Cash Flow Volatility and Capital Structure Choice

60 Pages Posted: 6 Sep 2014 Last revised: 28 Jul 2015

See all articles by Evan Dudley

Evan Dudley

Queen's University - Smith School of Business

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: July 27, 2015

Abstract

Prior research finds a weak relation between cash-flow volatility and leverage. Using a novel measure of cash-flow volatility, we find that volatility matters more for firms that are financially constrained. Constrained firms issue debt when volatility is low, but have trouble deleveraging in response to increases in volatility. Constrained firms also hoard the proceeds from debt issues undertaken during low-volatility regimes, but invest the proceeds from debt issues when volatility is high. Overall, the observed relation between cash-flow volatility and capital structure choice is driven by financially constrained firms’ desire to ensure future financial flexibility.

Keywords: Capital structure, volatility, leverage, product-market competition, financial constraints

JEL Classification: G32

Suggested Citation

Dudley, Evan and James, Christopher M., Cash Flow Volatility and Capital Structure Choice (July 27, 2015). Available at SSRN: https://ssrn.com/abstract=2492152 or http://dx.doi.org/10.2139/ssrn.2492152

Evan Dudley

Queen's University - Smith School of Business ( email )

Goodes Hall
Kingston, Ontario K7L 3N6
Canada

Christopher M. James (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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