Inflexibility and Leverage

60 Pages Posted: 19 Dec 2018 Last revised: 13 Aug 2019

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)

Tong Li

The University of Hong Kong

Date Written: February 10, 2019

Abstract

We examine whether a firm's inflexibility (i.e., inability to adjust its scale in response to profitability shocks) influences its financial policy. Based on a firm's historical range of operating costs-to-sales ratio, scaled by the volatility of its sales growth, we find robust evidence that inflexible firms adopt a lower level of financial leverage compared with flexible firms. This effect is much more pronounced among value firms where the inflexibility to scale down during economic downturns is relatively more important. Following a positive credit supply shock induced by staggered state-level bank branching deregulation or the introduction of credit default swap (CDS), inflexible firms increase leverage more than flexible firms. These results suggest that operating flexibility plays an important role in shaping corporate financial policies.

Keywords: Bankruptcy, Capital Structure, Inflexibility, Bank Deregulation, CDS

JEL Classification: G32, G33

Suggested Citation

Gu, Lifeng and Hackbarth, Dirk and Li, Tong, Inflexibility and Leverage (February 10, 2019). Available at SSRN: https://ssrn.com/abstract=3296926 or http://dx.doi.org/10.2139/ssrn.3296926

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

Tong Li

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

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