TY - JOUR
T1 - Endogenous leverage and expected stock returns
AU - Johnson, T. C.
AU - Chebonenko, T.
AU - Cunha, I.
AU - D'Almeida, F.
AU - Spencer, X.
PY - 2011/9
Y1 - 2011/9
N2 - This note clarifies conditions under which endogenous choice of debt induces a negative relation between leverage or default risk and expected stock returns. In the context of the model of George and Hwang [2009. Journal of Financial Economics 96, 56-79], we correct the contention that variation in bankruptcy costs across firms is sufficient. Variation in asset risk parameters can lead to the desired relation, but may not when also controlling for variation in book-to-market ratios. A simple parameterization of cross-sectional heterogeneity in risk and profitability implies a negative association of expected return with leverage and distress risk and a positive association with book-to-market.
AB - This note clarifies conditions under which endogenous choice of debt induces a negative relation between leverage or default risk and expected stock returns. In the context of the model of George and Hwang [2009. Journal of Financial Economics 96, 56-79], we correct the contention that variation in bankruptcy costs across firms is sufficient. Variation in asset risk parameters can lead to the desired relation, but may not when also controlling for variation in book-to-market ratios. A simple parameterization of cross-sectional heterogeneity in risk and profitability implies a negative association of expected return with leverage and distress risk and a positive association with book-to-market.
KW - Expected stock returns
KW - Optimal capital structure
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U2 - 10.1016/j.frl.2010.12.003
DO - 10.1016/j.frl.2010.12.003
M3 - Article
AN - SCOPUS:80052393732
SN - 1544-6123
VL - 8
SP - 132
EP - 145
JO - Finance Research Letters
JF - Finance Research Letters
IS - 3
ER -