Real flexibility and financial structure: An empirical analysis

This thesis examines the relationship between real flexibility and financial structure using detailed economic and financial data on firms in 17 manufacturing industries. I investigate the impact of real flexibility on firms' finance capacity, namely, their ability to obtain debt, borrow long-term and issue public debt. I test whether real flexibility improves finance capacity by lowering the probability of failure, curbing debt overhang and enhancing the collateral value of assets, or impairs finance capacity by enabling shareholders to risk-shift through risky production plans or asset substitution. I measure real flexibility as the sensitivity of a firm's marginal production and investment decisions to variations in the economic environment given technology in place. I find that, overall, financial leverage and debt maturity are negatively related to real flexibility, consistent with flexibility facilitating shareholder opportunism. In contrast flexibility improves access to public debt markets and reduces reliance on bank loans, suggesting that real flexibility is a partial substitute for the ex post flexible terms of monitored debt However, based on an analysis of covariance, I find only a weak economic role for flexibility and traditional determinants of financial structure.