Premium
Can Operating Leverage Be the Cause of the Value Premium?
Author(s) -
GarcíaFeijóo Luis,
Jorgensen Randy D.
Publication year - 2010
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2010.01106.x
Subject(s) - operating leverage , value premium , leverage (statistics) , financial distress , equity premium puzzle , risk premium , economics , systematic risk , capital asset pricing model , stock (firearms) , financial economics , equity (law) , econometrics , actuarial science , finance , financial system , profitability index , mathematics , engineering , statistics , mechanical engineering , political science , law
Recent theoretical models (Carlson, Fisher, and Giammarino, 2004) predict an association between the book‐to‐market equity ratio (BE/ME) and operating leverage in the cross‐section. Consistent with these models, we find a positive association between BE/ME and the degree of operating leverage (DOL), between DOL and stock returns, and between DOL and systematic risk. Overall, our findings provide support for a risk‐based explanation for the value premium that is consistent with existing theoretical models. The evolution of systematic risk associated with firm‐level investment activity, rather than financial distress, seems to be the main determinant of the value premium.