An Empirical Test On Leverage And Stock Returns

This paper is an empirical work that investigates the effect of a firm's leverage on stock returns. The authors undertake their tests based on the explicit valuation model of Modigliani and Miller (1958) tested in the utilities, oil and gas industries. They test the relationship between leverage and stock returns in all risk classes. For utilities, returns increase in leverage. This is consistent with the findings of Modigliani and Miller (1958). For other risk classes the relationship is negative consistent with the recent work of Korteweg (2004), Dimitrov and Jain (2005) and Penman (2007) in the cross-section of all firms. Results are robust to other risk factors.