An additional analysis of estimation techniques for the degree of financial leverage

This study compares three different empirical proxies for the financial leverage component of a systematic risk-composition model employed in prior financial research. We consider one static accounting measure and two elasticity-based measures. We find that the traditional static accounting measure of financial leverage provides statistically different estimates of financial leverage when compared to estimates from elasticity-based measures of the degree of financial leverage. The findings are important because the elasticity-based models for the degree of financial leverage have clear theoretical links to market-based models of systematic risk, while the static accounting measure of financial leverage does not. Practitioners and researchers should carefully consider why they are estimating financial leverage and choose the appropriate method for doing so given the goals and potential consequences for biased estimation.