Abstract
This study analyzes the effect of financial leverage on firm value to determine whether there is an optimal capital structure. The paper separates the effect of leverage in financially constrained and unconstrained firms. Using a sample of 666 US companies belonging to seven different sectors between 1989 and 2007, we carry out two-stage least square panel data regressions estimated with fixed effects and using different leverage functions to find the one that best fits the data. The results show no clear effects of leverage on the market price of common shares, especially in the case of constrained firms. Furthermore, the effect of leverage on firm value is different among sectors and changes over time. These results make it redundant to ask for an optimal capital structure, and no guidance can be offered to CFOs seeking to maximize firm value using leverage.
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