Flexible Prices and Leverage

The frequency with which firms adjust output prices is an important determinant of persistent differences in capital structure across firms. The most flexible-price firms have a 19% higher long-term financial leverage ratio than the most sticky-price firms, controlling for known determinants of capital structure. We rationalize this novel fact in a costly-state-verification model, in which sticky-price firms are more exposed to shocks, and face tighter financial constraints. In the model, a better monitoring ability reduces asymmetric information and narrows the leverage gap between inflexible- and flexible-price firms. Consistently, sticky-price firms increased leverage more than flexible-price firms following the staggered implementation of the Interstate Banking and Branching Efficiency Act across states and over time, which we use in a triple-differences identification strategy. Firms' frequency of price adjustment did not change around the deregulation.

Keywords: Capital Structure, Nominal Rigidities, Bank Deregulation, Industrial Organization and Finance, Price Setting, Bankruptcy

JEL Classification: E12, E44, G28, G32, G33

Suggested Citation: Suggested Citation

D'Acunto, Francesco and Liu, Ryan and Pflueger, Carolin E. and Pflueger, Carolin E. and Weber, Michael, Flexible Prices and Leverage (May 2016). Robert H. Smith School Research Paper No. RHS 2692893, Available at SSRN: https://ssrn.com/abstract=2692893 or http://dx.doi.org/10.2139/ssrn.2692893