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Does companies' financial flexibility drive their leverage dynamics? New evidence

Apoorva Arunachal Hegde (Department of Finance and Economics, National Institute of Industrial Engineering, Mumbai, India)
Ajaya Kumar Panda (Department of Finance and Economics, National Institute of Industrial Engineering, Mumbai, India)
Venkateshwarlu Masuna (Department of Finance and Economics, National Institute of Industrial Engineering, Mumbai, India)

Managerial Finance

ISSN: 0307-4358

Article publication date: 31 August 2022

Issue publication date: 26 January 2023

370

Abstract

Purpose

This paper aims to study the leverage adjustment behavior of firms distinguished based on financial flexibility. Financial flexibility is one of the key strengths of the companies to borrow funds for long-term capital investment. The lack of extensive studies in this domain motivates the authors to delve into the significance of financial flexibility in making corporate capital structure decisions.

Design/methodology/approach

The data comprise a combination of firm-specific and macroeconomic variables for firms in eight manufacturing sectors from 2009 to 2020. The authors employ an advance estimator, dynamic panel fraction, on the partial adjustment model to investigate the diverse impact on capital structure's speed of adjustment (SoA) between the financially flexible and financially inflexible firms. Furthermore, the authors utilize the generalized method of moments and panel-corrected standard errors to establish the robustness.

Findings

The empirical analysis reveals that the SoA of financially flexible firms lies between 19.75% and 35.38% and the SoA of financially inflexible firms lies between 11.66% and 25.81%. Due to their conserved debt capabilities, financially flexible firms can rely on leverage to stay near the target whenever they move away from it. Furthermore, financially inflexible firms exhibit a low adjustment speed due to their incompetence to borrow funds to benefit from new growth opportunities. The existence of a target ratio among the studied firms is identified from the positive coefficient of lagged dependent variable, and the relevance of trade-off theory is proved by the quick adjustment speeds in most sectors.

Originality/value

The sectoral distinction in the backdrop of the financial flexibility component adds to the research novelty and managerial implications.

Keywords

Citation

Hegde, A.A., Panda, A.K. and Masuna, V. (2023), "Does companies' financial flexibility drive their leverage dynamics? New evidence", Managerial Finance, Vol. 49 No. 2, pp. 270-290. https://doi.org/10.1108/MF-07-2022-0317

Publisher

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Emerald Publishing Limited

Copyright © 2022, Emerald Publishing Limited

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