We revisit the relation between equity returns and financial leverage through the lens of a trade-off model with costly … returns depend on whether a firm's leverage is above or below its target leverage. The data support the model predictions …. Controlling for leverage, overlevered (underlevered) firms earn higher (lower) returns. Controlling for target leverage the …

We revisit the relation between equity returns and financial leverage through the lens of a dynamic trade-off model …'s leverage is above or below its target leverage. We provide empirical evidence in support of the model predictions. Controlling … for leverage, overlevered (underlevered) firms earn higher (lower) returns. A quantitative version of our model reproduces …