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Leverage and the Beta Anomaly

Published online by Cambridge University Press:  22 April 2019

Malcolm Baker ,
Mathias F. Hoeyer  and
Jeffrey Wurgler Open the ORCID record for Jeffrey Wurgler [Opens in a new window]
Malcolm Baker
Affiliation:
Baker, mbaker@hbs.edu, Harvard Business School and NBER
Mathias F. Hoeyer
Affiliation:
Hoeyer, mfhoeyer@gmail.com, University of Oxford
Jeffrey Wurgler*
Affiliation:
Wurgler, jwurgler@stern.nyu.edu, NYU Stern School of Business and NBER
*
Wurgler (corresponding author), jwurgler@stern.nyu.edu
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Abstract

The well-known weak empirical relationship between beta risk and the cost of equity (the beta anomaly) generates a simple tradeoff theory: As firms lever up, the overall cost of capital falls as leverage increases equity beta, but as debt becomes riskier the marginal benefit of increasing equity beta declines. As a simple theoretical framework predicts, we find that leverage is inversely related to asset beta, including upside asset beta, which is hard to explain by the traditional leverage tradeoff with financial distress that emphasizes downside risk. The results are robust to a variety of specification choices and control variables.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 5 , August 2020 , pp. 1491 - 1514
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

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Footnotes

For helpful comments we thank Heitor Almeida (the referee), Hui Chen, Robin Greenwood, Sam Hanson, Lasse Pedersen, Thomas Philippon, Ivo Welch, and seminar participants at the American Finance Association, Capital Group, George Mason University, Georgetown University, the Ohio State University, NYU, the New York Fed, Southern Methodist University, University of Amsterdam, University of Cambridge, University of Tokyo, University of Toronto, University of Miami, University of Utah, USC, and University of Warwick. Baker and Wurgler also serve as consultants to Acadian Asset Management. Baker gratefully acknowledges financial support from the Division of Research of the Harvard Business School.

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