Inflexibility and Stock Returns

65 Pages Posted: 20 Nov 2017

See all articles by Lifeng Gu

Lifeng Gu

The University of Hong Kong

Dirk Hackbarth

Boston University - Department of Finance & Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Timothy C. Johnson

University of Illinois at Urbana-Champaign

Multiple version iconThere are 2 versions of this paper

Date Written: November 2017

Abstract

Investment-based asset pricing research highlights the role of irreversibility as a determinant of firms' risk and expected return. In a neoclassical model of a firm with costly scale adjustment options, we show that the effect of scale flexibility (i.e., contraction and expansion options) is to determine the relation between risk and operating leverage: risk increases with operating leverage for inflexible firms, but decreases for flexible firms. Guided by theory, we construct easily reproducible proxies for inflexibility and operating leverage. Empirical tests provide support for the predicted interaction of these characteristics in stock returns and risk.

Keywords: Operating flexibility, real options, risk premia, Stock returns

JEL Classification: D31, D92, G12, G31

Suggested Citation

Gu, Lifeng and Hackbarth, Dirk and Johnson, Timothy C., Inflexibility and Stock Returns (November 2017). CEPR Discussion Paper No. DP12441. Available at SSRN: https://ssrn.com/abstract=3074439

Lifeng Gu (Contact Author)

The University of Hong Kong ( email )

Hong Kong
+852 3917-1033 (Phone)

HOME PAGE: http://https://sites.google.com/site/uiuclifenggu/

Dirk Hackbarth

Boston University - Department of Finance & Economics ( email )

Department of Finance
595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 358-4206 (Phone)
(617) 353-6667 (Fax)

HOME PAGE: http://people.bu.edu/dhackbar/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Timothy C. Johnson

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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