IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v104y2019icp1-18.html
   My bibliography  Save this article

Capital structure and financial flexibility: Expectations of future shocks

Author

Listed:
  • Lambrinoudakis, Costas
  • Skiadopoulos, George
  • Gkionis, Konstantinos

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 when expectations for any one of the two types of future shocks increase 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 a greater fraction of leverage variation than most 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 DeAngelo et al. (2011) model's predictions and the evidence that managers seek for financial flexibility.

Suggested Citation

  • Lambrinoudakis, Costas & Skiadopoulos, George & Gkionis, Konstantinos, 2019. "Capital structure and financial flexibility: Expectations of future shocks," Journal of Banking & Finance, Elsevier, vol. 104(C), pages 1-18.
  • Handle: RePEc:eee:jbfina:v:104:y:2019:i:c:p:1-18
    DOI: 10.1016/j.jbankfin.2019.03.016
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426619300718
    Download Restriction: Full text for ScienceDirect subscribers only

    File URL: https://libkey.io/10.1016/j.jbankfin.2019.03.016?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Mark Gertler & Simon Gilchrist, 1994. "Monetary Policy, Business Cycles, and the Behavior of Small Manufacturing Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 109(2), pages 309-340.
    2. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 581-656, Elsevier.
    3. Calomiris, Charles W. & Himmelberg, Charles P. & Wachtel, Paul, 1995. "Commercial paper, corporate finance, and the business cycle: a microeconomic perspective," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 203-250, June.
    4. Chang, Bo Young & Christoffersen, Peter & Jacobs, Kris, 2013. "Market skewness risk and the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 107(1), pages 46-68.
    5. Dennis, Patrick & Mayhew, Stewart, 2002. "Risk-Neutral Skewness: Evidence from Stock Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 37(3), pages 471-493, September.
    6. MacKie-Mason, Jeffrey K, 1990. "Do Taxes Affect Corporate Financing Decisions?," Journal of Finance, American Finance Association, vol. 45(5), pages 1471-1493, December.
    7. Carola Frydman & Raven E. Saks, 2010. "Executive Compensation: A New View from a Long-Term Perspective, 1936--2005," Review of Financial Studies, Society for Financial Studies, vol. 23(5), pages 2099-2138.
    8. Huang, Rongbing & Ritter, Jay R., 2009. "Testing Theories of Capital Structure and Estimating the Speed of Adjustment," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(2), pages 237-271, April.
    9. Ivo Welch, 2004. "Capital Structure and Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 106-131, February.
    10. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
    11. Bates, David S, 1991. "The Crash of '87: Was It Expected? The Evidence from Options Markets," Journal of Finance, American Finance Association, vol. 46(3), pages 1009-1044, July.
    12. A. Colin Cameron & Jonah B. Gelbach & Douglas L. Miller, 2011. "Robust Inference With Multiway Clustering," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 29(2), pages 238-249, April.
    13. de Jong, Abe & Kabir, Rezaul & Nguyen, Thuy Thu, 2008. "Capital structure around the world: The roles of firm- and country-specific determinants," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1954-1969, September.
    14. Alexandros Kostakis & Nikolaos Panigirtzoglou & George Skiadopoulos, 2011. "Market Timing with Option-Implied Distributions: A Forward-Looking Approach," Management Science, INFORMS, vol. 57(7), pages 1231-1249, July.
    15. Thompson, Samuel B., 2011. "Simple formulas for standard errors that cluster by both firm and time," Journal of Financial Economics, Elsevier, vol. 99(1), pages 1-10, January.
    16. Murray Z. Frank & Vidhan K. Goyal, 2009. "Capital Structure Decisions: Which Factors Are Reliably Important?," Financial Management, Financial Management Association International, vol. 38(1), pages 1-37, March.
