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Operating Leverage

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  • Robert Novy-Marx

Abstract

I derive and test implications of the operating leverage hypothesis for the cross-section of expected returns. Using a novel measure of operating leverage, I document that operating leverage predicts returns in the cross-section, and that strategies formed by sorting on operating leverage earn significant excess returns. Operating leverage also explains why the value premium is weak and non-monotonic across industries, but strong and monotonic within industries. Intra-industry differences in book-to-market are driven by differences in operating leverage, giving rise to expected return differences. Industry differences in book-to-market are driven by differences in the capital intensity of production unrelated to returns. Copyright 2011, Oxford University Press.

Suggested Citation

  • Robert Novy-Marx, 2011. "Operating Leverage," Review of Finance, European Finance Association, vol. 15(1), pages 103-134.
    • Handle: RePEc:oup:revfin:v:15:y:2011:i:1:p:103-134
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    File URL: http://hdl.handle.net/10.1093/rof/rfq019
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