Seminar – The Risk Anomaly Tradeoff of Leverage

Professor Malcolm P. Baker, Harvard Business School and the National Bureau of Economic Research

We develop the implications of the risk anomaly – the weak or inverse empirical relationship between the risk and cost of equity – for corporate leverage. The risk anomaly generates a trade-off: as firms lever up, the overall cost of capital falls as leverage increases equity risk, but as debt becomes riskier the marginal benefit of increasing equity risk declines. We show that there is an interior optimum in which firms with higher asset beta choose lower leverage. Firms with high upside asset beta choose lower leverage as well, a prediction not shared by the traditional trade-off with financial distress costs. These predictions find support in leverage regressions.

Speaker bio

Malcolm Baker is the Robert G. Kirby Professor of Business Administration at Harvard Business School, where he is the Unit Head for finance, and the programme director for corporate finance at the National Bureau of Economic Research. His research is in the areas of behavioural finance, corporate finance and capital markets, with a primary focus on the interactions among corporate finance, investor behaviour and inefficiency in capital markets. Professor Baker has made numerous presentations to academic and practitioner audiences. His research awards include the 2002 Brattle Prize, given annually by the American Finance Association to the best corporate finance paper in the Journal of Finance, second place for the 2012 Jensen Prize, given annually by the Journal of Financial Economics, the 2011 Sharpe Award, given annually by the Journal of Financial and Quantitative Analysis, and the 2011 and 2014 Graham and Dodd Scroll, given annually by the Financial Analysts Journal. He has served as associate editor for the Journal of Finance and the Review of Financial Studies.

Professor Baker has taught in the first and second year of the MBA programme at Harvard Business School and in several executive education programmes. He has developed elective courses in investment strategies and behavioural finance.

Professor Baker received a PhD in business economics from Harvard University, an MPhil in Finance from the University of Cambridge, and a bachelors degree in applied mathematics/economics from Brown University. Before beginning his doctoral studies, he was a senior associate at Charles River Associates and a member of the US Olympic rowing team.

Outside of Harvard, he serves as a director of research at Acadian Asset Management, an institutional asset management firm focusing in active global and international equity strategies, and as a board member at Triton International, the world’s largest intermodal container leasing company.