An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Jerry Wei Chen
The Hong Kong Polytechnic University

Ben-Hsien Bao
The Hong Kong Polytechnic University

Peter Shu - Tong Cheng
The Hong Kong Polytechnic University

Abstract: The recent working paper by Penman, Richardson and Tuna (2005) identified a negative correlation between market financing leverage and future stock returns, which casts doubt on the extensively documented positive relation in the literature. By distinguishing leverage that priced by the market from that cumulated in the balance sheet as well as leverage that arises in financing activities from that arises in operations, this paper documents the period specific problem and subsuming influence from book-to-market ratio to the market total and financing leverage; In addition, the non-significant coefficients of book leverage ratios demonstrates the superiority of the forward-looking measure to backward-looking measure in explaining stock returns; finally, the operating liability leverage is found to be highly and positively related to the stock returns, which demonstrates power of operating liability leverage in the multifactor model to capture cross-sectional variation of stock returns.

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