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The DOL-DFL Nexus: The Relationship between the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL)

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  • Marco A. Paganini

Abstract

In the present paper, I have modelled the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL) using the percentage variations of the economic quantities. I devoted a great effort to encompass the investment dynamic and its financing mix to design a robust model implementable in a business context. The relationship discovered between DOL and DFL is complex and manifold- first, it appears asymmetrical because DOL can influence DFL, but the former is unrelated to the latter. Second, there is an infra-annual relationship measurable through partial derivatives. Eventually, the stress tests shed light on some long-term impacts of one-off shocks even when the steady-state conditions are restored, disclosing an inter-annual relationship. The DOL-DFL nexus appears to be negatively related, but I also discovered positive relations and unrelated conditions. As argued in the economic literature, they cannot always behave as substitutes. The mathematical DOL-DFL model developed can admit positive, negative, and unrelated relations even though management might intervene to choose the right combination. Also, the Business Case shows positive and negative relationships, both at the infra-annual and inter-annual levels. The DOL-DFL nexus depends on circumstances and management decisions. Empirical evidence should find how management uses such a nexus and how effective such decisions have been over time.

Suggested Citation

  • 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.
    • Handle: RePEc:ibn:ijefaa:v:13:y:2021:i:6:p:71
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    References listed on IDEAS

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    1. Kristoffer J. Glover & Gerhard Hambusch, 2014. "The trade-off theory revisited: on the effect of operating leverage," International Journal of Managerial Finance, Emerald Group Publishing Limited, vol. 10(1), pages 2-22, January.
    2. Brenner, Menachem & Smidt, Seymour, 1977. "A Simple Model of Non-Stationarity of Systematic Risk," Journal of Finance, American Finance Association, vol. 32(4), pages 1081-1092, September.
    3. Mandelker, Gershon N. & Rhee, S. Ghon, 1984. "The Impact of the Degrees of Operating and Financial Leverage on Systematic Risk of Common Stock," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(1), pages 45-57, March.
    4. Chen, Zhiyao & Harford, Jarrad & Kamara, Avraham, 2019. "Operating Leverage, Profitability, and Capital Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 54(1), pages 369-392, February.
    5. Marco A. Paganini, 2019. "Potential and Real Operating Leverage," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 11(8), pages 138-138, August.
    6. 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.
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    Cited by:

    1. Marco A. Paganini, 2022. "New Concepts about DOL-DFL Nexus: The Relationships with Market Sensitivities, Firm-Specific Risk and Other Issues," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 14(1), pages 1-16, January.

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    • R00 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General - - - General
    • Z0 - Other Special Topics - - General

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