Capital Structure with Asset Flexibility

Abstract

The ability of equityholders/managers to partially control the earnings stream by temporarily shutting down to avoid negative earnings has an enormous effect on the choice of capital structure. Increasing switching costs reduces operating flexibility, and reduced operating flexibility implies less use of debt, but only up to a point beyond which the firm commits to significantly more debt.

Keywords: Dynamic Capital Structure, Asset Flexibility, Profitability, Growth Options, Switching Costs

JEL Classification: G32