Inflexibility and Leverage
60 Pages Posted: 19 Dec 2018 Last revised: 13 Aug 2019
Date Written: February 10, 2019
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
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