge UK; 24th CFEA (Kenan-Flagler Business School)
41 Pages Posted: 31 Jan 2013 Last revised: 22 Oct 2017
Date Written: 26 Sep, 2017
Operating leverage increases profitability and reduces optimal financial leverage. Thus, operating leverage generates a negative relation between profitability and financial leverage that is thought to be inconsistent with the trade-off theory, but is commonly observed in the data. We demonstrate the effect of operating leverage on firms’ profitability and financial leverage, as well as on the empirical relation between profitability and financial leverage, by using China’s entry into the World Trade Organization in 2001 and its effect on the capital-labor ratio of US firms.
Keywords: operating leverage, capital structure, financial leverage, trade-off theory,profitability, default risk
JEL Classification: G32
Suggested Citation: Suggested Citation