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In this paper the authors revisit the theoretical relation between financial leverage and stock returns in a dynamic world where both the corporate investment and financing decisions are endogenous. They find that the link between leverage and stock returns is more complex than the static textbook examples suggest and will usually depend on the investment opportunities available to the firm. In the presence of financial market imperfections leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities.
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