TY - JOUR AU - Pettengill, Glenn AU - Lander, Diane PY - 2015/10/15 Y2 - 2024/03/29 TI - Response of The Cost of Equity To Leverage: An Alternative Perspective JF - Journal of Business Strategies JA - J Bus Strategies VL - 32 IS - 2 SE - Research Articles DO - 10.54155/jbs.32.2.110-138 UR - https://jbs-ojs-shsu.tdl.org/jbs/article/view/65 SP - 110-138 AB - <p>In this paper we examine the change in a corporation’s cost of equity as<br>the corporation increases leverage. Standard textbook treatments present the wellknown<br>Modigliani-Miller hypothesis that the cost of leverage increases linearly with<br>increases in the debt-to-equity ratio in keeping with a constant cost of capital for the<br>firm. Less frequently, textbooks present the Modigliani-Miller argument that, if the<br>cost of debt rises with high levels of leverage, the cost of equity will increase at a<br>decreasing rate or even decline in order to keep the overall cost of capital constant.<br>Standard textbook presentations continue with additional discussions concerning<br>tax effects and bankruptcy costs but without mention of the cost of equity. These<br>presentations leave the impression that the cost of equity remains as presented<br>in the Modigliani-Miller framework. In this paper we present theoretical and<br>empirical arguments in support of our claim that the cost of equity increases slowly<br>with moderate increases in debt but increases dramatically as leverage increases<br>sufficiently to cause equity investors to fear bankruptcy.</p> ER -