How Much Is Too Much? Debt Capacity and Financial Flexibility

Hess, Dieter; Immenkötter, Philipp

doi:10.2139/ssrn.1990259

Download This Paper

Open PDF in Browser

Add Paper to My Library

How Much Is Too Much? Debt Capacity and Financial Flexibility

56 Pages Posted: 23 Jan 2012 Last revised: 17 Mar 2014

See all articles by Dieter Hess

Dieter Hess

University of Cologne - Department of Corporate Finance; University of Cologne - Centre for Financial Research (CFR)

Philipp Immenkötter

University of Cologne - Department of Corporate Finance

Date Written: March 2014

Abstract

We estimate the debt capacity of a firm as the critical debt ratio that causes a downgrade in creditworthiness. Unused debt capacities depict the temporal access to external debt funds and measure a firm's financial flexibility. Firms with high unused debt capacities realize a larger fraction of their investment opportunity set, borrow more often, and issue higher volumes of debt. Firms that have exhausted their debt capacity issue equity or pay down debt when having a financial surplus. These patterns of actively using and restoring unused debt capacities imply that preserving financial flexibility is of first-order importance in corporate finance.

Keywords: capital structure, debt capacity, credit ratings, capital budgeting

JEL Classification: G31, G32

Suggested Citation: Suggested Citation

Hess, Dieter and Immenkötter, Philipp, How Much Is Too Much? Debt Capacity and Financial Flexibility (March 2014). Available at SSRN: https://ssrn.com/abstract=1990259 or http://dx.doi.org/10.2139/ssrn.1990259