Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
5069761 | Finance Research Letters | 2011 | 13 Pages |
Abstract
Conventional wisdom, used to explain the value premium, is that greater operating leverage increases systematic risk and therefore leads to a higher expected rate of return earned by a firm's owners. This paper shows that the relationship between operating leverage and the expected return is actually non-monotonic when allowance is made for the option to abandon an unprofitable project: the expected return is an increasing function of operating leverage when the latter is low, but a decreasing function when it is high. This demonstrates the dangers in drawing inferences from models that ignore the flexibility embedded in typical investment projects.
Related Topics
Social Sciences and Humanities
Economics, Econometrics and Finance
Economics and Econometrics
Authors
Graeme Guthrie,