Effect of Leverage on the Growth of Total Factor Productivity: Empirical Evidence from the U.S.A.

Abstract

This paper examines the relationship between leverage and the total factor productivity (TFP) growth hoping to give an answer that leverage affects firm value through the change in company’ operating efficiency which means both managerial and production parts. Further, the trade-off theory also points out that borrowing beyond the optimal point could dampen value. Therefore, the investigation is conducted in the spirit of the capital structure theory. The threshold model is estimated on a sample of U.S. listed manufacturing companies during 2000 to 2012 which is the period that the economy encounters with a rapid credit growth in the corporate sector. Results indicate that productivity growth increases with leverage implying that leverage helps improving efficiency. This reveals how change in firm value happens by the use of leverage. The additional piece of evidence to confirm this mechanism is that firm value has a positive relation with productivity. Moreover, the link between leverage and firm value is also tested. The non-linear is found, however, the correlation is negative in all regimes. Therefore, it can be concluded that debt financing has the ability to increase efficiency which is beneficial to shareholders’ wealth at the same time with the cost of higher financial risk.