Financial Inflexibility and the Value Premium

35 Pages Posted: 28 Jul 2012

See all articles by Michael Poulsen

Michael Poulsen

University of Queensland - Business School

Robert W. Faff

University of Queensland

Stephen Gray

University of Queensland - Business School; Duke University - Fuqua School of Business; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: July 28, 2012

Abstract

This paper tests whether and to what extent the value premium is induced by financial inflexibility risk. In this context, financial flexibility refers to the ability of a firm to alter investment expenditure to mitigate exogenous shocks, so as to generate a smooth dividend stream. Consistent with a literature that identifies three related sources of inflexibility, we create a composite inflexibility index, based on the proportion of fixed assets and measures of total leverage and financial constraints. A positive relation is documented between inflexibility and the book-to-market ratio, and between the returns of inflexible firms and value firms. However, the value premium retains explanatory power independent of inflexibility, suggesting that it is not a proxy for inflexibility alone.

Keywords: Financial flexibility, value premium, fixed assets, leverage, financial constraints

Suggested Citation

Poulsen, Michael and Faff, Robert W. and Gray, Stephen, Financial Inflexibility and the Value Premium (July 28, 2012). Available at SSRN: https://ssrn.com/abstract=2119017 or http://dx.doi.org/10.2139/ssrn.2119017

Michael Poulsen

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Robert W. Faff (Contact Author)

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

Stephen Gray

University of Queensland - Business School ( email )

University of Queensland
Brisbane, Queensland 4072
Australia

Duke University - Fuqua School of Business

Box 90120
Durham, NC 27708-0120
United States

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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