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Capital Structure and Financial Flexibility: Expectations of Future Shocks

Author

Listed:
  • Costas Lambrinoudakis

    () (University of Piraeus)

  • Michael Neumann

    (Queen Mary University of London)

  • George Skiadopoulos

    () (Queen Mary University of London University of Piraeus)

Abstract

We test one of the main predictions of the financial flexibility paradigm that expectations about future firm-specific 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 expectations for future shocks decrease leverage and are statistically significant even when we control for traditional determinants. Moreover, they have a first-order effect to capital structure decisions affecting more the small and financially constrained firms. Our findings confirm the De Angelo et al. (2011) model predictions and evidence drawn from surveys that managers seek for financial flexibility.

Suggested Citation

  • 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.
  • Handle: RePEc:qmw:qmwecw:wp731
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    References listed on IDEAS

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    More about this item

    Keywords

    Capital structure; Financial flexibility; Options; Risk-neutral volatility; Risk-neutral kurtosis;

    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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