Equity profit differential may be explained by risk differential, and risk may be measured by the company's debt/equity ratio. After adjustment for risk, all companies in the same industry may be expected to earn the same rate of asset return. As illustration, let A denote Assets, L denote Liabilities, and E denote owner's Equity. Start with an accounting identity:

where t denotes corporate income tax rate, r denotes asset return, and g denotes the interest rate on company debt.

The return on equity of a company can be expressed in terms of the corporate tax rate, capital structure (as measured by the debt/equity ratio), return on assets, and interest rate. We can use debt/equity ratio x = (L / E) as the independent variable, and return on equity as the dependent variable, and discover the specific risk versus equity return relationship among comparable companies in the database. If the tax rate is negligible, equation (3) is simplified to yield a linear relationship:

Above, a = r is the intercept and b = (r - g) is the slope of the regression equation. The estimated intercept represents the uniform asset return earned across comparable companies. According to equation (3) or (4) above, return on equity (y) increases with increasing the company's financial leverage or risk (x). In reality, we may observe perverse relationships between risk and equity return because (among other things) equity return and/or debt/equity ratio may be negative for certain companies.  In theory, b > 0 implying that asset return exceeds the interest paid on company liabilities.  The linearity of formula (3) or (4) makes the relationship between equity return and risk implausible, because such linearity can be expected only in particular and not general circumstances.  E.g., a bouded quadratic formulation may be applicable in wider circumstances.