Unexpected inflation, capital structure and real risk-adjusted firm performance

Managers can improve real risk-adjusted firm performance by matching nominal assets with nominal liabilities, thereby reducing the sensitivity of real risk-adjusted returns to unexpected inflation. We model these returns as a function of nominal and real assets and liabilities and illustrate our proposition using a simulation. We test the empirical implications of our model in a sample of listed US equity real estate investment trusts (REITs), enabling simple identification and measurement of real and nominal contracts. We find evidence that our sample firms observe the proposed matching relationship between nominal assets and liabilities. Moreover, we find that real risk-adjusted performance and inflation hedging qualities are inversely related to deviations from the proposed matching relationship. We infer that corporate debt holdings reflect attempts to manage real risk-adjusted performance by modifying equity exposure to unexpected inflationary shocks. We further conclude that variation in inflation hedging qualities is related to capital structure. WORK IN PROGRESS DO NOT CITE OR QUOTE WITHOUT PERMISSION