Hostname: page-component-cd9895bd7-dk4vv Total loading time: 0 Render date: 2025-01-05T14:06:26.006Z Has data issue: false hasContentIssue false
  • English
  • Français

Leverage and the Beta Anomaly

Published online by Cambridge University Press:  22 April 2019

Malcolm Baker ,
Mathias F. Hoeyer  and
Jeffrey Wurgler Open the ORCID record for Jeffrey Wurgler [Opens in a new window]
Malcolm Baker
Affiliation:
Baker, [email protected], Harvard Business School and NBER
Mathias F. Hoeyer
Affiliation:
Hoeyer, [email protected], University of Oxford
Jeffrey Wurgler*
Affiliation:
Wurgler, [email protected], NYU Stern School of Business and NBER
*
Wurgler (corresponding author), [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

The well-known weak empirical relationship between beta risk and the cost of equity (the beta anomaly) generates a simple tradeoff theory: As firms lever up, the overall cost of capital falls as leverage increases equity beta, but as debt becomes riskier the marginal benefit of increasing equity beta declines. As a simple theoretical framework predicts, we find that leverage is inversely related to asset beta, including upside asset beta, which is hard to explain by the traditional leverage tradeoff with financial distress that emphasizes downside risk. The results are robust to a variety of specification choices and control variables.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 5 , August 2020 , pp. 1491 - 1514
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

For helpful comments we thank Heitor Almeida (the referee), Hui Chen, Robin Greenwood, Sam Hanson, Lasse Pedersen, Thomas Philippon, Ivo Welch, and seminar participants at the American Finance Association, Capital Group, George Mason University, Georgetown University, the Ohio State University, NYU, the New York Fed, Southern Methodist University, University of Amsterdam, University of Cambridge, University of Tokyo, University of Toronto, University of Miami, University of Utah, USC, and University of Warwick. Baker and Wurgler also serve as consultants to Acadian Asset Management. Baker gratefully acknowledges financial support from the Division of Research of the Harvard Business School.

