Inflexibility and Leverage

Abstract

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 after controlling for well-known drivers of capital structure. Following a positive credit supply shock induced by staggered state-level bank branching deregulation, inflexible firm increase leverage more than flexible firms. These results suggest that operating flexibility plays an important role in shaping corporate financial policies.