    17. Barone-Adesi, Giovanni & Whaley, Robert E, 1987. "Efficient Analytic Approximation of American Option Values," Journal of Finance, American Finance Association, vol. 42(2), pages 301-320, June.
    18. George J. Jiang & Yisong S. Tian, 2005. "The Model-Free Implied Volatility and Its Information Content," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1305-1342.
    19. Alexander S. Gorbenko, 2010. "Temporary versus Permanent Shocks: Explaining Corporate Financial Policies," Review of Financial Studies, Society for Financial Studies, vol. 23(7), pages 2591-2647, July.
    20. Faulkender, Michael & Flannery, Mark J. & Hankins, Kristine Watson & Smith, Jason M., 2012. "Cash flows and leverage adjustments," Journal of Financial Economics, Elsevier, vol. 103(3), pages 632-646.
    21. Hovakimian, Gayané, 2011. "Financial constraints and investment efficiency: Internal capital allocation across the business cycle," Journal of Financial Intermediation, Elsevier, vol. 20(2), pages 264-283, April.
    22. John R. Graham, 2000. "How Big Are the Tax Benefits of Debt?," Journal of Finance, American Finance Association, vol. 55(5), pages 1901-1941, October.
    23. Mark T. Leary, 2009. "Bank Loan Supply, Lender Choice, and Corporate Capital Structure," Journal of Finance, American Finance Association, vol. 64(3), pages 1143-1185, June.
    24. Fahlenbrach, Rüdiger & Stulz, René M., 2009. "Managerial ownership dynamics and firm value," Journal of Financial Economics, Elsevier, vol. 92(3), pages 342-361, June.
    25. Flannery, Mark J. & Nikolova, Stanislava (Stas) & Öztekin, Özde, 2012. "Leverage Expectations and Bond Credit Spreads," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(4), pages 689-714, August.
    26. Jaehoon Hahn & Hangyong Lee, 2009. "Financial Constraints, Debt Capacity, and the Cross‐section of Stock Returns," Journal of Finance, American Finance Association, vol. 64(2), pages 891-921, April.
    27. DeAngelo, Harry & DeAngelo, Linda & Whited, Toni M., 2011. "Capital structure dynamics and transitory debt," Journal of Financial Economics, Elsevier, vol. 99(2), pages 235-261, February.
    28. Jennifer Conrad & Robert F. Dittmar & Eric Ghysels, 2013. "Ex Ante Skewness and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 68(1), pages 85-124, February.
    29. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    30. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
    31. Neumann, Michael & Skiadopoulos, George, 2013. "Predictable Dynamics in Higher-Order Risk-Neutral Moments: Evidence from the S&P 500 Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 48(3), pages 947-977, June.
    32. Flannery, Mark J. & Rangan, Kasturi P., 2006. "Partial adjustment toward target capital structures," Journal of Financial Economics, Elsevier, vol. 79(3), pages 469-506, March.
    33. Michael Faulkender & Mitchell A. Petersen, 2006. "Does the Source of Capital Affect Capital Structure?," Review of Financial Studies, Society for Financial Studies, vol. 19(1), pages 45-79.
    34. Gurdip Bakshi & Nikunj Kapadia & Dilip Madan, 2003. "Stock Return Characteristics, Skew Laws, and the Differential Pricing of Individual Equity Options," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 101-143.
    35. David J. Denis & Stephen B. McKeon, 2012. "Debt Financing and Financial Flexibility Evidence from Proactive Leverage Increases," Review of Financial Studies, Society for Financial Studies, vol. 25(6), pages 1897-1929.
    36. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    37. Bernard Dumas & Jeff Fleming & Robert E. Whaley, 1998. "Implied Volatility Functions: Empirical Tests," Journal of Finance, American Finance Association, vol. 53(6), pages 2059-2106, December.
    38. Rajan, Raghuram G & Zingales, Luigi, 1995. "What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-1460, December.
    39. Clifford G. Holderness, 2009. "The Myth of Diffuse Ownership in the United States," Review of Financial Studies, Society for Financial Studies, vol. 22(4), pages 1377-1408, April.
