Refinancing and Mean Reversion in Earnings
We develop a dynamic two-stage trade-off model with refinancing when earnings are mean reverting, expanding previous theoretical work focusing on non-stationary dynamics. Our model predicts a negative relation between profitability and leverage ratios at refinancing, providing a possible explanation of the “leverage-profitability puzzle”. The model also shows that firms with earnings below their long-term profitability increase their leverage ratios at refinancing, whereas firms currently above their long-term profitability decrease their leverage ratios at refinancing. Our empirical results confirm the prevalence of mean reversion in earnings among US firms and largely corroborate with theoretical model predictions supporting a negative relation of profitability with leverage ratios at refinancing for mean reverting firms. We also find that, on average, firms’ leverage ratios increase during refinancing, driven mostly by firms on the lowest quantile with low leverage ratios
Year of publication: |
[2023]
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Authors: | Agliardi, Elettra ; Charalambides, Marios ; Chowdhury, Md Shahedur R. ; Koussis, Nicos |
Publisher: |
[S.l.] : SSRN |
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