Operating leverage: A critical analysis of the concept and the methods of measurement

Abstract

Operating leverage is one of the more popular parameters used in management practice and scientific research. However, in the literature, there are many definitions and methods of measurement, which are additionally presented imprecisely in both textbooks and scientific publications. This results in a great deal of freedom among authors in the selection of measures for estimating operating leverage and the interpretation of the results, which has a negative impact on functionality for synthesis and theory building. Although some authors made such reservations clear as early as the 1980s, the situation has not changed. Using a three-step process of asking questions relating to how it looks, how it works, and how it compares to other “somethings”, the article conducts a critical analysis of the operational leverage measures used in recent publications and proposes to organize and refine the concept of operational leverage as leverage to increase value added and profit at a given output level using a trade-off mechanism between variable and fixed costs. Finally, the article suggests directions for future research and provides tips on how to incorporate the proposed concept of operating leverage into empirical research.

Keywords

• DOL
• Financial leverage
• DFL
• Trade-off
• Operating risk
• Fixed costs