The relationship between operating leverage and financial leverage

Abstract

We model the relationship between operating and financial leverage. When operating leverage is exogenously specified, financial leverage is a monotonically decreasing function of operating leverage. When financial leverage is exogenously specified, operating leverage is initially increasing and subsequently decreasing in financial leverage. Finally, when both operating and financial leverage are chosen by the firm, they can be positively related, negatively related or unrelated, depending on which underlying parameter is driving the changes. Thus, operating leverage and financial leverage do not always behave as substitutes, as argued in the traditional literature. The relationship is complex, possibly non-monotonic and dependent on the circumstances; empirical tests need to take this reality into account.

The DOL-DFL Nexus: The Relationship between the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL)

“…The considerations exposed by Paganini (2019) on DOL are extensible to the studies on the DFL with the further observation that there has been no attempt to model it by including the financing mix and understanding whether DFL depends primarily on tax burden or financial variables. Prezas (1987) includes the safe debt but excludes both the financing mix and the taxation, while Sarkar (2020) embeds the debt ratio in his model even though the latter is not the DFL.…”

“…which represents the debt ratio (Brigham, 2011) for the period n and that many authors define improperly as "degree of financial leverage" (Sarkar, 2020), we obtain the following compact equation for ∆% t :…”

Efeito Moderador Da Alavancagem Operacional Na Relação Entre Investimento Corporativo E Rentabilidade Da Firma

“…Chen et al (2019), consideraram que a AO de uma empresa é determinada pela tecnologia de produção em seu setor e, como tal, é amplamente exógena; os gestores, então, escolhem endogenamente a AF e o investimento, levando em consideração sua AO. Sarkar (2020) argumenta que o nexo entre AO e AF envolve algumas das decisões gerenciais mais importantes em finanças corporativas, como investimento (que impacta AO), estrutura de capital (que determina AF) e a gestão de risco (tanto o risco sistemático quanto o risco de inadimplência são impactados pelos dois tipos de alavancagem).…”

“…Por isso, uma explicação adicional para esse comportamento seria o fator risco, que é afetado tanto pela AF quanto pela AO (Sarkar, 2020). Chen et al (2019) confirmam isso quando argumentam que custos operacionais inflexíveis reduzem a capacidade da empresa de pagar sua dívida em caso de dificuldade financeira e que tanto a AF quanto a AO aumentam a probabilidade de inadimplência.…”

Does operating leverage increase firm's profitability and bankruptcy risk? Evidence from China's entry into WTO

“…Leverage and profitability relationship has added significant interest in corporate finance (Chen, Harford, & Kamara, 2019; Danis, Rettl, & Whited, 2014; Mandelker & Rhee, 1984). This is because the operating leverage 1 (Operating LEV), profitability and financial leverage 2 (Financial LEV) connection is the primary determinant of a firm's performance and more importantly, they are parts of managerial strategies and decision makings (Cathcart, Dufour, Rossi, & Varotto, 2020; Sarkar, 2018). Operating LEV is positively aligned with profitability if firm quasi‐fixed operating costs (QFOC) do not show upswings at the same rate as sales growth (Chen et al, 2019).…”