Can Operating Flexibility Alleviate Stock Price Crash Risk?

Operating flexibility enables firms to promptly curtail further losses during bad times and thereby reduces their stock prices’ crash risk. We formalize this insight through studying a real-options asset-pricing model. Consistent with the loss-curtailment mechanism, our theoretical analyses reveal that the operating-flexibility effect is more prominent for firms with lower productivity, lower profitability, or higher operating leverage. Using U.S. data between 1962 and 2019, we find strong empirical evidence supporting the model’s predictions. Our work suggests that firms’ operational decisions affect their stock price crash risk without appealing to more widely recognized bad news hoarding arguments in the crash risk literature