Production Flexibility, Product Markets, and Capital Structure Decisions

Review of Financial Studies, Volume 29, Issue 6, 1 June 2016, Pages 1501–1548

Posted: 12 Jun 2012 Last revised: 23 Jan 2018

See all articles by Sebastian J. Reinartz

Sebastian J. Reinartz

Technische Universität München (TUM)

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics

Date Written: December 9, 2015

Abstract

We examine how production flexibility affects financial leverage. A worldwide sample of energy utilities allows us to apply direct measures for production flexibility based on their power plants. We find that production flexibility increases financial leverage. For identification, we exploit privatizations and deregulations of electricity markets, geographical variations in natural resources, the technological evolution of gas-fired power plants, and differences in electricity prices and recapitalization cost across regions. Production flexibility affects financial leverage via the channels of reduced expected cost of financial distress and higher present value of tax shields. The relative importance of these channels depends on firms' profitability.

Keywords: Capital structur, financial leverage, production flexibility, operating leverage, product markets, energy utilities

JEL Classification: G30, G32

Suggested Citation

Reinartz, Sebastian Johannes and Schmid, Thomas, Production Flexibility, Product Markets, and Capital Structure Decisions (December 9, 2015). Review of Financial Studies, Volume 29, Issue 6, 1 June 2016, Pages 1501–1548, Available at SSRN: https://ssrn.com/abstract=2081902 or http://dx.doi.org/10.2139/ssrn.2081902

Sebastian Johannes Reinartz

Technische Universität München (TUM) ( email )

Arcisstrasse 21
Munich, DE 80333
Germany

Thomas Schmid (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

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