Profitability and Financial Leverage: Evidence from a Quasi-Natural Experiment

Davidson Heath, Giorgo Sertsios

Research output: Contribution to journalArticlepeer-review


The relationship between profitability and leverage is controversial in the capital structure literature.We revisit this relation in light of a novel quasi-natural experiment that increases market power for a subset of firms.We find that treated firms increase their profitability throughout the treatment period. However, they only transiently reduce financial leverage, gradually reverting to their preshock level. Firms respond differently according to size with large firms gradually adjusting their leverage toward a new target and small firms reducing it. The patterns are broadly consistent with dynamic trade-off models with both fixed and variable adjustment costs.

Original languageEnglish
Pages (from-to)8386-8410
Number of pages25
JournalManagement Science
Issue number11
StatePublished - Nov 2022
Externally publishedYes

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  • capital structure
  • market power
  • product markets
  • profits-leverage relation
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