    40. Lamont, Owen & Polk, Christopher & Saa-Requejo, Jesus, 2001. "Financial Constraints and Stock Returns," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 529-554.
    41. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    42. Murillo Campello & Long Chen, 2010. "Are Financial Constraints Priced? Evidence from Firm Fundamentals and Stock Returns," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(6), pages 1185-1198, September.
    43. Brounen, Dirk & de Jong, Abe & Koedijk, Kees, 2006. "Capital structure policies in Europe: Survey evidence," Journal of Banking & Finance, Elsevier, vol. 30(5), pages 1409-1442, May.
    44. Ferrando, Annalisa & Marchica, Maria-Teresa & Mura, Roberto, 2014. "Financial flexibility across the euro area and the UK," Working Paper Series 1630, European Central Bank.
    45. Michael L. Lemmon & Michael R. Roberts & Jaime F. Zender, 2008. "Back to the Beginning: Persistence and the Cross‐Section of Corporate Capital Structure," Journal of Finance, American Finance Association, vol. 63(4), pages 1575-1608, August.
    46. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. "Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-1632, December.
    47. Franck Bancel & Usha R. Mittoo, 2004. "Cross-Country Determinants of Capital Structure Choice: A Survey of European Firms," Financial Management, Financial Management Association, vol. 33(4), Winter.
    48. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    49. Edward I. Altman, 1968. "The Prediction Of Corporate Bankruptcy: A Discriminant Analysis," Journal of Finance, American Finance Association, vol. 23(1), pages 193-194, March.
    50. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    51. Hess, Dieter & Immenkötter, Philipp, 2014. "How much is too much? Debt capacity and financial flexibility," CFR Working Papers 14-03, University of Cologne, Centre for Financial Research (CFR).
    52. Maria‐Teresa Marchica & Roberto Mura, 2010. "Financial Flexibility, Investment Ability, and Firm Value: Evidence from Firms with Spare Debt Capacity," Financial Management, Financial Management Association International, vol. 39(4), pages 1339-1365, December.
    53. Hovakimian, Armen & Li, Guangzhong, 2011. "In search of conclusive evidence: How to test for adjustment to target capital structure," Journal of Corporate Finance, Elsevier, vol. 17(1), pages 33-44, February.
    54. Lakonishok, Josef & Lee, Inmoo, 2001. "Are Insider Trades Informative?," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 79-111.
    55. Korajczyk, Robert A. & Levy, Amnon, 2003. "Capital structure choice: macroeconomic conditions and financial constraints," Journal of Financial Economics, Elsevier, vol. 68(1), pages 75-109, April.
    56. Leslie A. Jeng & Andrew Metrick & Richard Zeckhauser, 2003. "Estimating the Returns to Insider Trading: A Performance-Evaluation Perspective," The Review of Economics and Statistics, MIT Press, vol. 85(2), pages 453-471, May.
    57. Steven N. Kaplan & Luigi Zingales, 1997. "Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 169-215.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Machokoto, Michael & Chipeta, Chimwemwe & Aftab, Nadeem & Areneke, Geofry, 2021. "The financial conservatism of firms in emerging economies," Research in International Business and Finance, Elsevier, vol. 58(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Costas Lambrinoudakis & Michael Neumann & George Skiadopoulos, 2014. "Capital Structure and Financial Flexibility: Expectations of Future Shocks," Working Papers 731, Queen Mary University of London, School of Economics and Finance.
    2. Antzoulatos, Angelos A. & Koufopoulos, Kostas & Lambrinoudakis, Costas & Tsiritakis, Emmanuel, 2016. "Supply of capital and capital structure: The role of financial development," Journal of Corporate Finance, Elsevier, vol. 38(C), pages 166-195.
    3. Shofiqur Rahman, 2020. "Credit supply and capital structure adjustments," Financial Management, Financial Management Association International, vol. 49(4), pages 949-972, December.