References

Acharya, V.; Almeida, H.; and Campello, M.. “Aggregate Risk and the Choice between Cash and Lines of Credit.” Journal of Finance, 68 (2013), 2059–2116.CrossRefGoogle Scholar
Almeida, H., and Philippon, T.. “The Risk-Adjusted Cost of Financial Distress.” Journal of Finance, 62 (2007), 2557–2586.CrossRefGoogle Scholar
Baele, L.; Bekaert, G.; and Inghelbrecht, K.. “The Determinants of Stock and Bond Return Comovements.” Review of Financial Studies, 23 (2010), 2374–2428.CrossRefGoogle Scholar
Baker, M.; Bradley, B.; and Taliaferro, R.. “The Low-Risk Anomaly: A Decomposition into Micro and Macro Effects.” Financial Analysts Journal, 70 (2014), 43–58.CrossRefGoogle Scholar
Baker, M.; Bradley, B.; and Wurgler, J.. “Benchmarks as Limits to Arbitrage: Understanding the Low-Volatility Anomaly.” Financial Analysts Journal, 67 (2011), 40–54.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 1–32.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure, and the Risk Anomaly.” American Economic Review, 105 (2015), 315–320.CrossRefGoogle Scholar
Bali, T.; Brown, S.; Murray, S.; and Tang, Y.. “A Lottery-Demand-Based Explanation of the Beta Anomaly.” Journal of Financial and Quantitative Analysis, 52 (2017), 2369–2397.CrossRefGoogle Scholar
Black, F.; Jensen, M. C.; and Scholes, M.. “The Capital Asset Pricing Model: Some Empirical Tests.” Studies in the Theory of Capital Markets. Jensen, M. C., ed. New York, NY: Praeger (1972), 79–121.Google Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–659.CrossRefGoogle Scholar
Bradley, M.; Jarrell, G.; and Kim, E. H.. “On the Existence of an Optimal Capital Structure: Theory and Evidence.” Journal of Finance, 39 (1984), 857–878.CrossRefGoogle Scholar
Brennan, M.“Agency and Asset Pricing” Working Paper, University of California at Los Angeles (1993).Google Scholar
Campello, M., and Giambona, E.. “Real Assets and Capital Structure.” Journal of Financial and Quantitative Analysis, 48 (2013), 1333–1370.CrossRefGoogle Scholar
Cargo, G. T.“Comparable Means and Generalized Convexity.” Journal of Mathematical Analysis and Applications, 12 (1965), 387–392.CrossRefGoogle Scholar
Choi, J.“What Drives the Value Premium? The Role of Asset Risk and Leverage.” Review of Financial Studies, 26 (2013), 2845–2875.CrossRefGoogle Scholar
Denis, D., and McKeon, S. B.. “Debt Financing and Financial Flexibility: Evidence from Proactive Leverage Increases.” Review of Financial Studies, 25 (2012), 1897–1929.CrossRefGoogle Scholar
Fama, E., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.CrossRefGoogle Scholar
Fama, E., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 153–193.CrossRefGoogle Scholar
Frank, M. Z., and Goyal, V. K.. “Capital Structure Decisions: Which Factors Are Reliably Important?” Financial Management, 38 (2009), 1–37.CrossRefGoogle Scholar
Frazzini, A., and Pedersen, L. H.. “Betting Against Beta.” Journal of Financial Economics, 111 (2014), 1–25.CrossRefGoogle Scholar
Graham, J.“How Big Are the Tax Benefits of Debt.” Journal of Finance, 63 (2000), 1901–1941.CrossRefGoogle Scholar
Graham, J., and Harvey, C.. “The Theory and Practice of Corporate Finance: Evidence from the Field.” Journal of Financial Economics, 60 (2001), 187–243.CrossRefGoogle Scholar
Graham, J., and Mills, L.. “Simulating Marginal Tax Rates Using Tax Return Data.” Journal of Accounting and Economics, 46 (2008), 366–388.CrossRefGoogle Scholar
Hackbarth, D.“Determinants of Corporate Borrowing: A Behavioral Perspective.” Journal of Corporate Finance, 15 (2009), 389–411.CrossRefGoogle Scholar
Hackbarth, D., and Mauer, D. C.. “Optimal Priority Structure, Capital Structure, and Investment.” Review of Financial Studies, 23 (2012), 747–796.CrossRefGoogle Scholar
Harford, J.; Martos-Vila, M.; and Rhodes-Kropf, M.. “Corporate Financial Policies in Misvalued Credit Markets.” Working Paper, University of Washington (2015).Google Scholar
Hogan, W., and Warren, J.. “Toward the Development of an Equilibrium Capital-Market Model Based on Semivariance.” Journal of Financial and Quantitative Analysis, 9 (1974), 1–11.CrossRefGoogle Scholar
Hong, H., and Sraer, D.. “Speculative Betas.” Journal of Finance, 71 (2016), 2095–2144.CrossRefGoogle Scholar
Long, M. S., and Malitz, I.. “Investment Patterns and Financial Leverage.” Corporate Capital Structures in the United States. Friedman, B. M., ed. Chicago, IL: University of Chicago Press (1985), 325–352.Google Scholar
Markowitz, H.“Portfolio Selection.” Efficient Diversification of Investments. New York, NY: Wiley (1959).Google Scholar
Merton, R. C.“On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–470.Google Scholar
Myers, S.“Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (1977), 147–175.CrossRefGoogle Scholar
Myers, S., and Majluf, N.. “Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have.” Journal of Financial Economics, 13 (1984), 187–221.CrossRefGoogle Scholar
Rajan, R., and Zingales, L.. “What Do We Know about Capital Structure? Some Evidence from International Data.” Journal of Finance, 50 (1995), 1421–1460.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “Liquidation Values and Debt Capacity: A Market Equilibrium Approach.” Journal of Finance, 47 (1992), 1343–1366.CrossRefGoogle Scholar
Stein, J.“Rational Capital Budgeting in an Irrational World.” Journal of Business, 69 (1996), 429–455.CrossRefGoogle Scholar
Welch, I.“Capital Structure and Stock Returns.” Journal of Political Economy, 112 (2004), 106–131.CrossRefGoogle Scholar