Basic assumptions and definitions in the analysis of financial leverage
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The financial leverage literature has been in a state of terminological chaos for decades as evidenced, forexample, 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 assumptionsand basic definitions. The objective of the paper is to answer this call. The paper defines leverage asa value neutral concept useful in explaining the magnification effect exerted by financial activity upon thewhole spectrum of financial results. By adopting constructivism as a methodological approach, we areable to introduce various types of leverage such as capital and income, base and non-base, accounting andmarket value, for levels and for distances (absolute and relative), costs and simple etc. The new definitionsformulated here are subsequently adopted in the analysis of the content of leverage statements usedby the leading finance textbook.
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