Abstract
The well-known weak empirical relationship between beta risk and the cost of equity (the beta anomaly) generates a simple tradeoff theory: As firms lever up, the overall cost of capital falls as leverage increases equity beta, but as debt becomes riskier the marginal benefit of increasing equity beta declines. As a simple theoretical framework predicts, we find that leverage is inversely related to asset beta, including upside asset beta, which is hard to explain by the traditional leverage tradeoff with financial distress that emphasizes downside risk. The results are robust to a variety of specification choices and control variables.
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