Debt/Equity Ratio and Expected Common Stock Returns: Empirical Evidence

Authors

  • LAXMI CHAND BHANDARI

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    • Faculty of Business, University of Alberta. Currently with the Capital Markets Group, Chemical Bank. This paper builds on a part of my Ph.D. thesis at the Graduate School of Business, University of Chicago (1984). I would like to thank Eugene Fama, Arnold Zellner and other members of my thesis committee, Gordon Sick, Giovanni Barone-Adesi, and anonymous referees for their comments at various stages of this research. Computer support from the Graduate School of Business, University of Chicago, and the Faculty of Business, University of Alberta, is gratefully acknowledged.

ABSTRACT

The expected common stock returns are positively related to the ratio of debt (noncommon equity liabilities) to equity, controlling for the beta and firm size and including as well as excluding January, though the relation is much larger in January. This relationship is not sensitive to variations in the market proxy, estimation technique, etc. The evidence suggests that the “premium” associated with the debt/equity ratio is not likely to be just some kind of “risk premium”.

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