Leverage (finance) | EPFL Graph Search

In finance, leverage (or gearing in the United Kingdom and Australia) is any technique involving borrowing funds to buy things, estimating that future profits will be many times more than the cost of borrowing. This technique is named after a lever in physics, which amplifies a small input force into a greater output force, because successful leverage amplifies the smaller amounts of money needed for borrowing into large amounts of profit. However, the technique also involves the high risk of not being able to pay back a large loan. Normally, a lender will set a limit on how much risk it is prepared to take and will set a limit on how much leverage it will permit, and would require the acquired asset to be provided as collateral security for the loan. Leveraging enables gains to be multiplied. On the other hand, losses are also multiplied, and there is a risk that leveraging will result in a loss if financing costs exceed the income from the asset, or the value of the asset falls.

Essays in Financial Economics

Kevin Marc Rageth

This thesis consists of two chapters that study separate subjects in the area of corporate finance.The first chapter, titled âEconomic Gains in Bank Mergers and Acquisitions â Evidence from Targetsâ, investigates economic gains in bank mergers and acquisitions (M&A) by focusing on bank targets. Demonstrating efficiency increases resulting from bank M&A has been elusive to the banking literature. Imake use of a novel hand-collected dataset, which allows to observe financial statements for transacted target banks both before and after the deal effective date. Addressing endogeneity concerns by constructing the counterfactual frommergers that fail for reasons exogenous to target performance, I show evidence that acquiring banks create economic value by pursuing M&A deals. Cost reductions and higher post-deal securities productivity constitute bankM&A related value sources. The results are consistent with banks pursuingM&A to realize economies of scale.The second chapter, which is co-authored work with RÃŒdiger Fahlenbrach and RenÃ© Stulz, is titled âHow Valuable Is Financial Flexibility when Revenue Stops? Evidence from the COVID-19 Crisisâ. We use the COVID-19 shock as a laboratory to investigate the value of financial flexibility. Firms with greater financial flexibility should be better able to fund a revenue shortfall resulting from the COVID-19 shock and benefit less from policy responses. We find that firms with high financial flexibility within an industry experience a stock price drop that is 26%, or 9.7 percentage points, lower than those with low financial flexibility. This differential return persists as stock prices rebound. Firms more exposed to the COVID-19 shock benefit more from cash holdings. No evidence suggests that recent payouts worsened the average firmâs drop in stock price. Our results cannot be explained by a leverage effect.

EPFL2022

Essays in Corporate Finance

Thomas Antonius Geelen

In this thesis I study how firms choose their optimal debt maturity. The recent financial crisis illustrated why debt maturity is an important determinant of firmsâ capital structure and it also renewed economistsâ interest in this topic, see for example Brunnermeier and Oehmke (2013), He and Milbradt (2016), Ju and Ou-Yang (2006), Crouzet (2016), and Huang et al. (2017). This thesis exists of two chapters. In the first chapter, titled âInformation Dynamics and Debt Maturityâ, I develop a dynamic model of financing decisions and optimal debt maturity choice in which creditors face adverse selection and learn about the firmâs quality from news. In equilibrium, shareholders may choose to postpone debt issuance to reduce adverse selection and improve the pricing of newly issued debt. Over time, the benefits of learning decrease and zero-leverage firms eventually decide to issue debt. Because shorter maturity debt is less sensitive to information, younger firms issue shorter maturity debt to alleviate adverse selection while mature firms issue longer maturity debt, leading to a life-cycle theory of debt maturity. In the second chapter, titled âDebt Maturity and Lumpy Debtâ, I develop a dynamic capital structure model in which shareholders determine a firmâs leverage ratio, debt maturity, and default strategy. In my model, the firmâs debt matures all at once. Therefore, after repaying the principal shareholders own all the firmâs cash flows and can pick a new capital structure. The possibility to alter the capital structure at maturity gives shareholders the incentive to issue finite maturity debt and allows me to study firmsâ joint choice of leverage and debt maturity. I also extend my model by allowing for time-varying capital supply to study time-variation in firmsâ joint choice of leverage and debt maturity.

EPFL2018

Three Essays in Banking and Finance

Damien Olivier Klossner

This thesis develops three models that study the motivation of various agents to take on debt, and the impact that excessive financial leverage can have on social welfare. In the chapter "Short-term Bank Leverage and the Value of Liquid Reserves", the incentive of a bank to take on leverage stems from the fact that its short-term debt provides liquidity benefits to depositors, at the cost of exposing the bank to the risk of runs. In the model, a bank possesses two instruments to manage the risk of runs: its funding policy and the size of its liquid asset holdings, modeled as government bonds. Issuing more debt allows the bank to better capture the liquidity benefits fits priced into deposits but increases illiquidity risk. Holding more bonds makes the bank more robust to withdrawals but it reduces the bank's asset returns. When the supply is scarce, banks are the natural buyers of government bonds. This links the liquidity premium priced into government bonds to the risk of bank runs. In the chapter "Liquidity, Debt Overhang, and Monetary Policy", firms take on bank credit to relax their liquidity constraint and purchase new capital. But taking on debt creates a debt overhang distortion which causes entrepreneurs to pass on protable projects. In the model, entrepreneurs arrange for their financing before they observe the profitability of their investment opportunity. After the latter becomes known, entrepreneurs are liquidity-constrained when investment conditions are favorable, and over-indebted when they are unfavorable. The monetary authority can generate welfare gains by lowering the cost of holding liquidity and, when debt is contracted in nominal terms, by pursuing a counter-cyclical monetary policy. In the chapter "Safe Claim Production and Capital Structure", firms issue debt to satisfy the demand of risk-averse investors for safe claims, at the cost of increasing default risk. In general equilibrium, firms need to be compensated for this service, which can only occur if their debt and equity claims are held and priced by different investor types. This segmentation of the investor base can be sufficient to prevent the existence of a symmetric equilibrium. Instead, only a fraction of firms opt for levered capital structures, and the gain in value obtained by tranching cash flows into debt and equity is offset by the expected cost of default. Changes in aggregate leverage can be divided into variations in extensive (the fraction of levered firms ) and intensive (the leverage ratio of levered firms ) margins. Changes in rm business risk have opposite effects on leverage, depending on whether the risk is of a systematic nature or firm-specific nature.

EPFL2019

Three Essays in Banking and Finance

Damien Olivier Klossner

EPFL2019