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Operating Leverage, Profitability, and Capital Structure

Published online by Cambridge University Press:  09 November 2018

Zhiyao Chen ,
Jarrad Harford  and
Avraham Kamara
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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.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 1 , February 2019 , pp. 369 - 392
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

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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