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Returns to scale, operating leverage, and expected stock returns

Author

Listed:
  • Roi D. Taussig

    (Ariel University)

  • Sagi Akron

    (University of Haifa)

Abstract

The asset pricing literature demonstrates a positive association between operating leverage and expected stock returns. We uniquely examine the predictive power of operating leverage on expected stock returns, in light of the industry returns to scale. Our inspection starts with a theoretical illustration of this facet, demonstrating higher sensitivity of operating profits to production inputs along higher level of production returns to scale. We then empirically examine 83,415 firm-year observations in the US manufacturing industry between 1963 and 2011. We find that the positive and significant relation between operating leverage and the cross-section expected stock returns appears only when the production returns to scale are high. Low returns to scale, however, alleviates both the economic and statistical significance positive effect.

Suggested Citation

  • Roi D. Taussig & Sagi Akron, 2017. "Returns to scale, operating leverage, and expected stock returns," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 7(1), pages 141-155, April.
    • Handle: RePEc:spr:eurasi:v:7:y:2017:i:1:d:10.1007_s40821-016-0053-5
    DOI: 10.1007/s40821-016-0053-5
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    References listed on IDEAS

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    1. repec:bla:jfinan:v:59:y:2004:i:6:p:2577-2603 is not listed on IDEAS
    2. repec:spr:eurasi:v:1:y:2011:i:2:p:125-144 is not listed on IDEAS
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    6. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-283, April.
    7. Robert Novy-Marx, 2011. "Operating Leverage," Review of Finance, European Finance Association, vol. 15(1), pages 103-134.
    8. Burnside, Craig, 1996. "Production function regressions, returns to scale, and externalities," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 177-201, April.
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    Cited by:

    1. Jonathan Batten & Xuan Vinh Vo, 2019. "Liquidity And Firm Value In An Emerging Market," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 64(02), pages 365-376, March.

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    More about this item

    Keywords

    Operating leverage; Stock returns; Returns to scale; Production technology;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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