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The relationship between operating leverage and financial leverage

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  • Sudipto Sarkar

Abstract

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.

Suggested Citation

  • Sudipto Sarkar, 2020. "The relationship between operating leverage and financial leverage," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(S1), pages 805-826, April.
    • Handle: RePEc:bla:acctfi:v:60:y:2020:i:s1:p:805-826
    DOI: 10.1111/acfi.12374
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    Cited by:

    1. Marco A. Paganini, 2021. "The DOL-DFL Nexus: The Relationship between the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL)," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 13(6), pages 1-71, June.
    2. Tibor Tarnóczi & Edit Veres & Edina Kulcsár, 2021. "Financial And Operating Risk Analysis Of Two Romanian-Hungarian Border Counties," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(1), pages 242-250, July.

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