Basic assumptions and definitions in the analysis of financial leverage
Basic assumptions and definitions in the analysis of financial leverage

Summary/Abstract: The financial leverage literature has been in a state of terminological chaos for decades as evidenced, for example, by the Nobel Prize Lecture mistake on the one hand, and the global financial crisis on the other. A meaningful analysis of the leverage phenomenon calls for the formulation of a coherent set of assump-tions and basic definitions. The objective of the paper is to answer this call. The paper defines leverage as a value neutral concept useful in explaining the magnification effect exerted by financial activity upon the whole spectrum of financial results. By adopting constructivism as a methodological approach, we are able to introduce various types of leverage such as capital and income, base and non-base, accounting and market value, for levels and for distances (absolute and relative), costs and simple etc. The new definitions formulated here are subsequently adopted in the analysis of the content of leverage statements used by the leading finance textbook.

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