Debt Financing and Financial Flexibility: Evidence from Pro-active Leverage Increases
David J. Denis
University of Pittsburgh
Stephen B. McKeon
University of Oregon - Department of Finance
December 30, 2011
Review of Financial Studies, Forthcoming
AFA 2010 Atlanta Meetings Paper
Firms that intentionally increase leverage through substantial debt issuances do so primarily as a response to operating needs rather than a desire to make a large equity payout. Subsequent debt reductions are neither rapid, nor the result of pro-active attempts to rebalance the firm’s capital structure towards a long-run target. Instead, the evolution of the firm’s leverage ratio depends primarily on whether or not the firm produces a financial surplus. In fact, firms that generate subsequent deficits tend to cover these deficits predominantly with more debt even though they exhibit leverage ratios that are well above estimated target levels. Our findings are broadly consistent with a capital structure theory in which financial flexibility, in the form of unused debt capacity, plays an important role in capital structure choices.
Number of Pages in PDF File: 52
Keywords: Financial Flexibility, Capital Structure, Rebalancing, Tradeoff, Pecking order
JEL Classification: G32, G35
Date posted: March 17, 2009 ; Last revised: January 20, 2012
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