A reconsideration of operating-financial leverage tradeoff hypothesis
Journal of Financial Economic Policy
ISSN: 1757-6385
Article publication date: 10 September 2018
Issue publication date: 23 October 2018
Abstract
Purpose
This paper aims to attempt to perform a test of the operating leverage-financial leverage tradeoff hypothesis that is more methodologically consistent with the logical framing of the hypothesis appearing in the Mandelker and Rhee (1984) paper.
Design/methodology/approach
The paper uses a sample of firms from the manufacturing industry to estimate their degree of operating leverage and degree of financial leverage coefficients. The switching regression methodology is then used to perform the empirical test of the tradeoff hypothesis.
Findings
The results suggest that firms tradeoff their operating and financial leverage during good economic times, but do not engage in the tradeoff behavior during recessionary times.
Originality/value
This paper refines the empirical testing of the tradeoff hypothesis using the innovative switching regression methodology. The paper also has important implications for the impact of firms’ risk on the capital markets as well as the economy as a whole, and for academic researchers in financial economics examining the relationships between operating and financial leverage and various firm-specific variables.
Keywords
Citation
Dugan, M.T., Medcalfe, S.K. and Park, S.H. (2018), "A reconsideration of operating-financial leverage tradeoff hypothesis", Journal of Financial Economic Policy, Vol. 10 No. 4, pp. 473-483. https://doi.org/10.1108/JFEP-01-2018-0005
Publisher
:Emerald Publishing Limited
Copyright © 2018, Emerald Publishing Limited