Capital Structure and Financial Flexibility: Expectations of Future Shocks

62 Pages Posted: 21 Sep 2014 Last revised: 29 Jan 2019

See all articles by Costas Lambrinoudakis

Costas Lambrinoudakis

University of Leeds - Leeds University Business School (LUBS)

George S. Skiadopoulos

Queen Mary, University of London, School of Economics and Finance; University of Piraeus, Department of Banking and Financial Management

Konstantinos Gkionis

UBS

Date Written: January 25, 2019

Abstract

We test one of the main predictions of the financial flexibility paradigm, that expectations about future firm-specific investment shocks affect the firm’s leverage. We extract the expectations of small and large future shocks from the market prices of equity options. We find that leverage decreases in anticipation of an increase in both types of future shocks and the relation is statistically significant even when we control for standard determinants of leverage and the firm’s probability of default. Expectations for future shocks explain more variation of the leverage than standard determinants of leverage do and they affect more the small and financially constrained firms. Our results are not subject to an endogeneity bias and they confirm De Angelo et al. (2011) model’s predictions and the evidence that managers seek for financial flexibility.

Keywords: Capital structure, Financial flexibility, Options, Risk-neutral volatility, Risk-neutral kurtosis

JEL Classification: G13, G30, G32

Suggested Citation

Lambrinoudakis, Costas and Skiadopoulos, George and Gkionis, Konstantinos, Capital Structure and Financial Flexibility: Expectations of Future Shocks (January 25, 2019). Available at SSRN: https://ssrn.com/abstract=2498481 or http://dx.doi.org/10.2139/ssrn.2498481

Costas Lambrinoudakis

University of Leeds - Leeds University Business School (LUBS) ( email )

Leeds LS2 9JT
United Kingdom

George Skiadopoulos (Contact Author)

Queen Mary, University of London, School of Economics and Finance

Lincoln's Inn Fields
Mile End Rd.
London, E1 4NS
United Kingdom

University of Piraeus, Department of Banking and Financial Management ( email )

80 Karaoli & Dimitriou Str.
18534 Piraeus, 185 34 -GR
Greece

HOME PAGE: http://https://sites.google.com/view/george-skiadopoulos

Konstantinos Gkionis

UBS ( email )

5 Broadgate
London, EC2M 2QS
United Kingdom

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