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Leverage, Volatile Future Earnings Growth and Expected Stock Returns
Working Papers
  • Jamie Alcock, University of Sydney
  • Eva Steiner, Cornell University School of Hotel Administration
  • Kelvin Jui Keng Tan, University of Queensland
Publication Date
We provide theory and evidence to complement Choi's [RFS, 2013] important new insights on the returns to equity in `value' firms. We show that higher future earnings growth ameliorates the value-reducing effect of leverage and, because the market for earnings is incomplete, reduces the earnings-risk sensitivity of the default option. Ceteris paribus, a levered firm with low (high) earnings growth is more sensitive to the first (second) of these effects thus generating higher (lower) expected returns. We demonstrate this by modeling equity as an Asian-style call option on net earnings and find significant empirical support for our hypotheses.

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Citation Information

Alcock, J., Steiner, E., & Tan, K. J. K. (2014). Leverage, volatile future earnings growth and expected stock returns. Retrieved [insert date], from Cornell University, School of Hotel Administration site: