leverage business definition
The use of fixed costs in order to increase the rate of return from an investment. One example of leverage is a company using debt financing to pay for an expansion of its operations. Even greater leverage is created when a company issues debt in order to raise funds that are used to repurchase stock. While leverage can operate to increase rates of return, it also increases the amount of risk inherent in an investment, for both individuals and businesses. Compare deleverage
. See also financial leverage
, operating leverage
Corporate managers sometimes decide owners would benefit financially if borrowed funds were used to repurchase shares of the company's stock. Substituting debt for equity increases leverage and results in more risk to both borrowers and owners. On the positive side, the increased leverage may increase the return the firm is able to earn on the shareholders' investment. International Business Machines (IBM) announced in April 2007 that it would increase its dividend by 33% and repurchase $15 billion of its own stock. With over 1.5 billion shares outstanding, the quarterly dividend alone would amount to over $600 million. The $15 billion stock repurchase was in addition to another $1.4 billion that remained from an earlier repurchase authorization. The firm planned to finance much of the stock buyback with borrowing because at the time of the announcement IBM had only $10.8 billion in cash, much less than required for both the dividend and authorized stock repurchase. The stock buyback was expected to increase the firm's earnings per share, but Fitch Ratings said the increased leverage would cause them to place IBM debt on “Watch Negative," indicating the possibility of a future downgrading of the firm's debt. Thus, increased leverage resulting from the stock buyback financed largely with debt financing appeared to benefit the firm's shareholders but harm its existing creditors, who would experience a deterioration in their claims against the firm.
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