The Deviation from Optimal Leverage and Abnormal Returns

According to Trade off theory, the firms have an optimal leverage and any deviation can weaken corporate performance and subsequently decrease the firms value. In this research, the relation between deviations from optimal leverage and accumulated abnormal returns of stocks was considered in order to study the effect of deviation from optimal leverage on market participants. To this end, this paper uses data from 96 firms listed in Tehran Stock Exchange during 2009-2017 and also applies the approach to control the industry and year effects. Results show that the market impounds the information about deviation from optimal leverage in stock prices and the above or below optimal leverage, equity overvalued or undervalued are main factors modify price impact. It means that market has positive reaction to increase the distance from optimal leverage in firms that their leverage are lower than optimal and their stock overvalued. Deviation from optimal leverage in these firms is leading to an increase in abnormal returns of stocks. Because the optimal leverage measurement don't affect on the results, in this paper four measures was used that among them, the results of moving average leverage measures had more compatibility with research literature.