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. The net asset value of US equity real estate investment trusts (REITs) serves as a good proxy for nominal assets and, accordingly, we use a sample of US REITs to test our hypothesis. We find that for the firms in our sample: (i) their real risk-adjusted performance, and (ii) their inflation-hedging qualities are inversely related to deviations from this 'matching-nominals' argument. In addition to providing managers with a vehicle to maximize real risk-adjusted performance, our findings also provide investors with the tools to infer inflation-hedging qualities of equity investments.