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Leverage, excess leverage, and future returns

Author

Listed:
  • Judson Caskey

    (UCLA Anderson School of Management)

  • John Hughes

    (UCLA Anderson School of Management)

  • Jing Liu

    (Cheung Kong Graduate School of Business)

Abstract

We examine the cross-sectional relation between leverage and future returns while considering the dynamic nature of capital structure and potentially delayed market reactions. Prior studies find a negative relation between leverage and future returns that contradicts standard finance theory. We decompose leverage into optimal and excess components and find that excess leverage tends to drive this negative relation. We also find that excess leverage predicts firm fundamentals and that the negative relation between excess leverage and future returns may be explained by investors’ failure to react promptly to information contained in excess leverage about future financial distress and asset growth.

Suggested Citation

  • Judson Caskey & John Hughes & Jing Liu, 2012. "Leverage, excess leverage, and future returns," Review of Accounting Studies, Springer, vol. 17(2), pages 443-471, June.
    • Handle: RePEc:spr:reaccs:v:17:y:2012:i:2:d:10.1007_s11142-011-9176-1
    DOI: 10.1007/s11142-011-9176-1
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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