Cost Inflexibility and Capital Structure
Hong Kong University of Science & Technology - Department of Finance
Laura Xiaolei Liu
Hong Kong University of Science & Technology
Nanyang Technological University (NTU) - Division of Accounting
March 14, 2012
We examine the empirical relationship between cost inflexibility and capital structure. We propose a cost inflexibility measure as a direct measure of a firm’s fixed cost proportion. We argue and show that this characteristic-based measure dominates previously used operating leverage measures because the sensitivity-based measure suffers from severe measurement error problems. This single factor can explain about 16% to 23% of the cross-sectional variation in capital structure. One standard deviation increase of the inflexibility variable relates to 8% to 9% decrease of debt ratio. The association is stronger among financially constrained firms, value firms and firms with low profitability. Our evidence suggests that cost inflexibility is one of the most important determinants of capital structure in the cross-section.
Number of Pages in PDF File: 46
Keywords: Capital Structure, Operating Leverage, Cost Structure, Flexibility, Inflexibility
JEL Classification: G32working papers series
Date posted: March 15, 2012
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