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Capital structure and financial flexibility: Expectations of future shocks

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  • 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
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    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).
    2. Kamoto, Shinsuke, 2023. "Investment decisions and financial leverage under a potential entry threat," Journal of Banking & Finance, Elsevier, vol. 154(C).
    3. Rehman, Obaid Ur & Wu, Kai & Liu, Jia, 2024. "COVID-19 exposure, financial flexibility, and corporate leverage adjustment," International Review of Economics & Finance, Elsevier, vol. 96(PB).
    4. Miglo, Anton, 2022. "Theories of financing for entrepreneurial firms: a review," MPRA Paper 115835, University Library of Munich, Germany.
    5. Mona Yaghoubi & Michael O’Connor Keefe, 2018. "The Influence of Investment Volatility on Capital Structure and Cash Holdings," Working Papers in Economics 18/20, University of Canterbury, Department of Economics and Finance.

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    Keywords

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    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

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