Capital Structure and Financial Flexibility: Expectations of Future Shocks

Costas Lambrinoudakis, Michael Neumann and George Skiadopoulos
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Costas Lambrinoudakis: University of Piraeus
Michael Neumann: Queen Mary University of London

No 731, Working Papers from Queen Mary University of London, School of Economics and Finance

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.

Keywords: Capital structure; Financial flexibility; Options; Risk-neutral volatility; Risk-neutral kurtosis (search for similar items in EconPapers)
JEL-codes: G13 G30 G32 (search for similar items in EconPapers)
Date: 2014-10-27
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Journal Article: Capital structure and financial flexibility: Expectations of future shocks (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:qmw:qmwecw:731

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