    4. Morais, Flávio & Serrasqueiro, Zélia & Ramalho, Joaquim J.S., 2022. "Capital structure speed of adjustment heterogeneity across zero leverage and leveraged European firms," Research in International Business and Finance, Elsevier, vol. 62(C).
    5. Hess, Dieter & Immenkötter, Philipp, 2014. "How much is too much? Debt capacity and financial flexibility," CFR Working Papers 14-03, University of Cologne, Centre for Financial Research (CFR).
    6. Borochin, Paul & Yang, Jie, 2017. "Options, equity risks, and the value of capital structure adjustments," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 150-178.
    7. Amini, Shahram & Elmore, Ryan & Öztekin, Özde & Strauss, Jack, 2021. "Can machines learn capital structure dynamics?," Journal of Corporate Finance, Elsevier, vol. 70(C).
    8. Mai, Nhat Chi, 2012. "Market timing, taxes and capital structure: evidence from Vietnam," OSF Preprints t3mvs, Center for Open Science.
    9. Andres, Christian & Cumming, Douglas & Karabiber, Timur & Schweizer, Denis, 2014. "Do markets anticipate capital structure decisions? — Feedback effects in equity liquidity," Journal of Corporate Finance, Elsevier, vol. 27(C), pages 133-156.
    10. Dang, Viet Anh & Kim, Minjoo & Shin, Yongcheol, 2014. "Asymmetric adjustment toward optimal capital structure: Evidence from a crisis," International Review of Financial Analysis, Elsevier, vol. 33(C), pages 226-242.
    11. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 581-656, Elsevier.
    12. Bontempi, Maria Elena & Bottazzi, Laura & Golinelli, Roberto, 2020. "A multilevel index of heterogeneous short-term and long-term debt dynamics," Journal of Corporate Finance, Elsevier, vol. 64(C).
    13. Elsas, Ralf & Florysiak, David, 2008. "Empirical Capital Structure Research: New Ideas, Recent Evidence, and Methodological Issues," Discussion Papers in Business Administration 4743, University of Munich, Munich School of Management.
    14. Paul Borochin & Jie Yang, 2016. "Options, Equity Risks, and the Value of Capital Structure Adjustments," Finance and Economics Discussion Series 2016-097, Board of Governors of the Federal Reserve System (U.S.).
    15. Drobetz, Wolfgang & Gounopoulos, Dimitrios & Merikas, Andreas & Schröder, Henning, 2013. "Capital structure decisions of globally-listed shipping companies," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 52(C), pages 49-76.
    16. Feld, Lars P. & Heckemeyer, Jost H. & Overesch, Michael, 2013. "Capital structure choice and company taxation: A meta-study," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2850-2866.
    17. Mustafa Caglayan & Abdul Rashid, 2010. "The response of firms' leverage to uncertainty: Evidence from UK public versus non-public firms," Working Papers 2010019, The University of Sheffield, Department of Economics, revised Oct 2010.
    18. M. E. Bontempi & L. Bottazzi & R. Golinelli, 2015. "Dynamic corporate capital structure behavior: empirical assessment in the light of heterogeneity and non stationarity," Working Papers wp988, Dipartimento Scienze Economiche, Universita' di Bologna.
    19. Wenfei Li & Cen Wu & Liping Xu & Qingquan Tang, 2017. "Bank connections and the speed of leverage adjustment: evidence from China's listed firms," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 57(5), pages 1349-1381, December.
    20. G. Oka Warmana & I. Ketut Rahyuda & Ida Bagus Anom Purbawangsa & Ni Luh Gede Sri Artini, 2020. "Investigating Capital Structure Speed of Adjustment (SOA) of Indonesian Companies for Corporate Value," Global Journal of Flexible Systems Management, Springer;Global Institute of Flexible Systems Management, vol. 21(3), pages 215-231, September.

    More about this item

    Keywords

    Capital structure; Financial flexibility; Options; Risk-neutral volatility; Risk-neutral kurtosis;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:104:y:2019:i:c:p:1-18. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: . General contact details of provider: http://www.elsevier.com/locate/jbf .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.