Operating leverage, profitability, and capitala structure

Zhiyao CHEN, Jarrad HARFORD, Avraham KAMARA*

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)peer-review

43 Citations (Scopus)

Abstract

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 U.S. firms.

Original languageEnglish
Pages (from-to)369-392
Number of pages24
JournalJournal of Financial and Quantitative Analysis
Volume54
Issue number1
Early online date9 Nov 2018
DOIs
Publication statusPublished - Feb 2019
Externally publishedYes

Bibliographical note

We thank Philip Bond, Jennifer Conrad (the editor), Max Croce (Conference on Financial Economics and Accounting (CFEA) discussant), Ran Duchin, Itay Goldstein, John Graham (the referee), Christopher Hennessy, Israela Kamara, Jennifer Koski, Paul Malatesta, Thomas Noe, Stephen McKeon (European Financial Association (EFA) discussant), Ilya Strebulaev, Mark Westerfield, Xueping Wu (China International Conference in Finance (CICF) discussant), and seminar participants at the Chinese University of Hong Kong, the University of Texas at Dallas, and the University of Washington.

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